Credibility of earnings from a principal-agent coalition perspective

The paper examines the basis of performance measurement between principal and agent. There is a need for an objective and measurable performance measurement. The most common performance measures in practice are based on earnings as reported in the financial statements. The relationship between the principal and agent is characterised by informational asymmetry and mutual distrust. For this reason it is essential to define objectively measurable earnings categories that can serve as a basis of performance measurement between the principal and its agent. The very situation created by the principal-agent problem causes that the two have different perceptions of earnings. This paper researches the question, how do the different income categories satisfy the criteria of credibility, objectivity and non-manipulability for earnings measurement. Three earnings categories are used that satisfy different levels of realisation. We conclude that only monetarily realised earnings are the category that satisfies the credibility criteria making it the intersection between the acceptable earnings to both principle and agent. We propose implementing this earnings realisation model in measuring performance and for the agents’ compensation schemes, because principles will be able to minimise agency costs when opting for more credible earnings categories.