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

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