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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : International Journal of Production Economics, Volume 121, Issue 2, October 2009, Pages 519–532
The economic accuracy of accrual-based managerial performance measures is most essential for value added investment decisions in decentralised firms. Contemporary EVA-literature often lends support to annuity-based depreciation schedules for accomplishing congruence between capital budgeting criteria, like NPV, and accounting measures, like ROI and RI. This is incongruent with the principal agent literature aiming at designing managerial incentive contracts. We introduce a strict market-based depreciation schedule which is shown to be superior to ordinary straight-line, annuity-based or IRR-based depreciation schedules. It gives the right managerial investment incentives also in the case of growth, inflation or technological development.
Both within single firms and in the society a lot of efforts have been put down over the years in order to develop routines and adequate decision criteria for accepting profitable investment alternatives and rejecting unprofitable ones. The rationale behind these efforts is in accordance with the principal agent theory (Jensen and Meckling, 1976), describing the costs that arise due to asymmetric information and goal incongruence between the principal (in first hand the owners) and the agent (management). Decision authority is also delegated throughout the organisation leading to arising agent costs also on lower levels within the organisation. In hierarchical organisations, there exist a number of principal agent relationships where “a middle level manager might be the agent of managers above him and the principal to employees below him” (Lambert, 2001, p. 6). The development and implementation of accurate information systems and incentive control mechanisms are essential for minimising agent costs due to conflicts of interest. However, for obtaining goal congruence and efficient resource utilisation in the long run it is also vital to stimulate decision-makers (managers) to use adequate investment appraisal or capital budgeting techniques, like a discounted cash flow (DCF) technique in the form of the net present value (NPV) formula. In surveys of the use of investment appraisal techniques it is repeatedly discovered that managers are often using and, in some cases, even seeming to favour simpler and less advanced techniques and decision criteria, like the pay-back criterion (Sandahl and Sjögren, 2003). Moreover, only in a few firms the manager is relying on one single capital budgeting technique implying that users of the (slightly) more advanced NPV-formula are considering other criteria as well (Arnold and Hatzopoulos, 2000 and Graham and Harvey, 2001). Many of them even adopt ordinary accounting measures, like return on investment (ROI) and residual income (RI) (cf. Drury et al., 1993), as complementary decision criteria. This is likely to be explained by the fact that managerial compensation as well as the evaluation of firm/division performance is usually based on accounting income instead of economic profit (Antle and Smith, 1986, Stern et al., 1996, Biddle et al., 1997, Rogerson, 1997, Sullivan and LaScola Needy, 2000 and Dutta, 2003). Hence, before accepting a new project, managers are interested in finding out what impact it would have on the book of accounts. A common argument among advocators of bringing in new managerial incentive programmes is that investment appraisals based on accruals (accounting figures) are likely to lead to either under- or overinvestment. Accounting measures are widely known to be subject to significant errors, which “arise in large part because accounting methods of depreciation do not adequately measure true depreciation” (McFarland, 1990, p. 521). In general firms are using a linear or straight-line depreciation schedule (Berliner and Brimson, 1988 and Ask and Ax, 1997), assuming implicitly that the decline in value of a project is the same in each period (year) of its economic life. In many cases the loss in (market) value is thereby overestimated during the first part of the project's life, which means too high initial capital charges in the form of interest and depreciation charges. This implies that the financial performance of the manager in charge of the project would look worse than it actually is. Hence, managers may be reluctant to approve certain projects even if the projects are profitable in terms of NPV. In the case of intangible assets, i.e. investments in R&D, education of employees, marketing, etc., the effect of underinvestment is emphasised even more. Such projects are in principle fully depreciated at the first period (i.e. year) of their economic life. This may give the impression that there is an inherent and unsolvable conflict between economic profitability and accounting profitability. That is not necessarily the case, though. Economic profitability is project oriented and concerns cash flows generated during the whole economic life of a project, whereas accounting profitability is period oriented and may be seen as a partial estimation of a project's profit (operating income) for a certain period of time, often a year. Even so they need not to be in contradiction with each other. Preinreich (1938) was early to point out that there exists a fundamental relationship between the economic measure, NPV, and accounting measures, like RI. As will be shown in this paper, NPV equals the sum of the discounted periodical RI estimations over the economic life of a project regardless of the depreciation rate chosen (O’Hanlon and Peasnell, 1998). As the forecasted