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We are grateful for helpful comments provided by workshop participants in Florida International University and the 2015 AAA Annual Meeting. We are responsible for all remaining errors.

We investigate the impact of financial misreporting on peer firms’ operational efficiency, defined as a firm’s efficiency in converting investments into revenues. We find that, on average, peers’ operational efficiency declines after rival firms misstate their financial performance. However, we also find that the impact of financial misreporting is not homogeneous across peer firms. The negative effect is mainly driven by non‐misstating firms that had high performance. For firms that had lower past performance, the negative effect is significantly weaker, suggesting that the perceived competition induced by misreporting has a more positive effect. In addition, we document that the effect of misreporting is influenced by peer firms’ external financing need, industry leadership status and information environment.

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