An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

N V Ramanan
Kellogg School of Management

Sri S Sridhar
Kellogg School of Management

Abstract: We find that market prices in wage contracts not only proxy for non-contractibles but also mitigate earnings management tendencies of the manager. Further, an increase in market price informativeness may lower both goal congruence and expected utility of the principal. Moreover, we establish that, in the presence of a non-contractible value driver, the manager's self-serving reporting behavior can actually improve goal congruence between the principal and the agent and yet reduce the principal's expected utility. Thus, we demonstrate that improvements in goal congruence do not always lead to greater expected welfare for the principal. Finally, we show that contracting with multiple managers, when some of their performance measures are not contractible, can induce both contracting and production externalities even when they face independent production environments. Such externalities lead to lower productive actions and higher earnings management than in a single-manager setting.

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