Marking to Market and Inefficient Investment Decisions

We examine how mark-to-market accounting affects investment decisions in an agency model with reputation concerns. Reporting the current market value of a firm's assets in the financial statements can serve as a disciplining device because the information contained in the market price provides a benchmark against which the agent's actions can be evaluated. However, the fact that market prices are informative can have a perverse effect on the investment decisions: The agent may prefer to ignore relevant but contradictory private information whose revelation would damage his reputation. Surprisingly, this effect makes mark-to-market accounting less desirable as market prices become more informative.