On the effects of the degree of discretion in reporting managerial performance

A.M.B. De Waegenaere, J.L. Wielhouwer

Research output: Contribution to journalArticleScientificpeer-review

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Abstract

We consider a principal-agent setting in which a manager’s compensation depends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of compensation, and the manager’s expected utility. We find that a minimal degree of discretion may be necessary for successful contracting. We also find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased reporting discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation. Finally, we find that when reporting discretion induces costly effort on the part of the manager, the optimal degree of discretion can be higher than when it is costless.
Original languageEnglish
Pages (from-to)359-392
JournalOR Spectrum
Volume33
Issue number2
DOIs
Publication statusPublished - 2011

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Managerial performance
Managers
Discretion
Reporting discretion
Costs
Expected utility
Contracting
Optimal contract

Keywords

  • feasibility goals
  • planning
  • bounded/procedural rationality
  • life cycle saving
  • portfolio choice

Cite this

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title = "On the effects of the degree of discretion in reporting managerial performance",
abstract = "We consider a principal-agent setting in which a manager’s compensation depends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of compensation, and the manager’s expected utility. We find that a minimal degree of discretion may be necessary for successful contracting. We also find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased reporting discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation. Finally, we find that when reporting discretion induces costly effort on the part of the manager, the optimal degree of discretion can be higher than when it is costless.",
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pages = "359--392",
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}

On the effects of the degree of discretion in reporting managerial performance. / De Waegenaere, A.M.B.; Wielhouwer, J.L.

In: OR Spectrum, Vol. 33, No. 2, 2011, p. 359-392.

Research output: Contribution to journalArticleScientificpeer-review

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AU - De Waegenaere, A.M.B.

AU - Wielhouwer, J.L.

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N2 - We consider a principal-agent setting in which a manager’s compensation depends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of compensation, and the manager’s expected utility. We find that a minimal degree of discretion may be necessary for successful contracting. We also find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased reporting discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation. Finally, we find that when reporting discretion induces costly effort on the part of the manager, the optimal degree of discretion can be higher than when it is costless.

AB - We consider a principal-agent setting in which a manager’s compensation depends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of compensation, and the manager’s expected utility. We find that a minimal degree of discretion may be necessary for successful contracting. We also find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased reporting discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation. Finally, we find that when reporting discretion induces costly effort on the part of the manager, the optimal degree of discretion can be higher than when it is costless.

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KW - planning

KW - bounded/procedural rationality

KW - life cycle saving

KW - portfolio choice

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