Information versus Investment

Firms both make long term investments and reveal information about performance. These activities serve crucial roles in the economy and capital markets, yet they are in direct conflict in the presence of realistic managerial incentives to smooth reported performance. To gauge the quantitative importance of this tradeoff, we estimate a dynamic model that captures the tradeoff between investment efficiency and information accuracy. The model matches a range of observable moments constructed from data on firm investment and periods of detected misreporting by firms. Managers in our model distort reported profits on average by 3% of sales. Counterfactual analysis reveals that eliminating this misreporting through disclosure regulation is possible, but doing so incentivizes managers to distort real investment. The result would be around 1% lower firm value on average, reflecting a quantitatively meaningfully tradeoff.