Can earnings manipulation create value?
AbstractExisting 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.
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Bibliographic InfoPaper provided by University of Guelph, Department of Economics and Finance in its series Working Papers with number 0803.
Length: 22 pages
Date of creation: 2008
Date of revision:
Earnings manipulation; intertemporal substitution; design of securities; property rights; moral hazard.;
Find related papers by 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 - - Intertemporal Choice - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-01-12 (All new papers)
- NEP-BEC-2008-01-12 (Business Economics)
- NEP-ENT-2008-01-12 (Entrepreneurship)
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