Manipulation and obfuscation of financial reports

Abstract

AbstractAnecdotally, not all investors are able to read and understand the financial report. I consider a strategic reporting game where investors are bounded rational and only pay attention to randomly sampled parts of the financial report and then extrapolate the value of the firm based on this. The manager can both obfuscate and bias the financial report. Obfuscation works by disaggregating the report into any number of line items, modeled as nonnegative signals, whose mean is constrained to be equal to the biased profitability of the firm. There can be synergies between biasing and obfuscation, causing financial statements to be both less transparent and more biased when investors are extrapolative.