Working Paper: NBER ID: w12645
Authors: Keith J. Crocker; Joel Slemrod
Abstract: This paper examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm. When realized, these earnings constitute hidden information that is privately observed by the manager, who may expend resources to generate an inflated earnings report. We characterize the optimal managerial compensation contract in this setting, and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits, and to report those profits honestly. As a result, some degree of earnings management must be tolerated as a necessary part of an efficient agreement.
Keywords: No keywords provided
JEL Codes: A12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| structure of compensation contracts (J33) | potential for earnings manipulation (M52) |
| need for profit maximization (L21) | acceptance of some earnings manipulation (M48) |
| higher equity incentives (M52) | increased earnings manipulation (M52) |