Strategic Misreporting and Investment Distortions: How Agency Costs Shape Project Selection and Timing

This paper introduces a dynamic model of corporate investment that integrates misreporting incentives with leverage and growth option timing. Unlike existing models, it shows how strategic income misreporting distorts project ranking, leading firms to prioritise short-term cash-generating investments over higher-NPV alternatives. The model reveals a novel interaction between moral hazard and debt overhang, generating a history-dependent wedge between marginal and average q. It also predicts serial investment correlation and endogenous dividend policy. These insights extend the literature on dynamic contracting and investment under agency frictions, offering new empirical predictions and implications for optimal financial contract design.

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