Equilibrium earnings management and managerial compensation in a multiperiod agency setting

Sunil Dutta () and Qintao Fan ()
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Sunil Dutta: University of California, Berkeley
Qintao Fan: University of Illinois at Urbana-Champaign

Review of Accounting Studies, 2014, vol. 19, issue 3, No 1, 1047-1077

Abstract: Abstract To investigate how the possibility of earnings manipulation affects managerial compensation contracts, we study a two-period agency setting in which a firm’s manager can engage in window-dressing activities to manipulate reported accounting earnings. Earnings manipulation boosts the reported earnings in one period at the expense of the reported earnings in the other period. We find that the optimal pay-performance sensitivity may increase and expected managerial compensation may decrease as the manager’s cost of earnings management decreases. When the manager is privately informed about the payoff of an investment project to the firm, we identify plausible conditions under which prohibiting earnings management can result in a less efficient investment decision for the firm and more rents for the manager.

Keywords: Earnings management; Compensation contract; Pay-performance sensitivity; Information asymmetry (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1007/s11142-014-9279-6

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