Honesty in Managerial Reporting

TLDR

The study investigates how wealth and honesty preferences shape managerial reporting via three experiments. Results show that subjects sacrifice wealth for honesty, do not increase lying with higher payoff, honesty drops when managers receive a smaller share, and that an optimal agency contract—especially one incorporating honesty preferences—maximizes firm profit, suggesting firms can design more profitable contracts than conventional theory.

Abstract

This study reports the results of three experiments that examine how preferences for wealth and honesty affect managerial reporting. We find that subjects often sacrifice wealth to make honest or partially honest reports, and they generally do not lie more as the payoff to lying increases. We also find less honesty under a contract that provides a smaller share of the total surplus to the manager than under one that provides a larger share, suggesting that the extent of honesty may depend on how the surplus is divided between the manager and the firm. The optimal agency contract yields more firm profit than a contract that relies exclusively on honest reporting. However, a modified version of the optimal agency contract, which makes use of subjects' preferences for honest reporting, yields the highest firm profit. These results suggest that firms may be able to design more profitable employment contracts than those identified by conventional economic analysis.