[Banker and Hughes (1994) demonstrate the economic sufficiency of normal activity-based unit cost for optimal pricing decisions. This paper provides an agency parallel to their analysis by examining how, in the presence of capacity costs, the desirable tradeoff between risk-sharing and incentives can be achieved through modification of the performance measures on which the contract is based. Similar to Banker and Hughes (1994), I find that the optimal capacity cost allocation is a function only of budgeted volume when capacity can be used to produce a single product. Analysis of a joint production setting, however, reveals the optimal allocation to be based on the joint products' estimated net realizable values.]

I study the joint choice of responsibility assignment, performance measures, and rewards for a two-stage process where the quality of the initial stage work affects the required final stage effort. By assigning responsibilities to give the initial stage agent an incentive to sabotage the final stage, output is made informative about this agent's attention to quality. I find conditions under which it is cost-effective to create and to contractually use such information. This analysis makes formal that the value of a performance measure is determined not simply by its congruity and precision but by its influence on the optimal organisational design.

For a two-stage production process, two assignments of tasks among two agents are studied: an ‘assembly line’, where each agent is responsible for one stage, vs. a ‘team’, where agents are jointly responsible for all tasks. When attention paid to quality at the initial stage affects the final-stage task, the team approach is optimal for unsophisticated production technology. As technology improves, the assembly line becomes dominating while continued improvements eventually makes it optimal to abandon the assembly line again in favor of the team approach. When such switches in job design occur, the optimal investment in technology exhibits positive jumps.

This paper demonstrates that options can be used to eliminate agency costs in the formal agency model. When an agent's action can determine the mean of future cash flows assumed to follow a binomial random walk, the principal can design a compensation package using options which are hedged by other components of the compensation package to be risk-free only if the agent takes the action desired by the principal and therefore risky if the agent is shirking. Thus, a risk- (and effort-) averse agent can be given incentives to take the action desired by the principal without sacrificing optimal risk sharing, even when the agent's action cannot be observed, either directly or indirectly.

We provide an informational theory for how the ownership claims to a firm might be structured. When the market price of equity provides valuable contracting information there is a benefit to creating separate ownership claims to each of a firm's divisions. However, creating this information also generally has adverse incentive effects because it enriches the agent's strategy space. We show in a complete contracting setting that under a large class of agencies the firm is strictly better off bundling the ownership claims to divisions that are sufficiently similar and creating separate ownership claims only to divisions that are sufficiently different.

In this paper I revisit the issue of real income smoothing in the setting used by Lambert (1984). I demonstrate that the particular effect identified in his paper is actually an error: under his assumptions, there is no input-driven equilibrium income smoothing of the type he suggests. There are, however, several other drivers of equilibrium behavior ignored in that paper. In this paper, I identify those and, for the particular model structure, show that when all effects are considered together, there is little support for the suggestion that second-best earnings generally are being smoothed through the equilibrium behavior.

Examines the allocation of sunk capacity costs and joint costs. Trade-off between risk-sharing and incentives; Optimal capacity cost allocation as a function of budgeted volume; Previous research on capacity cost allocation; Insights from principal-agent theory.

Frank Gigler, Thomas Hemmer, On the Frequency, Quality, and Informational Role of Mandatory Financial Reports, Journal of Accounting Research, Vol. 36, Studies on Enhancing the Financial Reporting Model (1998), pp. 117-147

We study how friendly boards design the structure of optimal compensation contracts in favor of powerful CEOs. Our study yields unexpected results. First, powerful managers receive higher pay and a contract with a higher pay-performance sensitivity (PPS) if firm performance is low and vice versa. Moreover, we identify conditions where expected pay and expected PPS are both increasing in the friendliness of the board. Second, we show that friendly boards provide managers with higher salaries, more shares, but less options. Third, friendly boards offering contracts with a higher PPS also make more intensive use of relative performance evaluation (RPE). Overall, our results suggest that frequently used indicators of poor (or sound) compensation practices should be interpreted with care. Extending the scope of our model beyond executive pay, we show that powerful managers underinvest in capital but have less incentives to manage earnings.

In this paper we study when it is advantageous to improve corporate transparency by allowing shareholders direct access to corporate information and when it is preferable to rely on a reporting system in which shareholders only gain access to information that management chooses to disclose. We show that in an agency model that allows for contract renegotiation, the desirability of a fully transparent reporting regime hinges on the stewardship properties of the information in question. Specifically, information that is mainly useful for predicting future events and of little use for evaluating past actions should only be made available to the public through management's self‐interested disclosures. Only if the information is useful for making inference about managerial actions can it be optimal to have full corporate transparency, so that outsiders have independent access to the same information as management.