The small number of full-scale adoptions of activity-based costing (ABC) coupled with ABC implementation failures have fueled a debate about the costs and benefits of ABC relative to more traditional volume-based costing (VBC) systems. ABC differs from VBC by focusing attention on activities and resources that are under the control of multiple workers. Reducing these costs often requires a coordinated effort. Therefore, incentives that motivate workers to cooperate are a prerequisite to successful process improvements based on ABC. Alternatively, when competitive incentives are combined with ABC, the result can be unexpected and negative. We examine how accounting cost system and incentive structure choices interact. We find that profits are highest when ABC is linked with group-based incentives, which provide high motivation to cooperate. In contrast, the lowest level of profit occurs when the same information-rich cost system, ABC, is coupled with tournament-based incentives. VBC, a cost system that provides a lower level of cost driver information, moderates the incentive effect. Thus, our results demonstrate that the effectiveness of ABC relative to traditional VBC is influenced by its interactive effect with incentive compensation.

Accounting researchers (and potentially others) generally select rather simple, lower-order, time-series models to develop proxies for earnings persistence. However, measures of persistence produced by such models are not related to characteristics of the firm's economic environment that are expected to influence earnings persistence. Using a sample of 162 calendar year-end New York Stock Exchange firms, we document the cross-sectional relations between a set of relatively constant, firm-specific, economic characteristics that are theoretical determinants of persistence and measures of earnings persistence derived from both lower-order and higher-order Autoregressive, Integrated, Moving-Average (ARIMA) models. When lower-order ARIMA models are used to generate measures of earnings persistence, the cross-sectional regression models measuring the association between persistence and economic determinants of persistence yield very low adjusted R2s. In sharp contrast, when differenced, higher-order ARIMA models are used to measure earnings persistence, adjusted R2s are in the 10–12 percent range. Moreover, independent variables such as capital intensity, barriers-to-entry, and product-type are all significant in the directions suggested by economic theory. Our results are consistent with Lipe and Kormendi (1994) who argue that higher-order ARIMA models do a better job of capturing the valuerelevance of current period earnings than lower-order models.