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

53 Pages Posted: 23 Apr 2018 Last revised: 14 Jan 2019

See all articles by Delphine Samuels

Delphine Samuels

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

Daniel J. Taylor

Wharton School, University of Pennsylvania

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Date Written: December 1, 2018

Abstract

This paper examines how the ex ante level of public scrutiny influences a manager’s subsequent decision to misreport. The conventional wisdom is that high levels of public scrutiny facilitate monitoring and increase the cost of misreporting, suggesting a negative relation between scrutiny and misreporting. However, public scrutiny 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 level of public scrutiny increases, misreporting first increases, reaches an inflection point, and then decreases. We find evidence of such a relation in multiple empirical measures of misreporting and multiple measures of public scrutiny.

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? (December 1, 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)

Wharton School, University of Pennsylvania ( 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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