The Strategic Interaction between Committing and Detecting Fraudulent Misreporting

• In Event: Financial Reporting and Corporate Governance

Abstract

This paper develops an agency model of equity-based compensation (EBC) and fraudulent misreporting in which there are interactions between the fraud commission strategy of the manager, the investigation strategy of a monitor, and the efficacy with which EBC motivates the manager to exert effort. Given variation in exogenous parameters characterizing general economic conditions and the firm’s contracting and monitoring environment, the model generates a richer set of relationships between equilibrium levels of EBC, manipulation, and managerial productivity than available in existing models. Consistent with the mixed results of recent empirical studies on the relationship between EBC and evidence of manipulation, the theory implies the relationship is not unidirectional and depends upon a variety of conditioning variables not universally accounting for in empirical studies. The paper examines the extent to which the conditional implications of the model are consistent with the evidence documented in the empirical literature and suggests specific conditioning variables for future conditional tests.

Authors

• Steve L. Slezak, University of Cincinnati

• Buhui Qiu, Erasmus University Rotterdam