structure executive compensation in such a way as to reduce the incentives for executives to engage in unproductive activities. However, compensation is, of managements’ necessity, tightly tied to success—as A board of reported by management! directors’ decision to renew the contract, the movement of stock prices, and the executive’s achievement of stated criteria for performance bonuses are all functions of corporate data; corporate data that are prepared by management. Certainly, there are other sources of information (news reports, independent reports, direct observation of products analysts’ and traffic at stores, etc.) but most of the information about most corporations comes from insiders whose current compensation and career prospects are directly tied to the content of that information. That so much of a prospects is reliant on information that the manager manager’s is responsible for providing creates a strong temptation for the manager, if the truth is not flattering, to manipulate the information that is released. Even managers who do not wish to mislead the public can make self-serving judgments and estimates (accounting is a far less concrete and definite art than most outsiders recognize) without fully recognizing their own biases (Bazerman and Tenbrunsel, 2011; Moore et al., 2006; Bazerman et al., 1997; Kunda, 1990). To reduce the ability of managers to report incomplete, misleading, or even fictional accounts of their modern corporate governance company’s performance, systems use several mechanisms. The primary explicit mechanism is the financial audit, the focus of this paper. Before the financial reports are issued to shareholders company’s and the market, an independent, external accounting firm is hired to audit the financial statements prepared by the issuer. The task of the auditors is to assure that items are
structure executive compensation in such a way as to reduce the incentives for executives to engage in unproductive activities. However, managements’ compensation is, of necessity, tightly tied to success—as reported by management! A board of directors’ decision to renew the executive’s contract, the movement of stock prices, and the achievement of stated criteria for performance bonuses are all functions of corporate data; corporate data that are prepared by management. Certainly, there are other sources of information (news reports, independent analysts’ reports, direct observation of products and traffic at stores, etc.) but most of the information about most corporations comes from insiders whose current compensation and career prospects are directly tied to the content of that information. That so much of a manager’s prospects is reliant on information that the manager is responsible for providing creates a strong temptation for the manager, if the truth is not flattering, to manipulate the information that is released. Even managers who do not wish to mislead the public can make self-serving judgments and estimates (accounting is a far less concrete and definite art than most outsiders recognize) without fully recognizing their own biases (Bazerman and Tenbrunsel, 2011; Moore et al., 2006; Bazerman et al., 1997; Kunda, 1990). To reduce the ability of managers to report incomplete, misleading, or even fictional accounts of their company’s performance, modern corporate governance systems use several mechanisms. The primary explicit mechanism is the financial audit, the focus of this paper. Before the company’s financial reports are issued to shareholders and the market, an independent, external accounting firm is hired to audit the financial statements prepared by the issuer. The task of the auditors is to assure that items are
AB-JAK_20110531-jn.docx