An Equilibrium Model of Incentive Contracts in the Presence of Information Manipulation

Posted: 30 Mar 2006

See all articles by Eitan Goldman

Eitan Goldman

Indiana University - Kelley School of Business - Department of Finance; European Corporate Governance Institute (ECGI)

Steve L. Slezak

University of Cincinnati - Department of Finance - Real Estate

Abstract

This paper develops an agency model in which stock-based compensation is a double-edged sword, inducing managers to exert productive effort but also inducing managers to divert valuable firm resources to misrepresent performance. We examine how the potential for manipulation affects the equilibrium level of pay-for-performance sensitivity and derive several new cross sectional implications that are consistent with recent empirical studies. In addition, we analyze the impact of recent regulatory changes contained in the Sarbanes-Oxley Act of 2002 and show that in some cases policies intended to increase firm value by reducing misrepresentation may actually reduce firm value or increase the upward bias in manipulated disclosures.

Keywords: Fraud, earnings manipulation, optimal contract

JEL Classification: D82, G34, J33, K22, M41, M43

Suggested Citation

Goldman, Eitan and Slezak, Steve L., An Equilibrium Model of Incentive Contracts in the Presence of Information Manipulation. Journal of Financial Economics (JFE), Forthcoming, EFA 2004 Maastricht Meetings Paper No. 3206, Available at SSRN: https://ssrn.com/abstract=892608 or http://dx.doi.org/10.2139/ssrn.465201

Eitan Goldman (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-856-0749 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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1000 Brussels
Belgium

Steve L. Slezak

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business Administration
Cincinnati, OH 45221
United States