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The accounting art of war: Bounded rationality, earnings management and insider trading

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  • Elitzur, Ramy

Abstract

The study uses the idea of a multi-faceted managerial strategy and examines the effects of bounded rationality and ethical compass on insider trading, earnings management, and managerial effort. The analysis establishes that bounded rationality and the ethical compass play an important role in the managers' decisions. As such, the study provides an insight into why managers would engage in schemes that could potentially ruin their lives. The analysis also demonstrates that earnings management has multi-period dynamic properties, while the effort and insider trading decisions are made independently each period. Another interesting finding is that that earnings manipulation can only occur in a world with ethically diverse managers. Contrary to common wisdom, the study shows that shareholders have a vested interest in eliciting income management because it boosts their wealth. Consequently, expected market losses to shareholders' value, in response to detected accounting manipulations, are necessary to mitigate shareholders' preferences for earnings management. It is interesting to note that shareholders' preferences for earnings management (balanced by the expected market losses) imply that they would not necessarily prefer to hire the most ethical and least 'bounded rationality' decision-making managers. Finally, the study examines the public policy implications of the topic in light of the recent US Senate Financial Regulation Overhaul bill.

Suggested Citation

  • Elitzur, Ramy, 2011. "The accounting art of war: Bounded rationality, earnings management and insider trading," Journal of Accounting and Public Policy, Elsevier, vol. 30(3), pages 203-216, May.
  • Handle: RePEc:eee:jappol:v:30:y:2011:i:3:p:203-216
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    Cited by:

    1. Esther B. Brio & Ilidio Lopes-e-Silva & Javier Perote, 2016. "Effects of opportunistic behaviors on security markets: an experimental approach to insider trading and earnings management," Economia Politica: Journal of Analytical and Institutional Economics, Springer;Fondazione Edison, vol. 33(3), pages 379-402, December.
    2. Hu, May & Tuilautala, Mataiasi & Yang, Jingjing & Zhong, Qian, 2022. "Asymmetric information and inside management trading in the Chinese market," The North American Journal of Economics and Finance, Elsevier, vol. 62(C).
    3. Lenka Zemánková, 2015. "Big Bath as a Determinant of Creative Accounting in Small and Micro Enterprises," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 63(5), pages 1779-1785.

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