Deceiving Two Masters: The Effects of Labor Market Incentives on Reporting Bias and Market Efficiency

Abstract

We study managers’ decisions to bias financial reports that are used not only in capital markets but also in labor markets. Managers manipulate reports to influence the labor market assessment of their talents. This manipulation introduces noise in financial reports and reduces their usefulness for capital markets. We study the determinants of price informativeness and expected reporting bias as two measures of capital market efficiency and develop novel predictions. For instance, higher uncertainty about firm fundamentals can decrease earnings response coefficients if the uncertainty is related to managers’ unknown talents. Supplemental disclosures on managerial talent help mitigate the detrimental effects of managers’ labor market incentives. We find that such disclosures may become more useful if they are increasingly susceptible to manipulation.

Keywords: reporting bias, labor markets, multiple audience, market efficiency

JEL Classification: G14, J24, M12