N. Lu (PRC)
Earnings manipulation; Information game; Decision analysis; Quality control
Quality of financial statements has always received considerable attention from the public, accounting community and regulators. Under the presumption that earnings manipulation is more likely to occur when a firm has a strong motive and economic reason, we have analyzed the equilibrium of Investors-Management-Auditor information game. We draw a conclusion that whatever the type of the firm, the manager who wants to maximize his income derived from market value (share price) would choose a high earnings report to push the firm’s share price as high as possible, and thus threat the auditor to supply a dishonest report, even the firm is a bad firm. The analysis of the Auditor-Supervisor inspection game indicates that in order to reduce the probability of financial misreporting, the supervisor should decrease inspect costs, increase the intensity and frequency of monitoring, and punish severely the auditors who issued fraud reports.
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