| Abstract: | This paper uses the principal-agent model to show that a manager's optimal compensation should generally include non-controllable factors of production such as the firm's investment in capital. This implies that the managerial accounting distinction between profit and investment centres is artificial. Examples are shown in which the ROI or RI criteria could be optimal for compensating managers implying that the optimal compensation criterion is very much specific to the firm's production and risk parameters. Thus, the debate about which criterion is more appropriate is vacuous. |
