Optimal Information Design and Incentive Contracts with Performance Measure Manipulation
49 Pages Posted: 4 Dec 2019
Date Written: November 18, 2019
We study how a firm owner motivates a manager to create value by optimally designing an information system and a compensation contract based on a manipulable performance measure. In equilibrium, the firm either implements a perfect or an uninformative system. The information system and the pay-performance sensitivity (PPS) of the compensation contract can be substitutes in a sense that the firm optimally combines a perfect information system with a low PPS or an uninformative system with a high PPS. Because the information design is endogenous, firms facing relatively high manipulation threat may offer financial incentives that are higher-powered than the ones offered by their peers facing lower manipulation threat. If the manager is in charge of implementing the information system, he chooses a perfect one unless the firm uses the information for internal control. The firm may prefer to commit to an internal control level before observing any information.
Keywords: Bayesian persuasion, ex ante information design, performance manipulation, earnings management, incentive contracting, multi-task problem
Suggested Citation: Suggested Citation