Because of imperfections in auditing technology, firms can successfully misrepresent financial reports. We offer a new mechanism, a “sunshine rule,” by which firms are required to publicize a management draft prior to the audited reports. If the final reports are materially different from the management's draft, the market penalizes both the firm and the manager. The proposal's effectiveness in eliminating “earnings management,” increasing the quality of the financial reports, and reducing the cost of the manager's incentives is illustrated in signaling games with perfect and imperfect information and a principal-agent model with perfect information.
Review of Quantitative Finance and Accounting – Springer Journals
Published: Sep 30, 2004
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