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Formerly Graduate
School of Industrial Administration (GSIA) William Larimer Mellon, Founder Schenley Park Pittsburgh, Pennsylvania 15213-3890 United States of America |
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Pierre Jinghong Liang |
Equilibrium Earnings Management, Incentive Contracts,
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Pierre Jinghong Liang
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Contemporary Accounting Research Vol. 21, no. 3 (Fall 2004) p. 685-718 |
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| Downloading the paper | ||||
| 2003-Jun Draft | ||||
| Abstract: | ||||
| In this paper, we model earnings management as a consequence of the interaction among self-interested economic agents, namely the managers, the shareholders, and the regulators. In our model, a manager controls a stochastic production technology and makes periodic accounting reports about his performance; an owner chooses a compensation contract to induce desirable managerial inputs and reporting choices by the manager; and a regulatory body selects and enforces accounting standards to achieve certain social objectives. We restrict attention to linear contracts. As a result of this restriction, the owner may be better-off designing contracts that encourage the manager to manage his accounting performance. Such earnings management activity produces accounting reports that deviate from what is prescribed by accounting standards. Given such reports, the valuation of the firm may be nonlinear and S-shaped, recognizing the manager's reporting incentives. We also explore policy implications, noting (i) the regulator may find enforcing a zero-tolerance policy – no earnings management is allowed – economically undesirable; and (ii) when selecting the optimal accounting standard, valuation concerns may conflict with stewardship concerns. We conclude earnings management is better understood in a strategic context involving various economic trade-offs. | ||||
| English Version Last updated May 2, 2005 send comments to liangj@andrew.cmu.edu |
Chinese Version Last updated January 6, 2004 send comments to liangj@andrew.cmu.edu |
