Financial Reporting, Auditing, Analyst Scrutiny, and Investment Efficiency

This paper presents an economic framework to study strategic interactions along the analyst--auditor--owner monitoring chain in a financial reporting game and sheds light on possible consequences of various capital market regulations. We find that enhancing the analyst's independence alleviates financial misreporting and improves audit quality, analyst scrutiny, financial statement reliability, and investment efficiency. A surprising result emerges from the model that enhancing the auditor's legal liability and increasing the owner's misreporting cost might have unintended consequences in terms of their impacts on financial statement reliability and investment efficiency