Management Accounting Section Midyear Meeting

Subjective Leading Indicator Variables and Long-Term Investment

• In Event: Managerial Topics in Analytical Research

Abstract

In this paper, we investigate the economic relationship between subjective (non-contractible) leading indicator variables (LIVs) and long-term investment in a two-period short-term contract setting. There is a hold-up problem with respect to the long-term investment, but the agent’s superior information about the successfulness of the investment creates an information rent that mitigates the hold-up problem. The LIV improves the second-period contract efficiency but may discourage ex ante investment incentives. We find that the informativeness of the LIV is not sufficient to determine the usefulness of the LIV, and the bias in the LIV (i.e., type I or II error) alone may determine the usefulness of the LIV. Viewed as a design problem, the optimal LIV is downward biased: always reporting failures accurately and sometimes reporting successes as failures.

Authors

• Jonathan Glover, Columbia University Business School

• Wei Li, University of Washington Bothell

• Hao Xue, Duke University