Working Paper: CEPR ID: DP4850
Authors: Guido Friebel; Sergei Guriev
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.
Keywords: agency costs; flat hierarchies; sarbanes oxley act; whistleblowing
JEL Codes: D23; G30; M40; M52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Earnings manipulation by top management (M12) | Incentives of division managers (M54) |
| Incentives of division managers (M54) | Effort and value creation within firms (D22) |
| Organizational structure (L22) | Incidence of earnings manipulation (M48) |
| Low performance of divisions (D29) | Increased likelihood of whistleblowing (D73) |
| Increased likelihood of whistleblowing (D73) | Incentives to exert effort (J33) |
| Regulatory changes (Sarbanes-Oxley Act) (G38) | Incidence of earnings manipulation (M48) |