Prof. Wagenhofer will present his new paper "Punishing Firms for Their Managers' Misreporting" at the SOWI Research Seminar.
The seminar will be held from 12-1 p.m. in the room SR15.25.
Topic of the paper:
Upon discovery of misreporting, not only managers but also firms incur penalties. We develop a model to study the effects of managers' and corporate penalties for financial reporting quality, firm value, the ex ante cost of capital, and the asymmetry in market reactions to positive and negative earnings news. Our model features a myopic manager who engages in accounting manipulation, a benevolent board that exerts costly oversight effort to prevent misreporting, and a perfectly competitive capital market. Corporate penalties have two immediate implications: they provide oversight incentives to the board, and investors assign a discount to the firm's stock price, which is detrimental to the firm's cost of capital. We derive the following main results. (i) Corporate penalties unambiguously improve financial reporting quality and reduce the asymmetry in market reactions, whereas managers' penalties can impair quality and increase asymmetry if corporate penalties are large. (ii) Firm value and the ex ante cost of capital can increase or decrease in both corporate and managers' penalties, where the effect again depends on the size of corporate penalties. (iii) Increasing the ex post misreporting detection likelihood (e.g., by increasing public enforcement intensity) improves financial reporting quality and market reaction asymmetry in most cases but has an ambiguous effect on firm value and the cost of capital. We discuss empirical and regulatory implications of our results.