Earnings Manipilation and Incentives in Firms

Guido Friebel () and Sergei Guriev

No w0055, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: We show that earnings manipulation destroys incentives within the corporate hierarchy. In the model, top management has incentives to over-report earnings. An insider, for instance, a division manager may gain evidence about over-reporting. We show that the division manager is more likely to have evidence, when the performance of her own division is low. Top management wants to prevent information leakage to the outside world. Hence, when the division manager threatens to blow the whistle, top management pays her a bribe. As this occurs when division output is low, the wedge between payments in high and low states of nature decreases. Earnings manipulation therefore undermines incentives to exert effort and destroys value. We show that earnings manipulation is more likely to occur in flatter hierarchies; we also discuss implications of the auditing and whistle-blowing regulations of the Sarbanes-Oxley Act.

Keywords: agency costs; Sarbanes-Oxley Act; whistleblowing; flat hierarchies (search for similar items in EconPapers)
JEL-codes: D23 G30 M40 M52 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2004-06, Revised 2005-10
New Economics Papers: this item is included in nep-acc and nep-tra
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http://www.cefir.ru/papers/WP55earningsmanipulation.pdf (application/pdf)

Related works:
Working Paper: Earnings Manipilation and Incentives in Firms (2005)
Working Paper: Earnings Manipulation and Incentives in Firms (2005)
Working Paper: Earnings Manipulation and Incentives in Firms (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:cfr:cefirw:w0055

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