Equilibrium earnings management and managerial compensation in a multiperiod agency setting

Sunil Dutta, Qintao Fan

Research output: Contribution to journalArticlepeer-review

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.

Original languageEnglish (US)
Pages (from-to)1047-1077
Number of pages31
JournalReview of Accounting Studies
Volume19
Issue number3
DOIs
StatePublished - Sep 2014

Keywords

  • Compensation contract
  • Earnings management
  • Information asymmetry
  • Pay-performance sensitivity

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)

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