ABSTRACT
Reported earnings can provide important information about the economic performance of a firm and may serve as a guide to a firm’s value. The usefulness of this information is balanced by the wide scope of managerial judgement inherent in existing accounting rules which govern financial reporting. This provides managers with the opportunity to present earnings which coincide with their personal interests rather than with those of the firm’s various stakeholders, and allows the reporting of corporate performance in ways which may obscure the firm’s true economic situation. The fact that users of financial information deem a particular financial reporting measure of importance gives managers one reason to manipulate this variable (Watts, 2003a, b). Basing managerial compensation on firm performance, measured by accounting variables under the direct control of the very same managers, provides further motivation for manipulation.
