Rank-and-File Accounting Employee Incentives and Financial Reporting Quality

An extensive literature examines whether senior executives’ contractual incentives influence their financial reporting decisions. However, little is known about whether— and how—the incentives of lower-level (or “rank-and-file†) employees, who are perhaps even more directly involved in the financial reporting process, influence their behavior. We use a proprietary database with detailed, employee-specific information about these employees’ incentive-compensation plans and find that although firms with relatively well-paid accounting employees tend to issue higher quality financial reports, their reports tend to be of lower quality when these employees’ compensation is contingent rather than fixed. We also find that these relationships are more pronounced at firms whose senior executives have stronger contractual incentives to misreport, which sheds light on when lower-level accounting employees have incentives to promote, discourage, or thwart financial misreporting.