Multiple Control Systems, Accrual Accounting, and Earnings Management

The article looks at the interaction of financial reporting systems with contracting systems using a principal-agent model. Reporting discretion is determined in a trade-off between the financial reporting system and the contracting system as well as the owner's decision of what is optimal. Reporting of a firm's economic earnings is termed truthful reporting while reporting discretion is looked at as earnings management. The manager manipulates accruals and economic earnings. The principal-agent model deals with moral hazard over managerial reporting with the contracting system in order to discipline reporting behavior.