The Economics of Fraudulent Accounting

41 Pages Posted: 25 May 2006 Last revised: 17 Aug 2022

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: August 2005

Abstract

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 aggregate, our model seems able to account for periods of jobless and investment-less growth.

Suggested Citation

Kedia, Simi and Philippon, Thomas, The Economics of Fraudulent Accounting (August 2005). NBER Working Paper No. w11573, Available at SSRN: https://ssrn.com/abstract=788438

Simi Kedia

Rutgers Business School ( email )

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Thomas Philippon (Contact Author)

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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