Audit error

We study a setting in which a manager can exaggerate the observed measure of his performance, e.g., engage in window dressing or adopt unusually aggressive accounting. To limit such behavior, the firm's owner can adopt an accounting system that is less prone to manipulation. However, such a system also reduces the information content of the observed performance measure. We identify conditions under which the firm's owner will intentionally adopt an accounting system that admits self-interested manipulation by the manager in order to secure a more informative performance measure.