Incentive System Design Based on Accrual Accounting: A Summary and Analysis

49 Pages Posted: 16 Apr 2010 Last revised: 28 Jul 2011

See all articles by Thomas Pfeiffer

Thomas Pfeiffer

University of Vienna - Accounting and Control

Louis Velthuis

Goethe University Frankfurt

Date Written: 2009

Abstract

This paper provides a formal analysis on how to design accrual based incentive systems so that a manager’s and owner’s interests are properly aligned. We introduce a general framework to summarize the literature, provide various extensions to it, and point to some of its limitations. We characterize the entire class of goal-congruent and preference-similar incentive systems when the owner has perfect as well as imperfect information about the manager’s preferences. This allows us to show how compensation functions and performance measures are interrelated and to demonstrate what information must be incorporated into compensation functions and performance measures. We illustrate how robust these results are, especially with respect to gaming and transaction smoothing. Furthermore, we show how to produce consistent performance measures by capitalizing investment costs and constructing appropriate depreciation schedules. Finally, we analyze the flexibility of accrual- versus cash-based allocation rules and highlight connections to the notion of conservatism.

Keywords: Incentive Systems, Accrual Accounting, Goal-Congruence, Preference-Similarity

JEL Classification: M4

Suggested Citation

Pfeiffer, Thomas and Velthuis, Louis J., Incentive System Design Based on Accrual Accounting: A Summary and Analysis (2009). Journal of Management Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1590785

Thomas Pfeiffer (Contact Author)

University of Vienna - Accounting and Control ( email )

Oskar-Morgenstern-Platz 1
Vienna 1090, Vienna
Austria
+43-1-4277-38002 (Phone)
+43-1-4277-38004 (Fax)

Louis J. Velthuis

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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