Abstract

How does information transmission from financial markets to the real economy affect asset prices’ reaction to manipulated news? We examine this question in a model in which a firm manipulates public information about its productivity, investors trade a financial asset whose payoff is contingent on the firm’s value, and a capital provider decides the capital input to the firm. We analytically demonstrate that the capital provider’s learning from the asset price (i.e., the feedback effect) lowers informed investors’ perceived asset payoff risk, facilitates informed trading, increases price informativeness, and mitigates the asset price’s response to the firm’s manipulation. Consequently, the feedback effect reduces the intensity of financial reporting fraud.

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