Information versus Investment

The accuracy of firm information disclosures and the efficiency of long-term investment both play crucial roles in the economy and capital markets. We estimate a dynamic model that captures a trade-off between these two goals that arises when managers confront realistic incentives to misreport financial statements and distort their real investment choices. Managers in our model distort reported profits by 6.7% of sales on average. Counterfactual analysis reveals that while eliminating this misreporting through disclosure regulation is possible, it incentivizes managers to distort real investment, which results in a 1% drop in average firm value, reflecting a quantitatively meaningfully tradeoff.