Dynamic incentives and dual-purpose accounting

Abstract

Ongoing employment relationships often give rise to implicit, dynamic incentives. We describe the implications of implicit incentives when firms use information about both an employee's past performance and his future productivity in a two-period agency model. We show that when an accounting system serves these dual objectives, an employee's implicit incentives may be beneficial or detrimental to the firm. As a consequence, firms may prefer an accounting system that reports a single metric that combines information about past performance and future productivity, over one that reports two distinct metrics, one for each purpose.