A Contracting Perspective on Earnings Quality
Journal of Accounting and Economics Volume 39, Issue 2, June 2005, Pages 265–294
Posted: 2 Jul 2013
Date Written: June 1, 2004
This paper analyzes the impact of signal-to-noise-ratios and the autocorrelation of a performance measure on the principal's welfare in dynamic agencies with renegotiation. We consider the impact of changes in the persistent, transitory, and reversible components of accounting earnings on its usefulness in valuation versus contracting. Increasing the persistent components and reducing the reversible components are generally desirable for valuation, but not for contracting. Eliminating transitory components of earnings is generally desirable for valuation, but not necessarily for contracting. We discuss the contracting implications of differences in the autocorrelations of accounting earnings versus stock returns.
Keywords: Contracting, Management compensation, Accruals, Earnings quality, Performance measure autocorrelation
JEL Classification: D80, J33, M41, M43
Suggested Citation: Suggested Citation