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The Contract Disclosure Mandate and Earnings Management under External Scrutiny

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Item Summary Carlos Corona Tae-Wook Ryan Kim 2019-12-06T18:42:18Z 2019-12-06T18:42:18Z 2019-09-02
dc.description.abstract This paper studies the effects of mandating compensation disclosure on executive incentive contracts, and the ensuing effects on earnings management, and shareholders' and social welfare. We develop a moral hazard model with multiple principal-agent pairs facing an external inspector who allocates resources across firms to uncover and penalize earnings management. Contract disclosure confers principals with a first-mover advantage, allowing them to design the contract anticipating the inspector's reaction. However, it may also exacerbate a coordination problem among principals, as they do not consider externalities on other principals caused by the effects of their contract choices on the inspector's scrutiny allocation. We find that, if the penalty the inspector imposes on executives is relatively harsher than that imposed on shareholders, contracts become more strongly contingent on reported earnings, earnings are more severely manipulated, and social welfare increases with contract disclosure. However, disclosure improves shareholders' welfare only if the scrutiny resources available to the inspector are not strongly constrained.
dc.subject compensation
dc.subject contract
dc.subject disclosure
dc.subject agency
dc.subject enforcement
dc.subject inspector
dc.title The Contract Disclosure Mandate and Earnings Management under External Scrutiny
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