ACTG 4P11 Chapter Notes - Chapter 10: Downside Risk, Risk Compensation, Moral Hazard
Document Summary
Agency contract between the firm and its manager that attempts to align the interests of owner and manager by basing the manager"s compensation on one or more measures of the manager"s performance in operating the firm. Wolfson (1985) argues that forces of reputation help to motivate, but incentive contracts are still needed: market forces reduce the moral hazard problem, but does not eliminate it. How to increase the sensitivity of net income: reduce recognition lag by moving to current value accounting. Payoffs from manager effort show up in current net income. However, current value accounting decreases precision: full disclosure, particularly of low-persistence items. More difficult for manager to disguise shirking by earnings management. Controlling length of manager decision horizon (control the nature of manager effort: short-run effort (e. g. cost control, maintenance, employee morale, advertising, and other day-to-day activities, long-run effort (e. g. planning, r&d, acquisitions)
