Lying to Speak the Truth: Selective Manipulation and Improved Information Transmission

40 Pages Posted: 3 Dec 2019

See all articles by Paul Povel

Paul Povel

University of Houston - Department of Finance, C.T. Bauer College of Business

Günter Strobl

University of Vienna - Department of Finance

Date Written: November 16, 2019

Abstract

We show that firms may benefit from allowing some earnings management, because it can make noisy signals more informative. We model a firm that cannot observe a manager's cost of effort, her effort choice, and whether she manipulated a publicly observable signal. An optimal contract links compensation to both the eventually realized firm value and the (possibly manipulated) signal, since both are noisy measures of effort provision. It may be optimal to allow for manipulation of the signal by a manager who exerted a high effort level: Doing so can convert a falsely unfavorable signal into a favorable signal, thereby strengthening the link between effort and compensation.

Keywords: Adverse Selection, Moral Hazard, Performance Manipulation, Earnings Management, Corporate Governance, Executive Compensation

JEL Classification: D82, D86, G34, M12, M41

Suggested Citation

Povel, Paul and Strobl, Günter, Lying to Speak the Truth: Selective Manipulation and Improved Information Transmission (November 16, 2019). Available at SSRN: https://ssrn.com/abstract=3488734 or http://dx.doi.org/10.2139/ssrn.3488734

Paul Povel (Contact Author)

University of Houston - Department of Finance, C.T. Bauer College of Business ( email )

University of Houston
334 Melcher Hall
Houston, TX 77204
United States
713-743-4759 (Phone)

HOME PAGE: http://www.bauer.uh.edu/povel

Günter Strobl

University of Vienna - Department of Finance ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria

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