Variance analysis and linear contracts in agencies with distorted performance measures
This paper investigates the role of variance analysis procedures in aligning objectives under the condition of distorted performance measurement. A riskneutral agency with linear contracts is analyzed, whereby the agent receives postcontract, pre-decision information on his productivity. If the performance measure is informative with respect to the agentâ€™s marginal product concerning the principalâ€™s objective, variance investigation can alleviate effort misallocation. These results carry over to a participative budgeting situation, but in this case the variance investigation procedures are less demanding.
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