Discussion Paper Details

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Title: Earnings Manipulation and Incentives in Firms

Author(s): Guido Friebel and Sergei Guriev

Publication Date: January 2005

Keyword(s): agency costs, flat hierarchies, Sarbanes Oxley Act and whistleblowing

Programme Area(s): Financial Economics and Industrial Organization

Abstract: We study the effect of earnings manipulation on incentives within the corporate hierarchy. When top management manipulates earnings, it must prevent information leakage from corporate insiders to the outside world. If an insider (e.g. a division manager) gains evidence about earnings manipulation, the threat to blow the whistle can provide them with an additional payment. We show that it is easier for division managers to prove top management?s manipulations when the performance of their own divisions is low. Earnings manipulation therefore undermines division managers? incentives to exert effort and destroys value. We show that earnings manipulation is more likely to occur in flatter hierarchies; we also discuss implications of the auditing and whistle-blowing regulations of the Sarbanes Oxley Act.

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Bibliographic Reference

Friebel, G and Guriev, S. 2005. 'Earnings Manipulation and Incentives in Firms'. London, Centre for Economic Policy Research.