Financial reporting and market efficiency with extrapolative investors

Abstract

We consider a competitive financial market in which companies engage in strategic financial reporting knowing that investors only pay attention to finitely many aspects of firms' reports and extrapolate from their sample. We investigate the extent to which stock prices differ from the fundamental values, assuming that companies must report all their activities but are otherwise free to disaggregate their reports as they wish. We show that no matter how many aspects investors are able to consider, a monopolist can induce a price of its stock bounded away from the fundamental. Besides, competition between companies may exacerbate stock mispricing.

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