Residual income-based compensation plans for controlling investment decisions under sequential private information

Residual income-based compensation plans for controlling investment decisions under sequential private information

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Article ID: iaor20082172
Country: United States
Volume: 53
Issue: 3
Start Page Number: 495
End Page Number: 507
Publication Date: Mar 2007
Journal: Management Science
Authors: ,
Keywords: information
Abstract:

Earlier literature has pointed to the effectiveness of residual income-type measures based on particular accrual accounting rules such as the relative benefit allocation rule. These performance metrics have been shown to generate desirable managerial incentives when investment decisions are delegated. This paper further attests to the robustness of these measures by extending the result to a sequential adverse selection model with an inherent real option (an option to abandon). In other words, as long as the residual income measures are judiciously constructed, neither private information nor the requirement to selectively exercise an option derails their use in this setting.

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