[Accounting numbers are frequently used for performance evaluation because they are typically the firm's main source of formal information. As a result, employees become concerned about accounting-based budgeting processes. Whether it would be economically valuable to allow an employee to become a participant in this process is determined by the link between accounting signals and the performance expected of that employee. This article shows that by dividing activities into those that directly influence accounting measurements and those that do not, certain aspects of this link can be modeled. The results of a principal-agent analysis indicate that, in some cases, participation designed to communicate the agent's private information has no economic value even though the principal is willing to pay nonzero amounts to observe that information. The result of zero value to participation is obtained because if the agent's compensation depends only on accounting data (e.g., product cost data), any information concerning indirectly related activities may have no motivational effect on the agent and, hence, would not be useful. Conversely, if the indirectly related activities are costly to the agent (i.e., if they cause disutility), it is useful for the principal to have access to this information to adjust the agent's compensation accordingly.]

[Williamson (1975) argues that firm organization is superior to open-market contracting due to the presence of an internal audit function that considers less formal evidence and explores byways not usually open to participants in open-market exchanges. This paper models the internal audit function as a scarce economic resource and the use of that resource for the provision of incentives. Information useful for incentives is assumed to be limited to verifiable information. The quantity of verifiable information produced by the internal audit function is constrained by either the time an internal auditor can spend verifying evidence or the time that employees have available to make such evidence verifiable (e.g., time spent with paperwork). The internal audit function is shown to produce near first-best solutions in a principal-agent model with simple and realistic policies that use only a small fraction of all available information. The attainment of such efficiency, however, depends on the level of management to which the internal auditors report. If independence is impaired, the firm may have to resort to other sources of contracting information, such as its financial reports. Because the information contained in financial reports is more limited than that provided by the internal audit function, first-best solutions may no longer be possible. Certain inadequacies of using financial reports as incentive devices may be mitigated by allowing the employee discretion over accounting alternatives. Such acts, however, may appear to outsiders to be income manipulations aimed solely at maximizing compensation.]

Explores the use of accounting numbers in employee evaluation. Employee participation in accounting-based budgeting processes; Determination of employee participation; Links between accounting signals and performances expected to employees; Results of principal-agent analysis; Results of zero value to participation.

Presents a study which models the internal audit function as a scarce economic resource and the use of that resource for the provision of incentives. Background on the internal audit function; Internal auditing used for performance evaluation; Internal auditing not used for performance evaluation.