ABSTRACT We use an agency model to address the benefits and costs of transparency in a hierarchical organization in which the principal employs a manager entrusted with contracting authority and several workers, all under conditions of moral hazard. We define the principal's transparency choices as a decision to allow workers to observe their coworkers’ performances ( observability ) and as an investment in monitoring worker performance ( precision ). We find that whereas precision alleviates agency conflicts as expected, observability can exacerbate agency conflicts, especially if the manager's interests are misaligned sufficiently with those of the principal. Our results suggest several testable hypotheses including predictions that opaque performance measurement practices are well suited for small organizational units at lower hierarchical ranks, and in settings where the sensitivity‐precision of the available measures is low, workers’ performances are correlated positively, and managerial productivity is modest.

ABSTRACT We study three elements of management control: incentive compensation, performance monitoring, and delegation of authority to managers to contract with lower‐level employees. Using a principal‐agent model, we highlight important direct and indirect interactions between and among these endogenous control elements, themes often emphasized in the economics and accounting literatures using the analogy of a three‐legged stool. We identify circumstances in which control elements are complements or substitutes and exhibit a coherent pattern of practices observed together. For instance, contrary to typical predictions that quality monitoring complements steep effort incentives, we find that when contracting authority adjusts easily to changes in firm circumstances, then both incentive pay and contracting authority substitute for monitoring quality, while incentive pay complements contracting authority. Overall, our findings suggest a number of empirical implications and generally inform a growing literature that documents the presence or absence of complementarities among management control elements.

ABSTRACT We study a principal's choice of whether to produce an imperfect forecast about a firm's outcome either before or after an agent's effort choice. The early forecast affects the agent's effort choice, which means the forecast can also be used to infer information about the effect of the agent's effort on outcome. The late forecast is more accurate because, by working hard, the agent also learns about productivity, implying that the late forecast has an additional performance measurement role. With verifiable information, the principal prefers a late forecast when the agent's effect on the accuracy of the forecast is either large or small. The agent has consistent preferences when the agent's effect on the accuracy of the late forecast is not too large. With unverifiable information, the agent's information rents imply that the principal cannot use either forecast as a performance measure. Thus, the accuracy of the late forecast has no effect on the principal's preference. However, if the accuracy of the early forecast is low and its decision‐making function is diminished, the principal prefers a late signal.

ABSTRACT We explore how a supervisor's hierarchical rank affects the extent to which employees’ targets reflect their past performance. Literature documents that supervisors do not fully ratchet targets for past performance, arguably because the commitment not to penalize successful employees with more difficult targets alleviates the severity of the ratchet effect. We argue that commitment is less credible in organizational hierarchies where a middle manager sets employees’ targets. Using data from an organization comprised of three hierarchical layers, we consistently find that a middle manager's exposure to performance pressure is positively associated with the ratcheting of the employees’ targets. Moreover, we show that management at headquarters reduces a middle manager's performance pressure when most of her employees missed their targets in the previous period. Overall, the results imply that the hierarchical rank is an important determinant of the credibility of a supervisor's commitment to deemphasize past performance in target setting.

Options, restricted stock, bonuses tied to total shareholder return, and similar equity-based compensation contracts stipulate payments that depend on stock price. Any such contract is a function of shareholder value net of the compensation payment, because stock price (1) is proportional to this net value or “net outcome” and (2) anticipates compensation-related payments and dilution. The net outcome, in turn, is reduced by the payment and so depends on the contract. Standard moral hazard analyses, wherein contractual payments are based on the gross outcome before any payment to the agent, overlook this dependency. We characterize the optimal net-outcome contract, describe its shape and pay-for-performance sensitivity, contrast it with the optimal gross-outcome contract, and discuss implications for equity-based compensation arrangements.

ABSTRACT We study the properties of long-term bonus pools (BPs) with rollover provision in a multiperiod moral hazard setting, where the principal uses subjective information to privately assess the agent’s performance and the agent is protected by limited liability (LL). To provide incentives, the principal funds a multiperiod BP with a fixed payment that may be distributed over time to the agent and a third party. We find that the optimal long-term BP contract features performance targets that are contingent on past performance. Specifically, high subjective performance implies an easy target, and low subjective performance implies a difficult target. To implement the long-term BP contract, the principal provides nondichotomous performance reports. The study contributes to the literature that discusses the mechanisms that make subjective performance information useful for incentive contracting. JEL Classifications: D82; M52; M54.

ABSTRACT We examine how accounting practices that aggregate or disaggregate the contributions of different economic agents influence the choice of organizational form. We consider a principal/multi-agent model where the principal either contracts with all parties directly or delegates part of the contracting authority to one of the agents. Delegated contracts improve risk sharing and generate implicit incentives for the agent entrusted with contracting authority. However, delegated contracts also entail a loss of control in motivating lower-level agents. In addition, when performance is aggregated, delegated contracts render agents' incentives more interdependent and create spillovers up and down the hierarchy. We demonstrate that accounting practices that aggregate the performance of multiple agents can complement organizational forms characterized by greater decentralization. In contrast, accounting practices that capture agents' performance contributions separately favor more centralized organizational forms. Our findings suggest that in settings where performance measurement systems are more aggregate, decentralization is more prevalent. JEL Classifications: L22; M12; M4.