Earnings Manipulation and Incentives in Firms Guido Friebel and Sergei Guriev

1
Earnings Manipulation and Incentives in
FirmsGuido Friebel and Sergei Guriev

• Discussion
• Jayamalathy Sadagopan

2
MAIN CONCLUSIONS

• Earnings manipulation by manager, when there are
  rent-seeking divisional heads, leads to distorted
  incentives for divisional effort, and hence value
  reduction
• Underperforming divisions are more likely to
  threaten to blow the whistle and attempt to
  extract rents
• Earnings management is more likely in flatter
  hierarchies

3
BACKGROUND THEORY

• Earnings manipulation Revelation principle
  (Myerson, 1979) and violations of RP in the
  earnings management context- Limits to
  communication, contract and commitment (Arya,
  Glover and Shyam Sunder, 1998)
• Earnings management and design of management
  compensation contracts (Kadan and Yang, 2004)
• Divisional rent seeking (Scharfstein and Stein,
  2000)

4
MODEL ASSUMPTIONS

• Sufficient date 1 investors willing to buy stock
  at reported value- subject to market
  expectations (Stein, 1989), smart investors,
  transparency requirements
• Initial owners who design managers compensation
  contracts homogenous or dispersed
• Divisions bargaining power exogenous,
  independent of their private information

5
BOTTOMLINE

• How significant is the whistle-blowing threat of
  insiders at the divisional level?
• Two crucial elements
• Quality of their information relative to
  sophisticated outside investors, relative to the
  market
• Costs of mis-reporting, to the manager, auditors
  and to investors with fiduciary responsibities