Incentive Consideration

Topics: Investment, Depreciation, Generally Accepted Accounting Principles Pages: 2 (461 words) Published: June 17, 2013

The use of book value based on cost to measure the investment or even the use of estimates of price-level-adjusted cost is subject to severe criticism. There is no reason why a system based on values estimated by management cannot be used for internal purposes instead of cost-based conventional accounting. Here we have an opportunity to apply ingenuity to bypass a valid objection by managers to cost-based accounting. Rather than asking an accountant or another staff person to supply the number on which the managers are to be judged, let us ask the managers to supply the value estimate. The procedure would be simple. Take a set of eligible managers and ask them to “bid” periodically for the assets they want to manage and for which a change in management is appropriate. The manager whose bid is accepted takes the asset, and the bid becomes the accounting base for performance evaluation. If the manager bids too high, that manager gets the asset but will find it hard to meet the return on investment and economic income requirements. If the manager bids too low, a competing manager will win, or alternatively the “board” may reject the bid and ask for revised bids. There is one major difficulty with this procedure. Managers can rig the time shape of projected earnings so that early targets can be easily attainable. This tendency would have to be controlled by the top managers awarding the bid. Large deferred benefits would have to be discounted.

The proposed procedure would have many advantages. It would establish an investment base whose measure is acceptable to both the operating manager and the top level of management (the former sets the value, the latter must accept it). The accountant serves the very important and proper function of supplying relevant information that is used by the managers in making their respective judgments and bids. The return on investment (ROI) and economic income measures are improved because the investment...
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