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Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting

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  • Tim Baldenius

    (Columbia University)

  • Amir Ziv

    (Arison School of Business
    Columbia University)

Abstract

We consider a setting where a firm delegates an investment decision and, subsequently, a sales decision to a privately informed manager. For both decisions corporate income taxes have real effects. We show that compensating the manager based on pre-tax residual income can ensure after-tax NPV-maximization (“goal congruence”) for each decision problem in isolation. However, this metric fails if both decisions are nontrivial, since it requires asset-specific hurdle rates and hence precludes asset aggregation. After-tax residual income metrics (e.g., EVA) allow the firm to consistently apply its after-tax cost of capital as the hurdle rate to its aggregate asset base. We show that existing tax depreciation schedules may explain why firms in practice use more accelerated depreciation schedules than those suggested by previous studies. Our findings also rationalize the widespread use of “dirty surplus” accounting for windfall gains and losses for managerial retention purposes.

Suggested Citation

  • Tim Baldenius & Amir Ziv, 2003. "Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting," Review of Accounting Studies, Springer, vol. 8(2), pages 283-309, June.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:2:d:10.1023_a:1024473630832
    DOI: 10.1023/A:1024473630832
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    References listed on IDEAS

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    1. Stefan Reichelstein, 1997. "Investment Decisions and Managerial Performance Evaluation," Review of Accounting Studies, Springer, vol. 2(2), pages 157-180, June.
    2. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.
    3. Sunil Dutta & Stefan Reichelstein, 1999. "Asset Valuation and Performance Measurement in a Dynamic Agency Setting," Review of Accounting Studies, Springer, vol. 4(3), pages 235-258, December.
    4. Sunil Dutta & Stefan Reichelstein, 2002. "Controlling Investment Decisions: Depreciation- and Capital Charges," Review of Accounting Studies, Springer, vol. 7(2), pages 253-281, June.
    5. Sunil Dutta & Xiao‐jun Zhang, 2002. "Revenue Recognition in a Multiperiod Agency Setting," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 40(1), pages 67-83, March.
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    Cited by:

    1. Alexander Nezlobin & Stefan Reichelstein & Yanruo Wang, 2015. "Managerial performance evaluation for capacity investments," Review of Accounting Studies, Springer, vol. 20(1), pages 283-318, March.

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