IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/4850.html
   My bibliography  Save this paper

Earnings Manipulation and Incentives in Firms

Author

Listed:
  • Friebel, Guido
  • Guriev, Sergei

Abstract

We study the effect of earnings manipulation on incentives within the corporate hierarchy. When top management manipulates earnings, it must prevent information leakage from corporate insiders to the outside world. If an insider (e.g. a division manager) gains evidence about earnings manipulation, the threat to blow the whistle can provide them with an additional payment. We show that it is easier for division managers to prove top management’s manipulations when the performance of their own divisions is low. Earnings manipulation therefore undermines division managers’ incentives to exert effort and destroys value. We show that earnings manipulation is more likely to occur in flatter hierarchies; we also discuss implications of the auditing and whistle-blowing regulations of the Sarbanes Oxley Act.

Suggested Citation

  • Friebel, Guido & Guriev, Sergei, 2005. "Earnings Manipulation and Incentives in Firms," CEPR Discussion Papers 4850, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4850
    as

    Download full text from publisher

    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4850
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Yingyi Qian, 1994. "Incentives and Loss of Control in an Optimal Hierarchy," Review of Economic Studies, Oxford University Press, vol. 61(3), pages 527-544.
    2. Bergstresser, Daniel & Philippon, Thomas, 2006. "CEO incentives and earnings management," Journal of Financial Economics, Elsevier, vol. 80(3), pages 511-529, June.
    3. Louis, Henock, 2004. "Earnings management and the market performance of acquiring firms," Journal of Financial Economics, Elsevier, vol. 74(1), pages 121-148, October.
    4. Denis Gromb, 2000. "Public Trading and Private Incentives," FMG Discussion Papers dp347, Financial Markets Group.
    5. Philippe Aghion & Patrick Bolton & Jean Tirole, 2004. "Exit Options in Corporate Finance: Liquidity versus Incentives," Review of Finance, Springer, vol. 8(3), pages 327-353.
    6. Anton, James J & Yao, Dennis A, 1994. "Expropriation and Inventions: Appropriable Rents in the Absence of Property Rights," American Economic Review, American Economic Association, vol. 84(1), pages 190-209, March.
    7. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Journal of Political Economy, University of Chicago Press, vol. 105(1), pages 1-29, February.
    8. Raghuram G. Rajan & Luigi Zingales, 2001. "The Firm as a Dedicated Hierarchy: A Theory of the Origins and Growth of Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 116(3), pages 805-851.
    9. Patrick Bolton & José Scheinkman & Wei Xiong, 2006. "Executive Compensation and Short-Termist Behaviour in Speculative Markets," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 577-610.
    10. Oyer, Paul & Schaefer, Scott, 2005. "Why do some firms give stock options to all employees?: An empirical examination of alternative theories," Journal of Financial Economics, Elsevier, vol. 76(1), pages 99-133, April.
    11. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    12. Guido Friebel & Michael Raith, 2004. "Abuse of Authority and Hierarchical Communication," RAND Journal of Economics, The RAND Corporation, vol. 35(2), pages 224-244, Summer.
    13. Jeremy C. Stein, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 104(4), pages 655-669.
    14. Antoine Faure-Grimaud, 2004. "Public Trading and Private Incentives," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 985-1014.
    15. Tirole, Jean, 2001. "Corporate Governance," Econometrica, Econometric Society, vol. 69(1), pages 1-35, January.
    16. Johnson, Marilyn F. & Nelson, Karen K. & Pritchard, Adam C., 2002. "Do the Merits Matter More? Class Actions under the Private Securities Litigation Reform Act," Berkeley Olin Program in Law & Economics, Working Paper Series qt6t80b57r, Berkeley Olin Program in Law & Economics.
    17. Raghuram G. Rajan & Julie Wulf, 2006. "The Flattening Firm: Evidence from Panel Data on the Changing Nature of Corporate Hierarchies," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 759-773, November.
    18. Kong-Pin & C.Y. Cyrus Chu, 2005. "Internal Control versus External Manipulation: A Model of Corporate Income Tax Evasion," RAND Journal of Economics, The RAND Corporation, vol. 36(1), pages 151-164, Spring.
    19. Bhattacharya, Sudipto & Guriev, Sergei, 2004. "Knowledge Disclosure, Patents and Optimal Organization of Research and Development," CEPR Discussion Papers 4513, C.E.P.R. Discussion Papers.
    20. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December.
    21. Desai, Mihir A. & Dharmapala, Dhammika, 2006. "Corporate tax avoidance and high-powered incentives," Journal of Financial Economics, Elsevier, vol. 79(1), pages 145-179, January.
    22. Bengt Holmstrom & Steven N. Kaplan, 2003. "The State Of U.S. Corporate Governance: What'S Right And What'S Wrong?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(3), pages 8-20.
    23. Paul Povel & Rajdeep Singh & Andrew Winton, 2007. "Booms, Busts, and Fraud," Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1219-1254.
    24. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
    25. Kong-Pin Chen & C.Y. Cyrus Chu, 2005. "Internal Control vs. External Manipulation: A Model of Corporate Income Tax Evasion," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 151-164, Winter.
    26. Aubert, Cecile & Rey, Patrick & Kovacic, William E., 2006. "The impact of leniency and whistle-blowing programs on cartels," International Journal of Industrial Organization, Elsevier, vol. 24(6), pages 1241-1266, November.
    27. Guidry, Flora & J. Leone, Andrew & Rock, Steve, 1999. "Earnings-based bonus plans and earnings management by business-unit managers1," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 113-142, January.
    28. Bebchuk, Lucian Arye & Stole, Lars A, 1993. " Do Short-Term Objectives Lead to Under- or Overinvestment in Long-Term Projects?," Journal of Finance, American Finance Association, vol. 48(2), pages 719-729, June.
    29. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    30. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-153, May.
    31. Paul M. Healy & Krishna G. Palepu, 2003. "The Fall of Enron," Journal of Economic Perspectives, American Economic Association, vol. 17(2), pages 3-26, Spring.
    32. Radner, Roy, 1993. "The Organization of Decentralized Information Processing," Econometrica, Econometric Society, vol. 61(5), pages 1109-1146, September.
    33. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
    34. Michael C. Jensen, 2005. "Agency Costs of Overvalued Equity," Financial Management, Financial Management Association, vol. 34(1), Spring.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Agliardi, Elettra & Andergassen, Rainer, 2009. "Last resort gambles, risky debt and liquidation policy," Review of Financial Economics, Elsevier, vol. 18(3), pages 142-155, August.
    2. Andersson Fredrik, 2011. "Make-or-Buy Decisions and the Manipulability of Performance Measures," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 11(1), pages 1-30, December.
    3. S. Guriev & G. Egorov & K. Sonin., 2007. "Media Freedom, Bureaucratic Incentives, and the Resource Curse," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
    4. repec:rim:rimwps:31-07 is not listed on IDEAS

    More about this item

    Keywords

    agency costs; flat hierarchies; Sarbanes Oxley Act; whistleblowing;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:4850. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.