RFS Advance Access originally published online on January 29, 2007
Review of Financial Studies 2007 20(4):1219-1254; doi:10.1093/revfin/hhm012
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Booms, Busts, and Fraud
Carlson School of Management, University of Minnesota, USA
Carlson School of Management, University of Minnesota, USA
Carlson School of Management, University of Minnesota, USA
Department of Finance, 3-259 Carlson School of Management, University of Minnesota, 321 19th Avenue South, Minneapolis, MN 55455, or e-mai: povel{at}umn.edu
JEL: E320, G300, G380
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Abstract |
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Firms sometimes commit fraud by altering publicly reported information to be more favorable, and investors can monitor firms to obtain more accurate information. We study equilibrium fraud and monitoring decisions. Fraud is most likely to occur in relatively good times, and the link between fraud and good times becomes stronger as monitoring costs decrease. Nevertheless, improving business conditions may sometimes diminish fraud. We provide an explanation for why fraud peaks towards the end of a boom and is then revealed in the ensuing bust. We also show that fraud can increase if firms make more information available to the public.
We would like to thank an anonymous referee for very helpful comments. We are also indebted to Ulf Axelson, Markus Brunnermeier, Sudipto Dasgupta, Eitan Goldman, Charlie Hadlock, Andrew Hertzberg, Simi Kedia, Tom Nohel, Oguzhan Ozbas, Javier Suarez, and seminar participants at Columbia University, Duke University, Göteborg University, McGill University, Michigan State University, the University of Alberta, the University of Iowa, the University of Minnesota, the University of Pennsylvania, the 2005 American Finance Association meeting in Philadelphia, the 15th Annual Conference on Financial Economics and Accounting at USC, the JFI conference "Corporate Governance: Present and Future" at Washington University St. Louis, the CEPR/SITE conference "Understanding Financial Architecture: On the Economics and Politics of Corporate Governance" at Stockholm School of Economics, the conference "People and Money: The Human Factor in Financial Decision-Making" at DePaul University, the RFS-IU conference "The Causes and Consequences of Recent Financial Market Bubbles", and the 2005 HKUST Finance Symposium for helpful comments.
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