The article comments on the analysis of two researchers on in-process inventories and multiproduct production systems. In a previous article, the author assumed that the in-process inventories are constant from period to period. He explains that the researchers' analysis did not define what the level of activity represents in this context. They also implicitly assumed that the units of in-process inventory are complete with regard to the internal inputs used in producing them. In an analysis designed to consider in-process inventories, such assumption is considered odd.
In recent years accountants have increased the emphasis on their role as suppliers of information for management decisions. This is partly a broadening of the scope of accounting and partly a recognition that more and better information can be produced. Accountants and other information producers must play a key role in deciding which information should be produced. However, the methodology for making these decisions is lacking. This article assumes that the criterion for designing information systems is that value should exceed cost. The purpose of the article is to provide a framework for determining the value of a change in the information system. In order to achieve this, the article formally develops individual components that are required to calculate the expected payoff for a particular information system. Relevance has been suggested as an important criterion for selecting information. In fact, many authors consider that a signal can only be called information if it is relevant to some decision by the receiver, i.e., relevant information is a redundant term. These discussions usually imply that a signal is relevant if its receipt changes the decision. Thus, relevance requires specification of both a decision maker and a decision.
[Accounting numbers are frequently used in evaluating management performance, and performance evaluation is an important ingredient in motivating managers. Three significant factors generally create difficulties in developing performance measures for a given manager. First, the actions and strategies implemented by the manager are not observable directly, so the manager cannot be compensated directly for his input into the firm. Second, the full consequences of the manager's actions are not observable, in large part because the impact of those actions extend beyond his subunit of the firm and beyond his time as manager of that subunit. Third, uncontrollable events influence the consequences that are observed. The agency theory literature has explored extensively the implications of the nonobservability of the manager's actions and the fact that performance measures are influenced by unobservable, uncontrollable events. However, this literature has given only limited attention to the fact that performance measures frequently are incomplete or imperfect representations of the economic consequences of the manager's actions.1 On the other hand, discussions of performance evaluation in management accounting texts often raise issues regarding the incompleteness and imperfectness of the accounting numbers that are used as performance measures. For example, divisional accounting profit is described as a short-term financial measure that may induce managers to ignore the future economic consequences of their current actions.2 More generally, management accounting texts discuss various problems that arise in inducing managers to have goals that are congruent with those of the firm's owners.3 These discussions typically follow one of two tacks. First, most texts discuss alternative methods for measuring various accounting numbers. For example, discussions of divisional profit measures often consider direct costing versus absorption costing, the elimination of allocated fixed costs, market versus cost based transfer prices, and the inclusion of interest charges for assets used. The objective here is to create a single measure that is as congruent with the firm's objectives as possible. Second, some texts discuss the use of additional, often nonfinancial, performance measures. Kaplan and Atkinson (1989, 536) refer to General Electric and McDonald's as leaders in the use of such measures, and Anthony et al. (1992, 651) provide the following summary of their measures. McDonald's evaluated its store managers on product quality, service, cleanliness, sales volume, personnel training, and cost control. When General Electric decentralized in the 1950s, it identified multiple measures of divisional performance: profitability, market position, productivity, product leadership, personnel development, employee attitudes, and public responsibility. This paper uses an agency theory model to explore the economic impact of variations in performance measure congruence and the use of multiple performance measures to deal with both problems of goal congruence and the impact of uncontrollable events on performance measures. To address the congruency issues, we use a multidimensional representation of the manager's actions. Most of the agency theory literature has examined models in which the manager's action space is either single dimensional or finite. Our approach is similar to the multi-task model examined by Holmstrom and Milgrom [HM] (1991). Our analysis differs from theirs in that we focus on performance measure issues and consider measures that may be influenced by more than one element of the manager's action. The key characteristics of a single performance measure are its congruence with the principal's expected gross payoff and its noisiness (due to uncontrollable events). The first-best result is achieved if, and only if, the performance measure is perfectly congruent and noiseless. A contract based on a noncongruent measure induces suboptimal effort allocation across tasks, whereas performance measure noise results in suboptimal effort intensity. We characterize the value of providing additional performance measures, and illustrate the use of additional measures to reduce risk and noncongruity (due to myopia and window dressing). The value of an additional measure is zero if, and only if, the existing measures constitute a sufficient statistic for the additional measure with respect to the manager's action. The terminal value of the firm is not contractible information if it is realized subsequent to the contract termination date. However, the market price (at the contract termination date) of a publicly traded firm is contractible information. The analysis demonstrates that while price efficiently aggregates investor information for valuation purposes, it is not likely to be an efficient aggregation for incentive purposes. Hence, there is a loss of efficiency if the price is used as the sole performance measure. Of course, it can be a valuable performance measure if it contains otherwise noncontractible information.]
