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Booms, Busts, and Fraud

Author

Listed:
  • Paul Povel

    (University of Minnesota)

  • Rajdeep Singh

    (University of Minnesota)

  • Andrew Winton

    (University of Minnesota)

Abstract

We examine firm managers' incentives to commit fraud in a model where firms seek funding from investors and investors can monitor firms at a cost in order to get more precise information about firm prospects. We show that fraud incentives are highest when business conditions are good, but not too good: in exceptionally good times, even weaker firms can get funded without committing fraud, whereas in bad times investors are more vigilant and it is harder to commit fraud successfully. As investors' monitoring costs decrease, the region in which fraud occurs shifts towards better business conditions. It follows that if business conditions are sufficiently strong, a decrease in monitoring costs actually increases the prevalence of fraud. If investors can only observe current business conditions with noise, then the incidence of fraud will be highest when investors begin with positive expectations that are disappointed ex post. Finally, increased disclosure requirements can exacerbate fraud. Our results shed light on the incidence of fraud across the business cycle and across different sectors.

Suggested Citation

  • Paul Povel & Rajdeep Singh & Andrew Winton, 2003. "Booms, Busts, and Fraud," Finance 0312007, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0312007
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    References listed on IDEAS

    as
    1. Persons, John C & Warther, Vincent A, 1997. "Boom and Bust Patterns in the Adoption of Financial Innovations," The Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 939-967.
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    4. Feroz, Eh & Park, K & Pastena, Vs, 1991. "The Financial And Market Effects Of The Secs Accounting And Auditing Enforcement Releases," Journal of Accounting Research, Wiley Blackwell, vol. 29, pages 107-142.
    5. Caplan, D, 1999. "Internal controls and the detection of management fraud," Journal of Accounting Research, Wiley Blackwell, vol. 37(1), pages 101-117.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Boom; Credit Cycle; Fraud; Monitoring;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G3 - Financial Economics - - Corporate Finance and Governance
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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