The Ambiguity of Earnings Announcements
Sofya Budanova, Davide Cianciaruso, Iván Marinovic
Management Science · 2021 · Volume 67 · Issue 4
Abstract
We study the consequences of misreporting in settings where ambiguity-averse investors face uncertainty about two aspects of the firm: its productivity and the weakness of its reporting system. We show that the joint presence of these two sources of uncertainty distorts the firm’s investment choices in opposing ways, leading to overinvestment by large firms (to signal productivity) and underinvestment by small firms (to signal that the reporting system is not weak). Our analysis suggests that uncertainty regarding reporting weakness affects both the level of the market-to-book ratio and its association with firm size. In addition, we show that, under plausible circumstances, reductions in uncertainty can be detrimental to social welfare: lower information asymmetry about reporting weakness always encourages more aggressive misreporting and boosts investment, thereby exacerbating the possible overinvestment problem faced by some firms. This paper was accepted by Suraj Srinivasan, accounting.
Keywords
bias, disclosure, investment, internal controls, ambiguity aversion, misreporting
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