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Review of Accounting Studies

Erschienen in:

01.06.2014

Fishing for excuses and performance evaluation

verfasst von: Francois Larmande, Jean Pierre Ponssard

Erschienen in: Review of Accounting Studies | Ausgabe 2/2014

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Abstract

We study a principal–agent model in which the agent can provide ex post additional relevant information regarding his performance. In particular, he can provide a legitimate excuse, that is, evidence that a poor result is only due to factors outside his control. However, building a convincing case requires time, time that is not spent on exerting productive effort and thus generating information represents an opportunity cost. We obtain necessary and sufficient conditions for the principal to prefer a policy of adjusting ex post the performance measure for the information provided by the agent to a policy of conforming to a result-based system with no adjustments. The risk aversion and a possible limited liability of the agent play an important role in the analysis. This paper clarifies the issues associated with the so-called “excuse culture” prevailing in some organizations.

Vorheriger Artikel Short-term earnings guidance and accrual-based earnings management

Nächster Artikel Evidence from impending bankrupt firms that long horizon institutional investors are informed about future firm value

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Larmande and Ponssard (2008) provide anecdotal evidence on how an appeal process might be implemented in practice. In this case study of the implementation of an EVA incentive scheme, introduced initially to foster a culture of results, the company did adjust the result when excuses were considered legitimate by neutralizing, for instance, the impact of a devaluation of local currency on the cost of invested capital, or the impact a regulatory change in the calculation of pension cost. While results were adjusted, the bonus function remained unchanged. Equity concerns were advanced to motivate such practices.

This proposition is actually a particular case of a more general result shown by Kim (1995). When the likelihood ratio distribution of an information system t is a mean preserving spread of the likelihood ratio distribution of another information system h, then the principal always prefers t, regardless of the preference of the agent (the utility function). When \(R^{{L}_{E}}\geq R^{H}\) and \(R^{{L}_{E}}\leq R^{L}\), it is possible to order both monitoring technologies, excuse and no-excuse, using the MPS criterion.

We were not able to show the converse of the second part of Proposition 3: that ∀ α > α₀, the no-excuse contract is optimal. However, a great number of numerical simulations leads us to conjecture that the converse always holds.

The reason why 1 now replaces R ^L is explained in Larmande (2013) . When the limited liability binds, the MPS criterion of Kim is no longer necessary to order two monitoring technologies, regardless of the utility function of the agent. A less stringent condition exists that involves the comparison of likelihood ratios for the high outcome and the comparison of marginal productivities of effort. The latter condition takes here the form of \(R^{{L}_{E}}\) below 1.

Arya, A., & Glover, J. (2008). Performance measurement manipulation: Cherry-picking what to correct. Review of Accounting Studies, 13, 119–139.CrossRef

Demski, J. (1998). Performance measure manipulation. Contemporary Accounting Research, 15, 261–285.CrossRef

Demski, J., Frimor, H., & Sappington, D. (2004). Efficient manipulation in a repeated setting. Journal of Accounting Research, 42, 31–50.CrossRef

Dutta, S., & Gigler, F. (2002). The effect of earnings forecasts on earnings management. Journal of Accounting Research,, 40, 631–655.CrossRef

Feltham, G., & Xie, J. (1994). Performance measure congruity and diversity in multi-task principal/agent relations. The Accounting Review, 429–453.

Fudenberg, D., & Tirole, J. (1990). Moral hazard and renegotiation in agency contracts. Econometrica, 58, 1279–1320.CrossRef

Kim, S.K. (1995). Efficiency of an information system in an agency model. Econometrica, 63, 89–102.CrossRef

Larmande, F. (2013). Limited liability, the first-order approach, and the ranking of information systems in agencies. Economics Letters, 118, 314–317.CrossRef

Larmande, F., & Ponssard, J.P. (2008). Implementation of an EVA compensation scheme, 69–98, In Reward management-facts and trends in Europe. Lengerich: Pabst.

MacLeod, B. (2003). Optimal contracting with subjective evaluation. The American Economic Review, 93, 216–240.CrossRef

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Titel: Fishing for excuses and performance evaluation
verfasst von: Francois Larmande
Jean Pierre Ponssard
Publikationsdatum: 01.06.2014
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 2/2014
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-013-9268-1

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