Dynamic incentives and responsibility accounting: a comment

Dynamic incentives and responsibility accounting: a comment Indjejikian and Nanda (J. Accounting and Economics 27 (1999) 177) establish that “lack of commitment” results in an expected economic loss, relative to a long-term full-commitment contract, if there is inter-period correlation of performance measures. They attribute this loss to a “ratchet effect”. We demonstrate the following. First, their proposed equilibrium is not sustained unless there is some form of limited commitment. Second, these limited commitment assumptions need not induce a “ratchet effect”. Third, the “ratchet effect” is neither necessary nor sufficient for an expected economic loss to occur—the loss is due to the principal's inability to commit ex ante to the second-period incentive rate. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Accounting and Economics Elsevier

Dynamic incentives and responsibility accounting: a comment

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Publisher
Elsevier
Copyright
Copyright © 2003 Elsevier B.V.
ISSN
0165-4101
D.O.I.
10.1016/S0165-4101(03)00040-5
Publisher site
See Article on Publisher Site

Abstract

Indjejikian and Nanda (J. Accounting and Economics 27 (1999) 177) establish that “lack of commitment” results in an expected economic loss, relative to a long-term full-commitment contract, if there is inter-period correlation of performance measures. They attribute this loss to a “ratchet effect”. We demonstrate the following. First, their proposed equilibrium is not sustained unless there is some form of limited commitment. Second, these limited commitment assumptions need not induce a “ratchet effect”. Third, the “ratchet effect” is neither necessary nor sufficient for an expected economic loss to occur—the loss is due to the principal's inability to commit ex ante to the second-period incentive rate.

Journal

Journal of Accounting and EconomicsElsevier

Published: Aug 1, 2003

References

  • Earnings management and the revelation principle
    Arya, A.; Glover, J.; Sunder, S.
  • Accounting policies in agencies with moral hazard and renegotiation
    Christensen, P.O.; Demski, J.S.; Frimor, H.

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