Economically Optimal Performance Evaluation and Control Systems

Abstract

The purpose of this paper is to analyze the uses of information in the firm's performance evaluation and control system. From an accounting perspective, we are interested in information. But it is important to acknowledge at the outset that the demand for information in this setting stems from the conjunction of evaluation and control. Thus, our focus is the economically optimal design of performance evaluation and control systems. This focus, in turn, allows us to study the demand for and uses of information in the internal management of the firm. In the most simple (partial equilibrium) setting, a firm might consist of a single owner (principal), the production process owned by the owner, and a single worker (agent). The agent's labor, and possibly knowledge, when combined with the production process and some state realization produce an outcome. If decision making is delegated to the agent, then information may be used in two ways within the firm's performance evaluation and control system. First, information may be gathered after the agent has chosen his action and the outcome has been generated in order to evaluate the agent's action choice and determine his compensation. Here, the information is used for motivational as well as risk-sharing purposes. Demski and Feltham [1976] have termed this use decision influencing. In addition, state information may be supplied to the agent before his action choice in order to improve his action choice. Demski and Feltham [1976] refer to this as information's decision-facilitating role. Notice that with a