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Discussion of “equilibrium earnings management and managerial compensation in a multiperiod agency setting”

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Abstract

Dutta and Fan (Rev Account Stud, 2014), this issue, study the implications of earnings management on managerial compensation, in a two-period LEN setting. They analyze the level as well as the evolution of compensation. Furthermore, they consider the possibility of joint moral hazard and adverse selection problems. I discuss the empirical implications of their analysis, in the context of a slightly more general dynamic setting, and examine the robustness of some of their results with respect to the assumption that the principal can enforce claw-backs.

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Notes

  1. Indeed, while recent literature in finance has examined the implications of manipulation for the dynamics of manager’s compensation, in the Finance literature the manager’s manipulation is contracted away in equilibrium [see e.g., DeMarzo and Fishman (2007), Edmans et al. (2009), Varas (2013)].

  2. “This idea is due to to Dye (1988) who assert “if shareholders wish managers to exert some nontrivial effort level, they must tolerate some earnings management.”

  3. In contracting settings, this assumption is also made by, for example, Dye (1988), Liang (2004) and Bertomeu et al. (2013).

  4. In contrast with the real earnings management literature, see e.g Stein (1989).

  5. The two period model in Dye 1988 exhibits a similar feature. Liang (2004) adopts the same assumption.

  6. Empirically, it has been shown that CEO incentives increase across periods: CEO’s equity ownership goes up steeply over time [see e.g., Guay et al. (2002), Edmans et al. (2009)]. In light of DF results, this evidence might suggest that earnings management may not be an important driver of managerial contracts or alternatively that the variation in pay for performance sensitivity across periods is relatively low.

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Acknowledgments

I thank the authors, Sunil Dutta and Qintao Fan, and Jeremy Bertomeu, Ron Dye, Ilan Guttman, Stefan Reichelstein, Felipe Varas for very helpful comments.

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  1. Stanford GSB, Stanford, California, USA

    Iván Marinovic

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  1. Iván Marinovic
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Correspondence to Iván Marinovic.

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Marinovic, I. Discussion of “equilibrium earnings management and managerial compensation in a multiperiod agency setting”. Rev Account Stud 19, 1078–1085 (2014). https://doi.org/10.1007/s11142-014-9287-6

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