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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page Executive Compensation and Earnings Management Under Moral Hazard
Bo Sun
2009-985  (December 2009)

Abstract:  This paper analyzes executive compensation in a setting where managers may take a costly action to manipulate corporate performance, and whether managers do so is stochastic. We examine how the opportunity to manipulate affects the optimal pay contract, and establish necessary and sufficient conditions under which earnings management occurs. Our model provides a set of implications on the role earnings management plays in driving the time-series and cross-sectional variation of executive compensation. In addition, the model's predictions regarding the changes of earnings management and executive pay in response to corporate governance legislation are consistent with empirical observations.

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Keywords
Earnings management, executive compensation, optimal contract, corporate governance

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