Financial Reporting and Market Efficiency With Extrapolative Investors
61 Pages Posted: 15 Nov 2019
Date Written: February 7, 2015
We model a financial market in which companies engage in strategic financial reporting knowing that investors only pay attention to a randomly drawn sample from firms' reports and extrapolate from this sample. We investigate the extent to which stock prices differ from the fundamental values, assuming that companies must report all their activities but are otherwise free to disaggregate their reports as they wish. We show that no matter how large the samples considered by investors are, a monopolist can induce a price of its stock bounded away from the fundamental. Besides, increasing the number of companies competing to attract investors may exacerbate the mispricing of stocks.
Keywords: extrapolation, efficient market hypothesis, competition, sophistication, financial reporting
JEL Classification: C72, D53, G14
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