The Equilibrium Relationships between Performance-Based Pay, Performance, and the Commission and Detection of Fraudulent Misreporting
The Accounting Review · 2019 · Volume 94 · Issue 2
Abstract
We develop an agency model in which managerial information manipulation creates pooling and entailsex postcosts internal and/or external to the firm. We examine the implications of the strategic interactions between shareholders (who set internal governance and managerial incentive compensation), the manager (who exerts effort and reports on its outcome), and an external regulatory authority or RA (who investigates for fraud and levies penaltiesex post). When the RA cannot pre-commit to anex postinvestigation strategy, a fraudulent equilibrium obtains if the firm's internal governance costs are sufficiently high. Consistent with (so far fairly scant) post-SOX empirical evidence, but the opposite of the implications of signal-jamming models and equilibria with pre-commitment, the model implies an increase in minimum internal governance standards orex postfraud penalties (as with SOX) results in decreased equilibrium pay-for-performance sensitivity and firm performance.
Keywords
performance-based compensation, performance, fraud commission, fraud detection
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