The Economics of Fraudulent Accounting

41 Pages Posted: 31 Oct 2008

See all articles by Simi Kedia

Simi Kedia

Rutgers Business School

Thomas Philippon

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

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Date Written: September 2006


We argue that earnings management and fraudulent accounting have important eco-nomic consequences. In a model where the costs of earnings management are endoge-nous, we show that in equilibrium, low productivity firms hire and invest too muchin order to pool with high productivity firms. This behavior distorts the allocation of economic resources in the economy. We test the predictions of the model using firm-level data. We show that during periods of suspicious accounting, firms hire and investexcessively, while managers exercise options. When the misreporting is detected, firmsshed labor and capital and productivity improves. Our firm-level results hold both be-fore and after the market crash of 2000. In the aggregate, our model provides a novelexplanation for periods of jobless and investment-less growth.

Suggested Citation

Kedia, Simi and Philippon, Thomas, The Economics of Fraudulent Accounting (September 2006). NYU Working Paper No. CLB-06-015, Available at SSRN:

Simi Kedia (Contact Author)

Rutgers Business School ( email )

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Thomas Philippon

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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