Relative Performance Evaluation and Contagion in Financial Reporting Quality
78 Pages Posted: 11 May 2022 Last revised: 29 Oct 2024
Date Written: July 11, 2023
Abstract
We examine the effect of relative performance evaluation contracts on a company’s financial reporting quality. Using data on actual peer firms, we find that the adoption of relative performance evaluation provides financial incentives for earnings management. On average, higher earnings management in the set of peer firms leads to higher earnings management in the target firm. If the peer firm also uses the target firm as its peer in their incentive plans, this mutual benchmarking strengthens the earnings management contagion effect. The contagion effect is weaker if there are significant differences in performance, as well as in incentives and costs of earnings management between the target firm and its peers.
Keywords: Relative performance evaluation, Earnings management, Earnings quality contagion, Financial reporting quality, Relative Performance Evaluation and Contagion in Earnings Management
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