The Ambiguity of Earnings Announcements
We study the consequences of misreporting in settings where ambiguity-averse investors face uncertainty about two aspects of the firm: productivity and reliability of the information system. We show that the joint presence of these two sources of uncertainty distort the firm’s investment choices in opposing ways, leading to over-investment by large firms (to signal productivity) and under-investment by small firms (to signal reliability). Our analysis suggests that uncertainty regarding the reliability of financial statements affects both the level of the market-to-book ratio and its association with firm size. In addition, we show that, under plausible circumstances, reductions in uncertainty can be detrimental to social welfare: lower information asymmetry about reliability always encourages more aggressive misreporting and boosts investment, thereby exacerbating the possible over-investment problem facing some firms.