Richard A. Young, A Note on "Economically Optimal Performance Evaluation and Control Systems": The Optimality of Two-Tailed Investigations, Journal of Accounting Research, Vol. 24, No. 1 (Spring, 1986), pp. 231-240

[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.]

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 paper is concerned with clarifying the relationship between the certainty equivalence and first order certainty equivalence results. The effects of applying the first order certainty equivalence result are examined by analyzing the effects on the control vector of a one period stochastic control problem of a change in elements of the covariance matrix of parameters.]

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.

This paper describes an experiment in which subjects, acting as division managers, exchanged privately held information before making intrafirm investment decisions. Social efficiency required that managers honestly disclose their private information, but managers had individual incentives to send biased messages. These features of the model created an important role for ex post verification, the main manipulation in the experiment. The matching protocol was also manipulated, using both random and continuous matching of subjects. This second manipulation was intended to examine whether an important institutional attribute — the frequency of interaction — would affect the usefulness of verification. The results of the experiment indicate that verification significantly increased the relative frequency of honest messages and the level of social efficiency. However, the improvements from verification were greater in settings where subjects did not interact repeatedly. The data also indicate that, in the continuous matching treatments, responses depended on the history of behavior of the message sender. However, this behavior was not observed in the random matching treatments. Thus, both the efficacy of verification and the extent of reputation formation depended on the institutional setting.