ABSTRACT: The literature addresses optimal contract design issues that the principal must address to provide proper incentives to the agent. However, there has been limited empirical assessment of how agents actually respond to the performance-evaluation schemes in the contracts offered them. Moreover, the literature overlooks factors, other than those from the pay-for-performance context, that may impact the effectiveness of incentive provisions. This study considers the effect of discriminability on agent performance. We find that (1) agent performance improvement is positively associated with the degree of discriminability, (2) subjective measures are inferior to objective measures in providing incentives to the agent because of the lack of discriminability, and (3) the inferiority of subjective measures for incentive purposes is exacerbated in circumstances in which the discriminability gap between objective and subjective measures is significant. Our findings suggest that, in order to have subjective measures effectively complement objective measures, the accounting profession must develop sound performance measurement systems that define and measure subjective performance with sufficient discriminability.

ABSTRACT We study manufacturing firms' asymmetric inventory investment in response to sales changes. Focusing on the costs of resource adjustment and stockout that likely differ in sales‐increasing and sales‐decreasing periods, we predict and find that inventory investment declines less during periods with sales decreases than it rises during periods with sales increases. We validate this claim by showing that managers' expectations of future demand and desire to avoid inventory stockouts are important determinants of this asymmetry. In addition, we find that asymmetric inventory investment provides useful information for predicting future sales growth, and that both managers' and analysts' sales forecasts are positively associated with the asymmetry. Lastly, we document that forecasts of future sales growth that incorporate asymmetric inventory investment are associated with lower absolute forecast errors than benchmark forecasts. Overall, we highlight the importance of inventory information in understanding managers' resource adjustment and utilization decisions that have implications for forecasting future demand. Our findings on asymmetric inventory management provide new insights to fundamental analysis based on inventory signals.