Performance Measure Garbling Under Renegotiation in Multi-Period Agencies

We present a two-period model in which the parties cannot commit to not renegotiate their contractual arrangement in mid-game. This is of interest because, institutionally, parties can always agree to renegotiate their arrangement and because this single friction is sufficient to induce endogenous performance measure manipulation. As is well known (e.g., Dye [1988] and Arya, Glover, and Sunder [1998]), accounting manipulation is a type of garbled communication between parties and will be a compelling phenomenon only when a revelation representation is not possible.1 Such a representation requires a rich message space, commitment to the contracted use of the communication, and, of course, an optimal contract. All requirements have been weakened in one form or another. For example, Dye [1988], Evans and

[1]  Ilia D. Dichev,et al.  Earnings Management to Avoid Earnings Decreases and Losses , 1997 .

[2]  D. Fudenberg,et al.  Moral Hazard and Renegotiation in Agency Contracts , 1990 .

[3]  Richard T. Boylan,et al.  An Algorithmic Approach to Contracting in an Infinite Agency Model , 1995 .

[4]  Peter Ove Christensen,et al.  Sequential Communication in Agencies , 1997 .

[5]  John C. Fellingham,et al.  Contracts without memory in multiperiod agency models , 1985 .

[6]  Shyam Sunder,et al.  Earnings Management and the Revelation Principle , 1998 .

[7]  C. Lewis,et al.  Earnings management and firm valuation under asymmetric information , 1995 .

[8]  Mark L. DeFond,et al.  Smoothing income in anticipation of future earnings , 1997 .

[9]  Jacques Crémer,et al.  Arm's Length Relationships , 1995 .

[10]  Ronald A. Dye,et al.  EARNINGS MANAGEMENT IN AN OVERLAPPING GENERATIONS MODEL , 1988 .

[11]  Richard G. Sloan,et al.  Annual bonus schemes and the manipulation of earnings , 1995 .

[12]  John C. Persons.  Liars Never Prosper? How Management Misrepresentation Reduces Monitoring Costs , 1994 .

[13]  Patrick Rey,et al.  Repeated moral hazard: The role of memory, commitment, and the access to credit markets , 1994 .

[14]  Pierre Jinghong Liang,et al.  Accounting Recognition, Moral Hazard, and Communication , 2000 .

[15]  S. Sridhar,et al.  Multiple control systems, accrual accounting, and earnings management , 1996 .

[16]  Sanford J. Grossman,et al.  AN ANALYSIS OF THE PRINCIPAL-AGENT PROBLEM , 1983 .

[17]  S. Perry,et al.  Earnings management preceding management buyout offers , 1994 .

[18]  Drew Fudenberg,et al.  A Theory of Income and Dividend Smoothing Based on Incumbency Rents , 1995, Journal of Political Economy.

[19]  Raffi Indjejikian,et al.  Dynamic Incentives and Responsibility Accounting , 1998 .

[20]  Paul R. Milgrom,et al.  AGGREGATION AND LINEARITY IN THE PROVISION OF INTERTEMPORAL INCENTIVES , 1987 .

[21]  Joel S. Demski,et al.  Performance Measure Manipulation , 1998 .

[22]  D. Sappington,et al.  On the timing of information release , 1986 .

[23]  Thomas Hemmer,et al.  On the frequency, quality, and informational role of mandatory financial reports , 1998 .