Abstract

Our paper examines the effect of product market competition on corporate financial misreporting. We find that while firms’ propensity for fraud in concentrated industries is relatively insensitive to industry investment booms, firms in competitive industries have a strongly pro-cyclical propensity to commit fraud. As a result, investment booms in competitive industries tend to be accompanied by significant waves of corporate securities fraud. Further analysis suggests that the lack of information gathering about individual firms in the product market and the use of relative performance evaluation in managerial compensation play important roles in generating the cyclical fraud commitment in competitive industries. Our study highlights the potential impact of the destructive forces associated with product market competition, particularly during industry boom-bust periods.