Stock Price, Earnings and Book Value in Managerial Performance Measures

Stanford GSB Research Paper No. 1873

44 Pages Posted: 2 Feb 2005

See all articles by Sunil Dutta

Sunil Dutta

University of California, Berkeley - Haas School of Business

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: April 2005

Abstract

This paper develops a multiperiod principal-agent model in which a manager must be given incentives to undertake investments and to exert personally costly effort. Investments are soft (e.g., intangible assets) and therefore entail measurement errors for the accounting system as it seeks to separate investments from operating expenditures. This separation is of no concern to the stock market which draws on its own information about future cash flows resulting from current investments. The firm's stock price, however, reflects all value relevant information, parts of which are not incentive relevant. Optimal incentive provisions must combine forward looking market information with backward looking accounting information. Under certain conditions, optimal performance measures can be expressed as a weighted average of economic value added (residual income) and market value added.

Keywords: Performance measurement, managerial compensation

JEL Classification: J33, G31, D82, M41

Suggested Citation

Dutta, Sunil and Reichelstein, Stefan J., Stock Price, Earnings and Book Value in Managerial Performance Measures (April 2005). Stanford GSB Research Paper No. 1873. Available at SSRN: https://ssrn.com/abstract=624669 or http://dx.doi.org/10.2139/ssrn.624669

Sunil Dutta (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-643-1229 (Phone)
510-643-1412 (Fax)

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1129 (Phone)
650-725-7979 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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