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

Raffi Indjejikian
University of Michigan

Michal Matejka
University of Michigan

Abstract: We examine how managers’ knowledge and information about their local operations affects the incentive weights placed on their performance measures. Using a simple principal-agent model, we show that firms may optimally deemphasize performance measures that are well understood by local managers. We apply this insight to explain the proportion of business unit (BU) managers’ annual bonus that is based on BU financial performance measures. Using survey data from 120 BUs, we find evidence consistent with our model. In particular, we find that the relative incentive weight on BU financial performance measures is lower when BU managers have access to BU-specific internal accounting systems, our proxy for a relatively good understanding of what drives BU financial results.

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