The Economics of Earnings Manipulation and Managerial Compensation

Keith J. Crocker and Joel Slemrod ()

No 12645, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm. When realized, these earnings constitute hidden information that is privately observed by the manager, who may expend resources to generate an inflated earnings report. We characterize the optimal managerial compensation contract in this setting, and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits, and to report those profits honestly. As a result, some degree of earnings management must be tolerated as a necessary part of an efficient agreement.

JEL-codes: A12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec
Date: Written
Note: LS CF
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