2011 Volume 4 Issue 2 Pages 1-11
This paper analyzes the impact of accounting for asset retirement obligations on managerial performance evaluation and on environmental costs caused by asset acquisition. The paper develops a two-period agency setting in which a manager must be given incentives to undertake investments that lead to environmental remediation costs. Focusing the short-term linear compensation contracts on the firm’s performance measures (i.e. accounting income), the paper demonstrates that the manager’s investment decision may be distorted by recognition and measurement of asset retirement obligations in the income measurement process, resulting in an increase in environmental costs.
