Equilibrium Earnings Management and Managerial Compensation in a Multiperiod Agency Setting

45 Pages Posted: 26 Jul 2012 Last revised: 12 Jan 2014

See all articles by Sunil Dutta

Sunil Dutta

University of California, Berkeley - Haas School of Business

Qintao Fan

University of Oregon, Lundquist School of Business

Date Written: January 10, 2014

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, managerial compensation, pay-performance sensitivity, information rents

JEL Classification: D82, M52

Suggested Citation

Dutta, Sunil and Fan, Qintao, Equilibrium Earnings Management and Managerial Compensation in a Multiperiod Agency Setting (January 10, 2014). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2116555 or http://dx.doi.org/10.2139/ssrn.2116555

Sunil Dutta

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-643-1229 (Phone)
510-643-1412 (Fax)

Qintao Fan (Contact Author)

University of Oregon, Lundquist School of Business ( email )

Lillis Business Complex
#374
Eugene, OR 97403
United States
5143464865 (Phone)

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