A seminar by Professor Paul Povel from the University of Houston
Title: Lying to Speak the Truth: Selective Manipulation and Improved Information Transmission
Abstract: We show that ﬁrms may beneﬁt from allowing some earnings management, because it can make noisy signals more informative. We model a ﬁrm that cannot observe a manager’s cost of eﬀort, her eﬀort choice, and whether she manipulated a publicly observable performance report. An optimal contract links compensation to both the eventually realized ﬁrm value and the (possibly manipulated) report, since both are noisy measures of eﬀort provision. It may be optimal to incentivize selective manipulation of the report by a manager who exerted a high eﬀort level: Doing so can convert a falsely unfavorable report into a favorable one, thereby strengthening the link between eﬀort and compensation.
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