accounting measures are in line with the expected NPV, managerial compensation based on RI would thus compensate managers correctly in the long run.1 From a managerial incentive perspective, however, the use of this kind of accrual-based managerial performance measurement criterion might still not lead to goal congruence. As Lambert (2001, p. 79) asserts, it is essential that the evaluation criterion is also displaying the true value in each period of the project's economic life. “In order to get residual income to correctly motivate the agent's investment choice, the principal must calculate the ‘correct’ depreciation schedule. To do this, the principal must be able to ‘match’ the depreciation to the time pattern of the cash flows generated by the investment.” Hence, in order to achieve a higher level of goal congruence the depreciation schedule in use should reflect the economic decline in the (asset) value of the project. Today there exist a number of value-based management methods (residual income methods) for measuring managerial performance. These methods are also being increasingly used as determinants for managerial compensation. An important motive for implementing managerial performance measures is to oblige managers to act in a way that will maximise the welfare of shareholders. “Ideally, the performance measures selected for management compensation contracts are those measures that best motivate management to maximise the value of the firm” (Wallace, 1997, p. 276). This paper aims at clarifying the fundamental relationship between economic and accounting measures. For this purpose, we introduce the concept of a strict market depreciation schedule. A second aim is to discuss implications for the designing of an efficient managerial performance measurement control system based on market valuation principles. The paper adopts a principal agent perspective by adhering to the work by Rogerson (1997), Reichelstein (2000) and Wagenhofer (2003) on optimal performance measures. In that respect this paper is distinguished from the vast literature on value-based management, like e.g. the EVA-literature. The focus on a strict market depreciation is, however, not on gaming and moral hazard issues. In terms of the categorisation by Magee (2001), it is more referable to performance measure design issues than the incentive function design. We assume a special form of a “plain vanilla” principal agent model implying that there is no information asymmetry ex-post between the principal and the agent. In contrast to the single-period modelling that is predominant in the principal agent literature (cf. Lambert, 2001), the robustness of our proposed solution is analysed and demonstrated under a multi-period framework.
نتیجه گیری انگلیسی
The idea of basing depreciation charges on economic valuation principles instead of accruals is not new in itself. The novelty of our proposed adjustment is that it is linking managerial investment incentives to firm performance. The implementation of a strict market depreciation schedule will lay a foundation for market value added investment decisions by improving the accuracy of accrual-based performance measures. The decision-maker that approves an investment with an expected positive NPV will be acknowledged and credited already the year the project is pursued. By this reduction of inconsistency between economic and accounting measures long term decisions are encouraged. Throughout our analysis, an important prerequisite has been that projected cash flows occur as expected and, thus, the project proceeds “according to plan”. In reality this is of course a very strong requirement. In real life estimates on future cash flows are likely to be based on unsatisfactory statistics and consequently these estimates may be rather insecure or even erroneous. With unreliable forecasts of future cash flows, a managerial incentive system based on expected present values will of course neither be a surety for the future success of projects approved nor a certain evaluation of the correctness of the decisions being made. Contrary to a conventional management accounting system, however, the use of the proposed depreciation schedule will indirectly contribute to a more reliable decision support system as it implies a more appropriate and qualitative follow-up of investment appraisal decisions. This will gradually lead to improved statistics and accurate information in a poor and insufficient post-auditing system. In this paper, the development and demonstration of a strict market depreciation schedule has been carried out without any explicit consideration of moral hazard problems. This does not mean that the implementation would increase agent costs due to opportunistic behaviour. On the contrary, as it enforces the firm to adopt a cash flow-based follow-up system of investment decisions, we are inclined to argue that over time it is likely to contribute to reduced information asymmetry between the principal and the agent as well as to more accurate estimations of future cash flows. A recent case study of EVA-based management by Riceman et al. (2002) lends support to this standpoint. An important finding in their study is that the success of introducing a value-based (EVA) bonus programme is highly dependent on managers understanding of the EVA concept. In order to improve the decision-making of middle managers it is vital to categorise the success or failure of investment decisions into manageable and transparent measures. In this respect, bonus programmes based on a strict market depreciation schedule ought to be qualified as the financial performance of managers would be judged on common and well-known evaluation criteria, i.e. RI or ROI.