Overinvestment and fraud

We analyze the interactions between two managerial tasks: investing and revealing information. We assume that a manager can invest influencing the firm's quality, then he reports this quality to investors. Whenever truthful reporting is not an equilibrium, the manager has incentives to overinvest relative to shareholders. Therefore, the potential for market manipulation is the key in understanding investment policy; it is the desire to manipulate prices that leads to inefficient investment. Also, more manipulation occurs when the manager is in control, so prices are less informative. Finally, we show that the manager is better off with an exogenous reporting policy. (C) 2007 Elsevier B.V. All rights reserved.