The economics of earnings manipulation and managerial compensation

Keith J. Crocker, Joel Slemrod

Research output: Contribution to journalArticle

68 Scopus citations

Abstract

This article 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.

Original languageEnglish (US)
Pages (from-to)698-713
Number of pages16
JournalRAND Journal of Economics
Volume38
Issue number3
StatePublished - Sep 1 2007

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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