Hans Frimor

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

Accounting Policies in Agencies with Moral Hazard and Renegotiation

We emphasize the role of accounting policies, and their audit, in an earnings management setting. We use a two–period agency in which three frictions interact: the agent privately observes action (or effort) supply and output, and the initial contract is subject to renegotiation. This creates a setting in which both players’ behavior is of concern, and, importantly, information rationing is efficient. Moreover, this information rationing is directly interpretable as being produced by an accounting policy whose application is ensured by an auditor.

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.

The Stewardship Role of Analyst Forecasts, and Discretionary Versus Non-Discretionary Accruals

We examine the interaction between discretionary and non-discretionary accruals in a stewardship setting. Contracting includes multiple rounds of renegotiation based on contractible accounting information and non-contractible but more timely non-accounting information. We show that accounting regulation aimed at increasing earnings quality from a valuation perspective (earnings persistence) may have a significant impact on how firms rationally respond in terms of allowing accrual discretion in order to alleviate the impact on the stewardship role of earnings. Increasing the precision of more timely non-accounting information (analyst earnings forecasts) increases the ex ante value of the firm and reduces costly earnings management. There is an optimal level of reversible non-discretionary accrual noise introduced through revenue recognition policies. Tight rules-based accounting regulation, as opposed to leaving firms more choice over non-discretionary accrual policies, may lead firms to rationally respond by inducing costly earnings management. More generally, regulating both earnings persistence and the tightness of admissible auditing policies may not result in less equilibrium earnings management.

Fair Value, Accounting Aggregation and Multiple Sources of Information

Accounting information is formed by an aggregation of the information available to the accounting system. Introduction of fair value accounting represents a new solution to the accounting aggregation problem as market information is merged into the accounting system. Multiple sources of information are available to market participants and accounting information is but one of these sources. Fair value information is available to the accounting system, to the public, and to individual market participants, hence, the aggregate information available in the economy — aggregate informativeness — depends on the confluence of accounting information and other sources of information. Particularly, the price process might well be informative but is influenced by the accounting policy chosen and, hence, it is not obvious the introduction of fair value accounting leads to an improvement in aggregate informativeness. Fair value accounting may destroy the aggregation mechanism of the market.

Pouring Money Down the Drain? How Sunk Investments and Signing Bonuses can Improve Employee Incentives

Abstract A common explanation for why firms incur sunk costs is that technology considerations make them inescapable. This paper shows that sometimes firms may prefer to make early (less informed) investment decisions even when technology allows such decisions to be delayed. Sunk costs commit and clarify a firms future course of action to prospective employees, thereby providing them with incentives to acquire firm-specific human capital. This benefit of sunk costs may also provide justification for offering employee signing bonuses.

On the Role of Receivables in Managing Salesforce Incentives

ABSTRACT Despite the obvious problems associated with collections, firms routinely sell on credit. Conventional wisdom suggests offering credit is a necessary evil when dealing with insistent cash-constrained customers. This paper provides a more positive view of trade credit. We find that offering credit can enhance the efficiency of incentive contracts with sales personnel. In effect, with a credit sale, a client gets a second chance to generate enough cash. The clients second chance gives the sales agent another opportunity to demonstrate his past diligence to the firm. Moreover, to limit the risk associated with the fact that even a high-quality client may fail to eventually come up with funds, the firm relies on the accrual system. In particular, the agents (discretionary and early) choice of the bad debt allowance conveys his private information regarding client quality; the payments associated with subsequent collections/default keep such reporting in check.