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On the effects of the degree of discretion in reporting managerial performance
De Waegenaere,A.M.B. Wielhouwer,J.L.
De Waegenaere,A.M.B.
Wielhouwer,J.L.
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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Appeared earlier as CentER DP 2008-21
Date
2011
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dewaegenaere_ORS.pdf
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Keywords
feasibility goals, planning, bounded/procedural rationality, life cycle saving, portfolio choice, D03 - Behavioral Microeconomics ; Underlying Principles, D81 - Criteria for Decision-Making under Risk and Uncertainty, D91 - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
Citation
De Waegenaere, A M B & Wielhouwer, J L 2011, 'On the effects of the degree of discretion in reporting managerial performance', OR Spectrum, vol. 33, no. 2, pp. 359-392. https://doi.org/10.1007/s00291-010-0220-5