Equilibrium (dis)honesty

This paper analyzes the production of fraudulent financial statements in a model featuring the main characteristics of the US corporate information market. Main players are managers, shareholders, auditors and the auditors’ public supervisor. It is shown that, in the overall equilibrium, not only managers at the head of bad firms, but also some of those running good firms may resort to dishonest reporting. The probability of cheating appears to be positively related to the frequency of good firms. Pushing too far the supervisor’s incentives to fight fraud might prompt more good firms’ managers to provide dishonest reports.