Earnings Manipulation and Incentives in Firms

35 Pages Posted: 30 Dec 2004

See all articles by Guido Friebel

Guido Friebel

Goethe University Frankfurt; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Sergei Guriev

Sciences Po; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: 29 October 2005

Abstract

We show that earnings manipulation destroys incentives within the corporate hierarchy. In the model, top management has incentives to over-report earnings. An insider, for instance, a division manager may gain evidence about over-reporting. We show that the division manager is more likely to have evidence, when the performance of her own division is low. Top management wants to prevent information leakage to the outside world. Hence, when the division manager threatens to blow the whistle, top management pays her a bribe. As this occurs when division output is low, the wedge between payments in high and low states of nature decreases. Earnings manipulation therefore undermines incentives to exert effort and destroys value. We show that earnings manipulation is more likely to occur in flatter hierarchies; we also discuss implications of the auditing and whistle-blowing regulations of the Sarbanes-Oxley Act.

Keywords: Agency costs, Sarbanes Oxley Act, whistle-blowing, flat hierarchies

JEL Classification: D23, G34, M41, M43, M52

Suggested Citation

Friebel, Guido and Guriev, Sergei, Earnings Manipulation and Incentives in Firms (29 October 2005). EFA 2005 Moscow Meetings Paper, Available at SSRN: https://ssrn.com/abstract=637221 or http://dx.doi.org/10.2139/ssrn.637221

Guido Friebel (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Sergei Guriev

Sciences Po ( email )

27 rue Saint-Guillaume
Paris Cedex 07, 75337
France

HOME PAGE: http://econ.sciences-po.fr/staff/sergei-guriev

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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