Describe how agency theory can be used to explain the mixture of Essay

Describe how agency theory can be used to explain the mixture of measurement methods observed in contemporary financial reporting. You may provide examples, where relevant, to support your answer - Essay Example orical costs for property and equipment, fair value for financial instruments) were developed, they are used to calculate such monetary amounts that will be used as the basis for the incentives and rewards and, ultimately, to calculate the rewards and incentives. In connection with the above, the principal also often have performance measurement systems in place to assess the performance of their agents. These systems include (among others) an analysis of the financial statements and its relevant ratios (particularly the debt to equity ratio). The measurement methods are used to provide reasonable monetary amounts that can be assigned to each account in the financial statements. In turn, these monetary amounts are used to assess the agent’s performance (in terms of profits, growth and asset base) and are also used to calculate the critical ratios used for such assessment. Thus, the agency theory and its related performance measurement and rewards systems are supported by the measurement methods as the latter provide the means by which the principals can assess the performance of their agents and the amount of rewards or incentives that the former will give to the latter. Corollary with the agency theory is the concept of agency costs (Jensen, n.d.). The measurement methods may actually affect the agency costs. Agency costs may actually encourage â€Å"companies to choose accounting methods that pre-commit against management opportunism† (Christensen and Nikolaev, 2009). This makes companies prefer the historical cost method it is perceived to be a â€Å"more effective mechanism for reducing agency costs† (Christensen and Nikolaev, 2009). Fair value and its estimates, on the other hand, may be subjected to the agent’s (management’s) discretion, which in turn, may translate to an increase in agency costs that will be borne by the company. Thus, the presence (or absence) of agency costs actually influence the choice of measurement methods that will be used by