Accrual-Based Compensation, Depreciation and Investment Decisions

Posted: 2 Jun 2003

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The paper studies the usefulness of accruals relative to cash flows for performance measurement in short-term contracts, if an agent undertakes activities with long-term and short-term consequences. It characterizes an optimal depreciation method for incentive purposes, and shows that it is not consistent with traditional depreciation methods. Rather, it aligns the performance measure with the expected long-term consequences of the investment, and shifts away compensation risk from the agent. The paper also identifies conditions under which accruals outperform cash flows as a performance measure even if the agent can manipulate the depreciation method.

Keywords: performance evaluation, accruals, depreciation, investment incentives, optimal contracts, multi-action agency model

JEL Classification: M40, M46

Suggested Citation

Wagenhofer, Alfred, Accrual-Based Compensation, Depreciation and Investment Decisions. European Accounting Review, Vol. 12, No. 2, 2003. Available at SSRN:

Alfred Wagenhofer (Contact Author)

University of Graz ( email )

+43 316 380 3500 (Phone)
+43 316 380 9565 (Fax)

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