A Contracting Perspective on Earnings Quality

Journal of Accounting and Economics Volume 39, Issue 2, June 2005, Pages 265–294

University of Alberta School of Business Research Paper No. 2013-1095

Posted: 2 Jul 2013

See all articles by Peter O. Christensen

Peter O. Christensen

Copenhagen Business School - Department of Finance

Gerald A. Feltham

University of British Columbia

Florin Sabac

University of Alberta - Department of Accounting, Operations & Information Systems

Date Written: June 1, 2004

Abstract

This paper analyzes the impact of signal-to-noise-ratios and the autocorrelation of a performance measure on the principal's welfare in dynamic agencies with renegotiation. We consider the impact of changes in the persistent, transitory, and reversible components of accounting earnings on its usefulness in valuation versus contracting. Increasing the persistent components and reducing the reversible components are generally desirable for valuation, but not for contracting. Eliminating transitory components of earnings is generally desirable for valuation, but not necessarily for contracting. We discuss the contracting implications of differences in the autocorrelations of accounting earnings versus stock returns.

Keywords: Contracting, Management compensation, Accruals, Earnings quality, Performance measure autocorrelation

JEL Classification: D80, J33, M41, M43

Suggested Citation

Christensen, Peter Ove and Feltham, Gerald A. and Sabac, Florin, A Contracting Perspective on Earnings Quality (June 1, 2004). Journal of Accounting and Economics Volume 39, Issue 2, June 2005, Pages 265–294, University of Alberta School of Business Research Paper No. 2013-1095, Available at SSRN: https://ssrn.com/abstract=2283375

Peter Ove Christensen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark
+45 6140 3237 (Phone)

Gerald A. Feltham

University of British Columbia ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8397 (Phone)
604-822-9470 (Fax)

Florin Sabac

University of Alberta - Department of Accounting, Operations & Information Systems ( email )

Edmonton, Alberta T6G 2R6
Canada

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