Property rights and earnings manipulation

Existing literature on property rights stresses the effect that distortions in future investment decisions have on establishing the optimal property rights. This paper demonstrates that property rights may also be affected by contracts which exist prior to the establishment of property rights. We consider a two-period model where a fi�rm�'s claimholders have contracts on current earnings and must determine the allocation of property rights on the �firm�'s residual assets. The allocation of these rights affects the claimholders' �incentives to undertake optimal fi�nancial decisions which simultaneously affects current cash fl�ows and the fi�rm'�s residual value. We argue that property rights should be connected to the existing contracts through the rule of marginal revenues in order to mitigate the intertemporal substitution (earnings manipulation) problem