Financial Misreporting: Hiding in the Shadows or in Plain Sight?

52 Pages Posted: 23 Apr 2018

See all articles by Delphine Samuels

Delphine Samuels

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA)

Daniel J. Taylor

University of Pennsylvania - The Wharton School

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Date Written: April 2018

Abstract

This paper examines how the quality of a firm’s information environment influences a manager’s subsequent decision to misreport. The conventional wisdom is that high-quality information facilitates monitoring and increases the cost of misreporting, suggesting a negative relation between the quality of the information environment and misreporting. However, high-quality information also increases the weight that investors place on earnings in valuing the firm. This in turn increases the benefit of misreporting, suggesting a positive relation. We formalize these two countervailing forces –– “monitoring” and “valuation” –– in the context of a parsimonious model of misreporting. We show that the combination of these two forces leads to a unimodal relation. Specifically, as the quality of the information environment improves, misreporting first increases, reaches an inflection point, and then decreases. We find evidence of such a relation in multiple empirical measures of misreporting. Misreporting is greatest in a medium-quality environment and least in both high- and low-quality environments.

Keywords: misreporting, misrepresentation, fraud, earnings management, monitoring, valuation, information quality, information environment

JEL Classification: G14, G34, L21, M41, M42, M43

Suggested Citation

Samuels, Delphine and Taylor, Daniel and Verrecchia, Robert E., Financial Misreporting: Hiding in the Shadows or in Plain Sight? (April 2018). Available at SSRN: https://ssrn.com/abstract=3157222 or http://dx.doi.org/10.2139/ssrn.3157222

Delphine Samuels

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

Daniel Taylor (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Robert E. Verrecchia

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6976 (Phone)
215-573-2054 (Fax)

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