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American Law and Economics Review Advance Access originally published online on September 13, 2006
American Law and Economics Review 2006 8(3):439-475; doi:10.1093/aler/ahl012
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© The Author 2006. Published by Oxford University Press on behalf of the American Law and Economics Association. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org

The Economic Consequences of Accounting Fraud in Product Markets: Theory and a Case from the U.S. Telecommunications Industry (WorldCom)

Gil Sadka

Columbia Business School, Columbia University

Send correspondence to: Gil Sadka, Columbia Business School, Columbia University, 613 Uris Hall, 3022 Broadway, New York, NY 10027; E-mail: gs2235{at}columbia.edu.

This article studies the effects of accounting fraud on the product market. The model presented in this article relies on the idea that a firm’s financial statements and actions must be consistent with each other. If the firm is behaving fraudulently, insofar as its financial statements portray it as relatively efficient, the firm must act accordingly, that is, increase its market share and/or reduce its prices. If the firm does not behave in keeping with its fraudulent financials, the market would be able to identify the fraud. As such, the manager will take actions and make pricing decisions that are not optimal. These actions can have a significant adverse effect on social welfare. This article utilizes the WorldCom case to illustrate the implications of such fraudulent behavior and its economic significance in product markets.


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