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The effects of imperfect auditing on managerial compensation

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  • Baglioni, Angelo
  • Colombo, Luca

Abstract

We study the optimal shareholder-manager contract having the property to induce the manager to exert high effort and truthfully reveal firm performance. This contract design problem is solved under the assumption of imperfect auditing, either because of mistakes or because of collusion between managers and auditors. The imperfection of the audit technology is costless up to a threshold, beyond which it causes a distortion in the incentive compatible contract or even prevents its existence. This result may help explain the observed decline in the use of stock options, tracing it back to an unfocused activity or poor performance of auditors.

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  • Baglioni, Angelo & Colombo, Luca, 2011. "The effects of imperfect auditing on managerial compensation," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 542-548, October.
    • Handle: RePEc:eee:reveco:v:20:y:2011:i:4:p:542-548
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    Cited by:

    1. Chen, Chao-Jung & Hsu, Chung-Yuan & Chen, Yu-Lin, 2014. "The impact of family control on the top management compensation mix and incentive orientation," International Review of Economics & Finance, Elsevier, vol. 32(C), pages 29-46.
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    3. Andergassen, Rainer, 2016. "Managerial compensation, product market competition and fraud," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 1-15.
    4. Loyola, Gino & Portilla, Yolanda, 2020. "Managerial compensation as a double-edged sword: Optimal incentives under misreporting," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 994-1017.

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