Pay Convexity, Earnings Manipulation, and Project Continuation

Volker Laux

31 citations0/0 files storedThe Accounting Review

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Auditing, Earnings Management, Governance Corporate Finance and Governance Accounting and Organizational Management

Abstract

ABSTRACT This paper studies the optimal design of long-term executive pay plans when boards of directors use accounting information for investment decision-making and executives can take costly actions to manipulate this information. The model predicts that a shift to more convex executive pay plans, such as equity plans that rely more on options and less on stock, is associated with higher levels of manipulation, lower reporting quality, and less efficient investment. When designing the optimal contract, the board trades off these effects with the cost of inducing executive effort. The paper also analyzes how the optimal pay convexity and the equilibrium level of manipulation change when the CEO's opportunistic reporting discretion changes. The model predicts that an increase in the CEO's marginal cost of manipulation increases the optimal level of pay convexity and first increases and then decreases the magnitude of manipulation. JEL Classifications: M12; M41; G31.

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References

1991Multitask Principal–Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design 2002Audit committee, board of director characteristics, and earnings management 1996Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*1997An Empirical Analysis of the Relation between the Board of Director Composition and Financial Statement Fraud 2009How does financial reporting quality relate to investment efficiency?2008International Accounting Standards and Accounting Quality 2001Financial accounting information and corporate governance 2004CEO incentives and earnings management

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2017Dysfunctional Behavior in Organizations: Insights from the Management Control Literature 2022A Simple Approach to Better Distinguish Real Earnings Manipulation from Strategy Changes*2014Corporate Governance, Board Oversight,and CEO Turnover 2023Clawback adoptions, managerial compensation incentives, capital investment mix and efficiency 2016Optimal Reporting Systems with Investor Information Acquisition

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