This article explores conventional questions of why and how budgets should be employed for motivation purposes in an economic setting. The authors focus on the types of employment contracts that are associated with equilibrium allocations in the labor market. Market incompleteness is a necessary condition for use of budgets in the employment contract. Beyond this, issues of controllability, management by exception, and tightness of standards are observed to depend on the contracting environment faced by the individual agents.
The article discusses forecast evaluation in accounting. Accounting data are often used in the development of forecasts and accountants are often called on to make forecasts. Development of a variable overhead rate per direct labor hour may, for example, be viewed as development of a forecast--whether it is used in a standard cost system, in a budget, or in a product mix decision. Similarly, establishment of a depreciation policy requires a forecast of service life. Furthermore, the ability to forecast some specific outcome has been offered as a criterion for selection among accounting alternatives. But, whatever its ultimate purpose, development of a forecast constitutes a decision--a conscious choice among alternatives. The concern in this paper is limited to this decision aspect of forecasting. In particular, in the first section it is demonstrated that selection among forecast alternatives is a subset of the accountant's general problem of selection among information alternatives. Following this, characterization is done of prevailing methods of selecting among forecast alternatives as a simplification of the basic information choice problem. The paper then concludes with two illustrative simulations.
The article discusses the nature of decision models and information evaluation models. The first section presents a general framework, or model, for information evaluation. The second examines the nature of the operational model that would be constructed in order to apply the general framework in a specific setting. The information evaluation process is viewed in cost-benefit terms; and the cost-benefit, or value, calculation is developed from the point of view of an individual who decides what information to supply. Different signals may result in different decisions, and, therefore, the information evaluator must develop a conditional probability distribution over the future events for each possible signal. Decision models seldom represent as controllable variables all actions that must be taken. Most mathematical models do not attempt to include detailed predictions of individual events. One simplified and well-known method for selecting information systems is to base the selection on personal opinion. Some insights that can be developed by such an exploration were then related to information choice issues and information research methods.
Discusses performance evaluations in management accounting. Use of an agency theory model to explore the economic impact of variations in performance measure congruence; Multi-task agencies; Multiple performance measures.
This paper provides a general version of the accounting-based valuation model that equates the market value of a firm's equity to book value plus the present value of expected abnormal earnings. Prior theoretical work (e.g., Ohlson 1995; Feltham and Ohlson 1995, 1996) assumes investors are risk neutral and interest rates are nonstochastic and flat. Our more general analysis rests on only two assumptions: no arbitrage in financial markets and clean surplus accounting. These assumptions imply a risk-adjusted formula for the present value of expected abnormal earnings. The risk adjustments consist of certainty-equivalent reductions of expected abnormal earnings. A key issue deals with the capital charge component of abnormal earnings. It is measured by applying the (uncertain) riskless spot interest rate to start-of-period book value. Risks do not affect the rate used in the capital charge, and accounting policies do not affect the formula's constructs. An application of the general formula shows how the classic risk-adjusted expected cash flows model derives as a special case.
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.