Dynamic Incentives and Responsibility Accounting
37 Pages Posted: 8 Apr 1998
Date Written: March 1998
In dynamic principal-agent relationships, unless a principal can precommit to a multiperiod contract, incentives are affected by a problem known as the ratchet effect. We present a two period agency model to show that the use of more aggregate performance measures and greater consolidation of responsibility helps mitigate the ratchet effect. For example, an aggregate measure may be preferred to a set of disaggregate measures to avoid aggravating the ratchet effect. Similarly, it may be preferable to consolidate responsibility for two activities in the hands of one agent despite the potential loss of performance evaluation information implied by consolidation.
JEL Classification: J23, L22, M41, M46
Suggested Citation: Suggested Citation