The Role of Accounting in Ponzi Schemes

Abstract

SYNOPSIS Do accounting reports bolster investors' trust? We examine this question by modeling the incremental effect of Ponzi scheme operators providing accounting reports on the magnitude and lifespan of the underlying fraud. This investigation is possible in our setting because some, but not all, Ponzi scheme operators provide discretionary accounting reports (like falsified financial statements or fictional audit opinions) to current and potential investors. We observe that falsified audit reports lower the likelihood of regulatory detection by about 40 percent, and falsified accounting statements increase individual investor contributions by about 30 percent. Together, these results indicate that accounting reports bolster investors' trust, and that fraudsters can exploit trust in accounting institutions to maximize gains and minimize the likelihood of detection, even when accounting misrepresentations are not necessary. JEL Classifications: D14; D19; G18.