Institutional Affiliation: Rutgers University
|The Economics of Fraudulent Accounting|
with : w11573
We argue that earnings management and fraudulent accounting have important economic consequences. In a model where the costs of earnings management are endogenous, we show that in equilibrium, bad managers hire and invest too much in order to pool with the good managers. This behavior distorts the allocation of economic resources among firms. We test the predictions of the model using new historical and firm-level data. First, we show that periods of high stock market valuations are systematically followed by large increases in reported frauds. We then show that during periods of suspicious accounting, firms hire and invest excessively, while insiders exercise options and sell stocks. When the misreporting is detected, firms shed labor and capital and productivity improves. In the aggregat...
Published: Kedia, Simi and Thomas Philippon. "The Economics of Fraudulent Accounting." Review of Financial Studies 22, 6 (2009): 2169-2199. citation courtesy of