Describes a model where an endogenous demand for cost reports exists, and characterizes optimal contracts. Achievement of cost report perspective; Necessary conditions for communication; Incorporation of cost reports within an optimal contract; Costs and benefits of communication-based two-period contracts.

[This article describes a model in which an endogenous demand for cost reports exists, and characterizes optimal contracts. A principal employs an agent to implement investment projects. The agent's payments are subject to bankruptcy constraints; that is, the agent's wealth cannot fall below zero. To achieve the cost report perspective, the agent is assumed to acquire and communicate his/her private information after investment and production. The principal usefully incorporates the agent's cost reports within an optimal contract, in spite of two constraining features. First, the agent's information is only about historical costs, which are not informative about future investment opportunities. Second, at no time can the principal verify the agent's cost reports. However, as a substitute for cost verification in our model, the principal and agent can write long-term contracts. Although an unverifiable report is not useful in a one-period setting, in two periods it may become useful. We demonstrate necessary conditions for communication to be valuable in two periods. If single period contracts are used, the principal's residual claim is sometimes less than it would be in a full information setting. This loss occurs if and only if the bankruptcy constraints are binding in one period; that is, they prevent the principal from efficiently selling the firm to the risk-neutral agent. The principal's optimal reaction, given the tightness of the bankruptcy constraints, is either to underinvest or to permit the agent to keep any informational rents. Long-term contracts loosen the bankruptcy constraints because they permit the agent to accumulate wealth. We identify costs and benefits of communication-based two period contracts. Through long-term contracts, the principal makes a tradeoff: he commits to ex post inefficient investment decisions in order to reduce the cost of obtaining truthful reports from the agent. In some cases, production increases, leading to larger cash distributions to both parties. In other cases, production decreases, but the principal's residual increases because the agent's informational rents are reduced.]

ABSTRACT: Models that characterize Pareto-efficient sharing of joint venture profits or constrained Pareto-efficient sharing of income in principal-agent contracting problems have ignored tax considerations. We extend the theory by showing that the effect of taxes on optimal contracting (both in the face of and in the absence of moral hazard problems) is related to the effect of changes in risk attitudes towards lotteries over pre-tax income. For example, optimal contracts will reflect the tax-induced demand for insurance of a risk-neutral individual who faces a progressive income tax schedule; that is, the risk-neutral individual will not bear all the risk, and in the face of moral hazard on the act selection of a risk-neutral agent, demand for monitoring will be created where none existed in the absence of the progressive tax. We also show that Pareto-optimal risk-sharing contracts do not generally result in expected tax minimization, even when taxes are modeled as a deadweight loss to the system.

ABSTRACT: A simplified audit setting is used to illustrate the crucial nature of strategic interactions in audit planning and in assessing audit risk. Unlike single-person decisiontheoretic models which essentially represent games against nature, the model developed here allows a prospective audit to influence the behavior of the auditee. We reformulate the problem in a game-theoretic framework with rational players which (1) encompasses strategic factors for both the auditor and auditee, (2) is consistent with behavioral hypotheses regarding the effect of an audit, and (3) is consistent with certain audit phenomena such as randomized strategies. An illustration is provided which demonstrates several points. First, both the auditor and the auditee may frequently use a randomized strategy. Second, the auditor's strategy depends on the interaction between the accounting control system and the auditee's actions. In addition, the use of traditional single-person decision theory may frequently cause errors in estimating audit risk because it fails to consider audit influences on the auditee. Settings in which decision theory may serve as an adequate model simplification are also considered.

[A simplified audit setting is used to illustrate the crucial nature of strategic interactions in audit planning and in assessing audit risk. Unlike single-person decision-theoretic models which essentially represent games against nature, the model developed here allows a prospective audit to influence the behavior of the auditee. We reformulate the problem in a game-theoretic framework with rational players which (1) encompasses strategic factors for both the auditor and auditee, (2) is consistent with behavioral hypotheses regarding the effect of an audit, and (3) is consistent with certain audit phenomena such as randomized strategies. An illustration is provided which demonstrates several points. First, both the auditor and the auditee may frequently use a randomized strategy. Second, the auditor's strategy depends on the interaction between the accounting control system and the auditee's actions. In addition, the use of traditional single-person decision theory may frequently cause errors in estimating audit risk because it fails to consider audit influences on the auditee. Settings in which decision theory may serve as an adequate model simplification are also considered.]

[Models that characterize Pareto-efficient sharing of joint venture profits or constrained Pareto-efficient sharing of income in principal-agent contracting problems have ignored tax considerations. We extend the theory by showing that the effect of taxes on optimal contracting (both in the face of and in the absence of moral hazard problems) is related to the effect of changes in risk attitudes towards lotteries over pre-tax income. For example, optimal contracts will reflect the tax-induced demand for insurance of a risk-neutral individual who faces a progressive income tax schedule; that is, the risk-neutral individual will not bear all the risk, and in the face of moral hazard on the act selection of a risk-neutral agent, demand for monitoring will be created where none existed in the absence of the progressive tax. We also show that Pareto-optimal risk-sharing contracts do not generally result in expected tax minimization, even when taxes are modeled as a deadweight loss to the system.]

Partnerships, Tax incentives, Investment decisions, Transaction costs

This paper adopts a valuation perspective within an asymmetric information setting and explores properties of economic income. The optimal intertemporal contract induces an accrual component of income which would not exist absent the information problem. The contracting solution introduces a dampening effect—if cash flow increases by one dollar, income increases by less than one dollar. Thus, the accrual is inversely related to cash flows. Further, this dampening is greater for more favorable cash outcomes. Résumé. Les auteurs adoptent la perspective de l'évaluation en situation d'asymétrie de l'information et explorent les propriétés du bénéfice économique. Le contrat intertemporel optimal fait intervenir une amplification du bénéfice qui n'existerait pas si ce n'était de la présence du problème d'information. La solution contractuelle amène un effet atténuateur — c'est‐à‐dire qu'à une augmentation du flux monétaire de un dollar correspond une augmentation du bénéfice de moins de un dollar. Ainsi, l'amplification est en relation inverse avec les flux monétaires. En outre, l'atténuation est plus marquée dans le cas de résultats monétaires plus avantageux.

ABSTRACT In an effort to better understand the dynamic market price adjustment process, this paper develops a model which describes the impact of new information on a financial market. The primary emphasis is on the price change‐volume relationship in the presence of a margin requirement. We find that the margin requirement significantly affects the relation of price change to volume. Furthermore, this relationship is shown to be affected by the number of investors in the market, the degree of information dissemination, differences in interpretation of information and the implicit cost of the margin requirement.