Liars Never Prosper? How Management Misrepresentation Reduces Monitoring Costs

Posted: 11 Apr 1995

Multiple version iconThere are 2 versions of this paper

Date Written: November 1994

Abstract

This paper shows that contracting costs are sometimes minimized by contracts that induce managers to make "false" reports to investors. Previous models presume that investors can be costlessly compelled to verify a manager's reports. In contrast, I assume that investors monitor only when they expect to benefit from doing so. This monitoring discretion overturns the Revelation Principle, and management misrepresentation can produce Pareto improvements. Discretionary monitoring also generates an equilibrium role for multiple-security financial structures, and efficiency improves when the investors are placed in conflict over monitoring strategy--one investor's decision to monitor hurts the other investor.

JEL Classification: G32, L14

Suggested Citation

Persons, John C., Liars Never Prosper? How Management Misrepresentation Reduces Monitoring Costs (November 1994). Available at SSRN: https://ssrn.com/abstract=6085

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