The John M. Olin Center

Paper Abstract

400. Lucian Arye Bebchuk and Oren Bar-Gill, Misreporting Corporate Performance, 12/2002.

Abstract: This paper develops a model of the causes and consequences of misreporting of corporate performance. We model why and when managers of public companies will choose to misreport and to invest in creating opportunities for misreporting. Even managers who cannot sell their shares in the short run might misreport in order to improve the terms upon which the company would be able to issue equity to finance new projects or stock acquisitions. When managers are free to sell some of their holdings in the short-run, incentives to misreport and the incidence of misreporting increase to an extent depending the fraction of their holdings that managers may sell and on their ability to sell without the market knowing about it. Investments in misreporting have real economic costs and lead to distortions in capital raising decisions, with firms that misreport raisin raising much equity and firms that do not misreport raising too little. Lax accounting and legal rules increase investments in opportunities to misreport and the incidence of misreporting and, as a result, reduce ex ante share value. Our analysis provides a range of testable predictions concerning the periods, industries, and type of firms in which misreporting is likely to occur. The analysis also has implications for corporate governance and executive compensation.

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