Job Market Paper

Earnings Manipulation, Manager’s Compensation and Reputation (This Version: November 20, 2009)

This paper analyzes the effects of manager's compensation and reputation concerns on earnings manipulation. I develop a model of earnings reporting with endogenous costs for dishonesty: in a two-period game, a manager privately observes firm earnings and reports to investors. The manager receives a share of reported earnings as compensation, giving him an incentive to report earnings that are higher than what he observes. Earnings manipulation is costly, however. Manipulating earnings will damage the manager's reputation and increase the likelihood that he will be fired by investors. In equilibrium the manager manipulates earnings, but not enough to make reports uninformative. He lies with positive probability when underlying earnings are low, but he reports the truth when underlying earnings are high. The model also predicts that earnings manipulation is stronger when i) accounting standards are worse; ii) underlying earnings are more volatile; iii) and managers are closer to retirement. The pattern of earnings manipulation is independent of how sensitive the manager's compensation is to reported earnings. These results are robust to different compensation schemes and the inclusion of an accruals' constraint.

Research Interests

Primary: Finance, Corporate Finance

Secondary: Asset Pricing, Money and Banking