Everlasting Fraud

This paper proposes a new theory to explain the persistence of corporate fraud despite stringent anti-fraud regulations. Our model reveals a "cat-and-mouse" equilibrium within firms, where detection strength optimally matches fraud severity and a "whacka-mole" equilibrium across firms, where regulatory resources are optimally concentrated on the most fraudulent firms. As such, regulations cannot eradicate fraud but synchronize firms' idiosyncratic fraud levels, contributing to waves. Structural estimation demonstrates the model's alignment with data. These results hold significant policy implications by highlighting fraud as an enduring risk in the financial markets and the limited efficacy of anti-fraud regulations.