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Stock Price, Earnings and Book Value in Managerial Performance Measures

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  • Dutta, Sunil

    (U of California, Berkeley)

  • Reichelstein, Stefan J.

    (Stanford U)

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    Abstract

    This paper develops a multiperiod principal-agent model in which a manager must be given incentives to undertake investments and to exert personally costly effort. Investments are "soft" (e.g., intangible assets) and therefore entail measurement errors for the accounting system as it seeks to separate investments from operating expenditures. This separation is of no concern to the stock market which draws on its own information about future cash flows resulting from current investments. The firm's stock price, however, reflects all value relevant information, parts of which are not incentive relevant. Optimal incentive provisions must combine "forward looking" market information with "backward looking" accounting information. Under certain conditions, optimal performance measures can be expressed as a weighted average of economic value added (residual income) and market value added.

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    Bibliographic Info

    Paper provided by Stanford University, Graduate School of Business in its series Research Papers with number 1873.

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    Date of creation: Oct 2004
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    Handle: RePEc:ecl:stabus:1873

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Bushman, Robert & Chen, Qi & Engel, Ellen & Smith, Abbie, 2004. "Financial accounting information, organizational complexity and corporate governance systems," Journal of Accounting and Economics, Elsevier, vol. 37(2), pages 167-201, June.
    2. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-64, April.
    3. Chandra Kanodia & Rajdeep Singh & Andrew E. Spero, 2005. "Imprecision in Accounting Measurement: Can It Be Value Enhancing?," Journal of Accounting Research, Wiley Blackwell, vol. 43(3), pages 487-519, 06.
    4. Kim, Oliver & Suh, Yoon, 1993. "Incentive efficiency of compensation based on accounting and market performance," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 25-53, April.
    5. Bagwell, Kyle, 1995. "Commitment and observability in games," Games and Economic Behavior, Elsevier, vol. 8(2), pages 271-280.
    6. Sunil Dutta & Stefan Reichelstein, 2003. "Leading Indicator Variables, Performance Measurement, and Long-Term Versus Short-Term Contracts," Journal of Accounting Research, Wiley Blackwell, vol. 41(5), pages 837-866, December.
    7. Dirk Sliwka, 2001. "On the Use of Nonfinancial Performance Measures in Management Compensation," Bonn Econ Discussion Papers bgse29_2001, University of Bonn, Germany.
    8. Ittner, Christopher D. & Lambert, Richard A. & Larcker, David F., 2003. "The structure and performance consequences of equity grants to employees of new economy firms," Journal of Accounting and Economics, Elsevier, vol. 34(1-3), pages 89-127, January.
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