Earnings Management, Reporting Frequency and Agency Cost

The paper considers, in a principal-agent framework, whether or not providing interim performance evaluations is more efficient when agents can manipulate the very performance reports by which they are evaluated. Providing interim performance evaluation introduces possible dependence of subsequent strategies on interim reports. Under reasonable assumptions, such dependence has two effects: first, it alleviates previous-period incentive compatibility constraints and secondly, it also increases the (expected) later-period performance manipulation costs. The first effect provides a risk-sharing benefit whereas the second effect increases the expected compensation cost to the agent (in utilities). As a result, there is a trade-off. Correspondingly, providing interim performance evaluation dominates not providing one when the manager is sufficiently risk-averse so that the risk-reduction effect dominates.