Working Paper

Executive compensation and earnings management under moral hazard

Abstract: This paper analyzes executive compensation in a setting where managers may take a costly action to manipulate corporate performance, and whether managers do so is stochastic. We examine how the opportunity to manipulate affects the optimal pay contract, and establish necessary and sufficient conditions under which earnings management occurs. Our model provides a set of implications on the role earnings management plays in driving the time-series and cross-sectional variation of executive compensation. In addition, the model's predictions regarding the changes of earnings management and executive pay in response to corporate governance legislation are consistent with empirical observations.

Keywords: Executives - Salaries;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2009

Number: 985