TY  - JOUR
AU  - Crocker,Keith J.
AU  - Slemrod,Joel
TI  - The Economics of Earnings Manipulation and Managerial Compensation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12645
PY  - 2006
Y2  - October 2006
UR  - http://www.nber.org/papers/w12645
L1  - http://www.nber.org/papers/w12645.pdf
N1  - Author contact info:
Keith Crocker
Pennsylvania State University
SMEAL College of Business
Department of Insurance and Real Estate
333 Business Building
University Park, PA  16802
E-Mail: kcrocker@psu.edu

Joel Slemrod
University of Michigan Business School
701 Tappan Street
Room R5396
Ann Arbor, MI  48109-1234
Tel: 734/936-3914
Fax: 734-615-4323
E-Mail: jslemrod@umich.edu
AB  - 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.
ER  -