Dynamic Incentives and Responsibility Accounting: A Comment

Abstract

Revisits the finding of a ratchet effect causing losses through lack of commitment by managers through their contracts by Indjejikian and Narda (1999). Demonstrates that equilibrium can be achieved by assuming the principal can commit in advance to offer a fair second-period contract and the agent can commit to stay for that period. Shows that the principal, by committing to seasonal period incentive rates in advance and to a fair fixed wage, can achieve full efforts from agents. Assumes that principals can offer a long-term contract which is ratchet-proof if no renegation takes place. Concludes that the principal's ability, or not, to commit to a second-period incentive rate in advance, is important, since it ties in the agent for a second period.

Keywords: Agency Theory, Contracts, Incentives, USA