Accounting Information and Contracting Dynamics

Abstract

I develop a dynamic principal-agent framework to examine the role of accounting information in a long-term contracting relationship with uncertainty over fundamental performance in which intertemporal incentives and termination are jointly determined. Learning and the reversal property embedded in the accounting performance measurement system gives rise to an accounting-driven demand for long-term incentives. Measurement precision directly influences the performance-based vesting behavior of these incentives over the course of the contracting relationship. Furthermore, equilibrium manipulation of the accounting report becomes increasingly positive as the agency approaches termination because such a policy reduces the chance of inefficient termination. My framework allows for falsifiable predictions regarding the relationship between the properties of accounting measurement and the evolving nature of incentives over the manager's tenure, managerial risk-taking activity, and managerial turnover.