by Mitchell Farlee, John Fellingham and Richard Young

October 1995

ABSTRACT

This paper adopts a valuation perspective within an asymmetric information setting and explores properties of economic income. The optimal intertemporal contract induces an accrual component of income which would not exist absent the information problem. The contracting solution introduces a dampening effect -- if cash flow increases by one dollar, income increases by less than one dollar. Thus, the accrual is inversely related to cash flows. Further, this dampening is greater for more favorable cash outcomes.