Using delegation and control systems to mitigate the trade-off between the performance-evaluation and belief-revision uses of accounting signals

Abstract

Two trade-offs arise in an agency relationship when the same accounting signal is used for both performance evaluation and investment evaluation. Using the signal for performance evaluation, (1) directly influences the informativeness of the signal for investment evaluation, (2) induces manipulation, which, in turn, lowers the informativeness of the signal for investment evaluation. The principal can increase her welfare by delegating the investment decision to the agent, setting up multiple control systems, or using the outcome of the investment for performance evaluation. We show the implications of using each alternative on incentive contracts, equilibrium effort, and manipulation levels.