This paper analyzes the links between cash flow rights, control rights and property rights in situations where a firm's security holders can manipulate earnings (intertemporal substitution). It is shown that the allocation of these rights a¤ects the incentives of claimholders when intertemporal substitution activities are numerous and cannot be contracted ex-ante. The main results we obtain are: 1) current cash flow rights and residual property rights are connected through the rule of marginal revenues; 2) the allocation of control rights does not necessarily coincide with the allocation of residual property rights; 3) when current cash flow rights are two-part linear, and in some cases when they are three-part linear, the problem of earnings manipulation can be eliminated through the appropriate design of property rights. However, for some contracts earnings manipulation is unavoidable. This theory provides new insights into the link between different rights of the holders of securities.
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Paper provided by University of Guelph, Department of Economics in its series Working Papers with number
0612.
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