Honesty Is the Best Policy–When There Is Money in It: Can Firms Promote Honest Reporting Behavior by Managers?

This paper provides experimental evidence on how incentive compensation, peer-group behavior, and audit (team) effectiveness influence managerial reporting behavior. Results show that an increase in incentive compensation intensity induces subjects to report less truthfully. High level of peer honesty promotes truthful reporting; however, the effects are weaker when incentive compensation intensity is high. Audit (team) effectiveness shows no significant influence on reporting behavior. The results provide the first clear evidence that firms need to consider carefully the effect of incentive compensation as well as the influence of peer groups when designing contracts. Furthermore, without a credible penalty for untruthful financial report, increased audit (team) effectiveness will not promote honest reporting.