Signal jamming models of fraudulent misreporting and economic prospects: An experimental investigation

This study uses experimental methodology to examine how the frequency and magnitude with which managers commit fraud varies with economic prospects (Boom, Middle and Bust). The experimental design is based on signal-jamming equilibrium (SJE) models of fraud in which managers make potentially inaccurate public reports and investors bid on shares. Under SJE, managers always exaggerate reports by a fixed amount up to the maximum possible report, independent of the truth. Shareholders can perfectly correct managers' reports (except for the maximum possible report). In contrast, the results of the experiment show four robust deviations from SJE predictions: (1) managers exaggerate and shareholders correct reports according to dominated mixed-strategies with probabilities significantly less than one, (2) managers exaggerate more frequently and by more when outcomes are poor, (3) shareholders adjust low reports by less than high reports, and (4) shareholders correct relatively high reports by more in booms than busts even though managers' reporting strategies are invariant to economic prospects.