Accounting discretion and the principle of conservatism are two salient features embedded in financial reporting systems. Arguably, the practice of conservative accounting choices can never be well understood without incorporating their effect on future periods (the intertemporal effect). This paper provides one explanation for managerial conservatism in a two‐period agency model with hidden information (a binary project type) and hidden actions (the agent's efforts). A piece‐wise linear incentive scheme with accounting earnings as the performance measure is employed. The agent's discretion is the choice of a depreciation method. Discretion is valuable if and only if the agent's marginal productivity of a “bad” project is greater than that of a “good” project, but not to an extreme degree. A conservative depreciation method decreases current compensation in exchange for a “bet” on future compensation and, hence, serves as a commitment device for the agent to signal that the prospect is indeed good. The accounting mechanism replicates the performance of the optimal direct mechanism.

ABSTRACT Matching talents to tasks is an important part of job design. Organizations routinely use performance thresholds to group agents by talent. We see thresholds defined both in terms of an individual's own performance (absolute value) and in terms of peer performance (percentile). Intuition suggests a preference for percentile thresholds because the resulting rank‐order statistic is sufficient to assess relative talent. Yet, in the context of a task assignment problem in which the objective is to match talent with task type (using two agents and two task types), we show that absolute thresholds can dominate percentile thresholds under either of two conditions. First, flexibility in task assignment tilts the balance toward absolute thresholds. Second, performance manipulation can adversely affect the inherent advantage of percentile thresholds because they motivate agents to invest relatively more in personally costly influence activities to cast their performance in a favorable light. We examine how these results hold up when there are countably large number of agents and discuss empirical implications.

ABSTRACT We develop a model to examine implications of empowering shareholders to replace directors. We find that shareholder empowerment functions as a double‐edged sword. On the one hand, it can weaken ineffective boards' incentive to hold on to their position. On the other hand, it can induce both effective and ineffective boards to behave strategically to avoid a potential dismissal. As a result, empowerment does not necessarily increase firm value; in some cases, empowerment exacerbates the agency problem it is intended to address. Giving shareholders the power to set board compensation (have a “say on pay”) can mitigate these problems. However, even when empowerment benefits (harms) the shareholders, firm value may decrease (increase). Finally, we discuss empirical and policy implications of the main findings.

ABSTRACT We study intertemporal incentive properties of conditional accounting conservatism. Conservatism has detrimental and beneficial properties. In our first model, conservatism introduces downward bias in the first period; any understatement of first-period performance is reversed in the second period. A conservative bias is not costly in the first period but instead is costly in the second period when a new manager may be rewarded for the performance of his predecessor. In an extension on learning, we illustrate a beneficial role of conservatism in fine-tuning incentives. In the second model, conservatism is modeled as recognizing effort-independent bad news early and good news late. Recognizing bad news early can be optimal because of intertemporal rent shifting, which improves incentives via an “incentive spillback.” We also study overlapping projects (a multi-task setting) in which an interior accounting system can be optimal to avoid making one of the overlapping projects an incentive bottleneck. JEL Classifications: D21; D74; D82; D86.

ABSTRACT: We examine the design of asset revaluation policies in settings where a regulator can mandate fair value disclosure in order to mitigate a lemons problem in the asset resale market. The welfare-maximizing policy generally prescribes fair value certification for the lower asset values and (less costly) historical cost reporting for the higher asset values. The potential for voluntary certification can reduce welfare by increasing equilibrium certification costs and promoting underinvestment in socially valuable projects. Thus, a single regulated source of information (mandated disclosure) can be preferable to two sources of information (mandated and voluntary disclosure).