Anil Arya

Commitment issues in budgeting

Antle and Fellingham [1995] study information system design in a budgeting setting in which the center (principal) has the ability to (ex ante) commit to both what information will be gathered (tracked) and the way in which the tracked information will be used.1 In this note on the Antle-Fellingham model, we assume the principal has limited powers of commitment; he can commit to what information will be tracked but not how it will be used. Antle and Fellingham find that installing a public information system that reduces the agents informational advantage sometimes makes the agent better off, and that more public information sometimes decreases productive efficiency. However, in their model, the principal always prefers more (finer) public information to less (coarser) public information. This preference is driven by the assumed unlimited ability to commit to how the tracked information will be used. The principal can and does commit to using information in a manner that is ex post not in his own

Intertemporal aggregation and incentives

Intertemporal aggregation results in a summarization of information and a natural delay in the release of information. We study a principal–agent model and show that intertemporal aggregation can be an optimal feature of a performance evaluation system. We then highlight subtleties associated with valuing additional information as the level of aggregation of existing information is varied.

Using Return Polices to Elicit Retailer Information

We show that a manufacturer may prefer to offer a return policy when dealing with a retailer who holds advance knowledge about market conditions. Roughly stated, the manufacturer offers a liberal return allowance in lieu of a lower price to satisfy a retailer facing unfavorable market conditions. A retailer facing favorable conditions finds this tradeoff unattractive because he is likely to sell the merchandise anyway and thus not make as much use of the generous return terms. As a consequence, a retailer is less inclined to misstate market conditions. By serving as an additional control instrument, a returns policy reduces the manufacturers need to ration (cut) production.

Capital Budgeting in a Multidivisional Firm

The purpose of this paper is to study capital budgeting in a setting where emphasis is on control over project selection. We construct a model of a multidivisional firm in which there are no constraints on investment and all projects have a positive net present value. Nevertheless, we show that it is optimal for the center to use relative project ranking in determining which projects are to be funded.

Discretionary Disclosure of Proprietary Information in a Multisegment Firm

The seminal “unraveling” result in the disclosure literature posits that discretion inevitably leads to full disclosure, even when such disclosure has detrimental consequences. In this paper, we revisit optimal disclosure of proprietary information when firms compete in multiple markets. The analysis demonstrates that in the presence of multiple segments, the unraveling result applies at the firmwide level but not necessarily segment by segment. Instead, when the firm has an ex ante desire to withhold information and segments are sufficiently similar, the ex post disclosure equilibrium entails aggregation of segment details. Aggregation arises because any ex post temptation to disaggregate and reveal particularly favorable news in one segment entails revealing unfavorable news in another segment. A desire to balance profits across segments then leads a firm to disclose firmwide information (a temptation that cannot be avoided), but only in the aggregate.

Friction in Related-Party Trade When a Rival Is Also a Customer

There are many circumstances in which manufacturers provide inputs to wholesale customers only to subsequently compete with these wholesale customers in the retail realm. Such dual distribution arrangements commonly suffer from excessive encroachment in that the manufacturers ex post retail aggression is harmful ex ante because it undercuts potential wholesale profits. This paper demonstrates that with dual distribution, a manufacturer can benefit from decentralized control and the use of transfer prices above marginal cost. Although these arrangements often create coordination concerns, a moderate presence of such concerns permits the manufacturer to credibly convey to its wholesale customer that it will not excessively encroach on its retail territory. This, in turn, permits the manufacturer to reap greater wholesale profits. We also note that this force can point to a silver lining in arms-length (parity) requirements on transfer pricing in that they can solidify commitments to a particular retail posture.

Pricing Internal Trade to Get a Leg up on External Rivals

The pricing of transfers from parent to subsidiary is an oft-explored issue. Linking the cost of internal transfers with external market prices is one common approach, typically justified when the market for the good is perfectly competitive. This paper shows that imperfect competition may also justify market-based transfer prices. Concern that transfer price will deviate from marginal cost and thereby distort subsidiary choices can lead a parent to undertake actions to influence the market price of the upstream good. Such efforts can provide a desirable strategic posture in the upstream market.

Inferring Transactions from Financial Statements

In this paper, we embed the double entry accounting structure in a simple belief revision (estimation) problem. We ask the following question: Presented with a set of financial statements (and priors), what is the reader’s “best guess” of the underlying transactions that generated these statements? Two properties of accounting information facilitate a particularly simple closed form solution to this estimation problem. First, accounting information is the outcome of a linear aggregation process. Second, the aggregation rule is double entry.

Abandonment Options and Information System Design

We study a principal-agent model of moral hazard in which the principal has an abandonment option. The option to abandon a project midstream limits a firms downside risk. From a consumption (production) perspective, the option is clearly beneficial. However, from an incentive perspective, the option can be costly. Removing the lower tail of the projects underlying cash flow distribution also eliminates the information it contains about an agents (unobservable) productive input. In addition, there is also the issue that the option holder cannot always (ex ante) commit to the precise circumstances under which the option will be exercised. These concerns introduce an interaction in the valuation of the abandonment option and information system. In particular, the manner in which information is coarsened and the direction of the flow of information are critical design parameters that affect option value.

The Controllability Principle in Responsibility Accounting: Another Look

In this paper, we illustrate some subtleties related to responsibility accounting by studying two settings in which there are interactions among multiple control problems. In the first setting, two agents are involved first in team production (e.g., coming up with ideas) and then in related individual production (e.g., implementing the ideas). We provide conditions under which the agents are not held responsible for the team performance measure, despite each agent conditionally controlling it. The conditions ensure the incentive problem related to individual production is so severe it drives out any demand for the team performance measure. The team incentive problem is not binding because of the large “spillback” from the individual problem to the team problem.