Earnings Management and Managerial Compensation

Kremena Bachmann and Thorsten Hens
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Kremena Bachmann: University of Zurich
Thorsten Hens: University of Zurich, Norwegian School of Economics and Business Administration (NHH), and Swiss Finance Institute

No 17-77, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper studies the earnings management behavior of a manager in a strategic game in which the manager may have incentives to avoid earnings below the analysts’ consensus forecast and the analysts aiming to provide accurate forecasts behave as rational Bayesians. Our analysis reveals the existence of equilibria in which the manager who is compensated with stocks manipulates earnings to meet the consensus forecasts and the earnings manipulation is not detected. When the manager holds stock options, these non-revealing equilibria do not exist. The manager exhausts his reporting discretion as earnings manipulation becomes costless once the price of firm’s shares falls below the exercise price of the options. Our model provides a set of implications for observing opportunistic earnings management in dependence of managerial compensation and investors’ aversion to negative earnings surprises. In addition, the model’s predictions regarding the relationship between earnings management and executive compensation are consistent with empirical observations.

Keywords: earnings management; disclosure policy; loss aversion (search for similar items in EconPapers)
JEL-codes: G38 J33 M41 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2017-12
New Economics Papers: this item is included in nep-hrm and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1777

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