Incentive Compensation and the Choice of Inventory Buffer

52 Pages Posted: 10 Dec 2011

See all articles by Richard E. Saouma

Richard E. Saouma

Eli Broad College of Business, Michigan State University

Serguei Netessine

The Wharton School, University of Pennsylvania

Stanley Baiman

University of Pennsylvania - Accounting Department

Date Written: December 9, 2008

Abstract

[enter Abstract Body]Previous research in management accounting and economics has noted the potential for complementarities between the firm’s performance measurement system and its other organizational design choices. We add to this literature by studying how the informativeness and incentive properties of a performance metric can be influenced by one particular organizational design choice — the size of the firm’s inventory buffers. We model a manufacturing setting in which an agent manages a workstation that processes intermediate units. As intermediate units arrive, they are stored in an inventory buffer until the agent can process them. The buffer can hold a maximum number of intermediate units — its buffer size. The agent is compensated on the basis of his workstation’s throughput. We characterize the conditions under which reducing the inventory buffer enhances/degrades the informativeness of the performance metric and, hence, mitigates/exacerbates the agent’s incentive problem.

Suggested Citation

Saouma, Richard E. and Netessine, Serguei and Baiman, Stanley, Incentive Compensation and the Choice of Inventory Buffer (December 9, 2008). Accounting Review, Vol. 85, No. 6, pp. 1839-1860, November 2010. Available at SSRN: https://ssrn.com/abstract=1970340

Richard E. Saouma (Contact Author)

Eli Broad College of Business, Michigan State University ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

Serguei Netessine

The Wharton School, University of Pennsylvania ( email )

3730 Walnut Street
Philadelphia, PA 19104-6367
United States
(215) 573 3571 (Phone)

HOME PAGE: http://www.netessine.com

Stanley Baiman

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6782 (Phone)
215-573-2054 (Fax)

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