Earnings Manipulation, Manager's Compensation and Reputation Concerns

This paper analyzes the effects of managerial compensation and reputation concerns on earnings manipulation. I develop a model of earnings reporting in which a privately informed manager trades-off incentives to manipulate earnings which increases his compensation against incentives to be honest which improves his reputation.In equilibrium the manager manipulates earnings, but not enough to make reports uninformative. He lies with positive probability when underlying earnings are low, and he reports the truth when underlying earnings are high. Earnings manipulation is stronger when the manager is closer to retirement. Manipulation is independent of the sensitivity of the manager's compensation to reported earnings. Finally, earnings manipulation and accounting discretion have a bell-shaped relation: increasing discretion when it is low, leads to more earnings manipulation, and vice-versa. These results are robust to different compensation schemes and the inclusion of an accruals' constraint