On the effects of the degree of discretion in reporting managerial performance (Q538488)

The authors consider a principal-agent model in which the agent's compensation depends on a noisy performance signal and the agent has the right to choose the measurement method. It is shown that a limited level of reporting flexibility is necessary for an optimal contract to exist. Results on the effect of increased flexibility on the level of compensation, on the manager's expected utility and the expected cost of compensation are derived. These results are further used to investigate implications of increased reporting flexibility for principal and manager and the effect of high costs of reporting flexibility.