Investment and Financial Reporting with Two-Dimensional Information Asymmetry

This paper analyzes the real consequences of making a firm’s executives more accountable for the fidelity of a firm’s financial reports using a basic model of investment under asymmetric information with reporting. Greater accountability generally leads to less underinvestment but more overinvestment. The level of accountability that maximizes investment efficiency is low enough to allow some misreporting to occur in equilibrium. The results yield a sharp testable implication and have implications for reporting regulation.