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Optimal Contracts with Performance Manipulation

Author

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  • ANNE BEYER
  • ILAN GUTTMAN
  • IVÁN MARINOVIC

Abstract

type="main"> We study optimal compensation contracts that (1) are designed to address a joint moral hazard and adverse selection problem and that (2) are based on performance measures, which may be manipulated by the agent at a cost. In the model, a manager is privately informed about his productivity prior to being hired by a firm. In order to incentivize the manager to exert productive effort, the firm designs a compensation contract that is based on reported earnings, which can be manipulated by the manager. Our model predicts that (1) the optimal compensation contract is convex in reported earnings; (2) the optimal contract is less sensitive to reported earnings than it would be absent the manager's ability to manipulate earnings; and (3) higher costs of manipulating reported earnings (e.g., due to higher governance quality) are associated with higher firm value, lower expected level of earnings management, and higher output.

Suggested Citation

  • Anne Beyer & Ilan Guttman & Iván Marinovic, 2014. "Optimal Contracts with Performance Manipulation," Journal of Accounting Research, Wiley Blackwell, vol. 52(4), pages 817-847, September.
  • Handle: RePEc:bla:joares:v:52:y:2014:i:4:p:817-847
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    File URL: http://hdl.handle.net/10.1111/1475-679X.12058
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    References listed on IDEAS

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    Cited by:

    1. Xie, Jun, 2015. "CEO career concerns and investment efficiency: Evidence from China," Emerging Markets Review, Elsevier, vol. 24(C), pages 149-159.

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