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Can earnings manipulation create value?

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  • Anton Miglo

    (University of Guelph, Department of Economics)

Abstract

Existing literature usually considers earnings manipulation to be a negative social phenomenon. We argue that earnings manipulation can be a part of the equilibrium relationships between firm's insiders and outsiders. We consider an optimal contract between an entrepreneur and an investor where the entrepreneur is subject to a double moral hazard problem (one being the choice of production effort and the other being intertemporal substitution, which consists of transferring cash flows between periods). Investment and production effort may be below socially optimal levels because the entrepreneur cannot entirely capture the results of his effort. The opportunity to manipulate earnings protects the entrepreneur against the risk of a low payoff when the results of production are low. Ex-ante, this provides an incentive for the entrepreneur to increase his level of effort and invest efficiently.

Suggested Citation

  • Anton Miglo, 2008. "Can earnings manipulation create value?," Working Papers 0803, University of Guelph, Department of Economics and Finance.
    • Handle: RePEc:gue:guelph:2008-3
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    File URL: http://www.uoguelph.ca/economics/repec/workingpapers/2008/2008-03.pdf
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    References listed on IDEAS

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    Cited by:

    1. Rong-Ruey Duh & Audrey Hsu & Sidney Leung, 2015. "Earnings management and government restrictions on outward foreign direct investment: evidence from Taiwanese firms," Review of Quantitative Finance and Accounting, Springer, vol. 44(1), pages 41-67, January.

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    More about this item

    Keywords

    Earnings manipulation; intertemporal substitution; design of securities; property rights; moral hazard.;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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