Management may start by exaggerating to attract investors, then find itself forced to continue to protect the valuation that exaggeration created.

The story of the shopping app Phia has brought this question back to the forefront. The app uses artificial intelligence to compare prices and find discounts, and generates part of its revenue from commissions linked to purchases.

But tests showed that some purchases were attributed to the app, even though the user did not reach the store through it or rely on it for the purchase decision. The user might enter the store on their own, select the product, then proceed to checkout, while the Phia extension places its referral code in the background, making it appear as if the app contributed to completing the transaction.

Thus, the app could be credited with sales it did not actually generate, and possibly receive commissions based on them. The company said what happened was due to a technical glitch in calculating referrals for some users, and that it fixed the issue after discovering it. Therefore, the incident alone is not enough to claim that the founders intentionally misled investors.

But the story raises a question larger than the app itself: What happens when a company's value is built on numbers that do not reflect the value it actually created?

The problem is not limited to apps or startups. It can affect a listed company trying to protect its stock price, or a private company seeking a higher valuation. The further results deviate from expectations, the greater the pressure on management to maintain the image they presented to investors.

Exaggeration does not always start with outright falsification of numbers; it may come in the form of seemingly limited decisions, such as choosing a metric that presents performance better, recording revenue earlier, or deferring some expenses. But these decisions raise investor expectations and put management under greater pressure to meet them in subsequent periods.

Luckin Coffee provides a clear example. The company was founded in China and positioned itself as a fast-growing competitor to major brands in the coffee market. With rising sales figures, its story became more attractive to investors.

During 2019 and 2020, the U.S. Securities and Exchange Commission said the company fabricated retail sales exceeding $300 million to make its revenue, growth, and profitability appear better than they were. Over the same period, it raised more than $864 million from equity and debt investors.

The numbers not only improved the picture of results but also helped the company convince investors to pour more money in. When the practices were uncovered, Luckin agreed in 2020 to pay a $180 million fine to settle the case, without admitting or denying the allegations.

The motivation in such cases is not limited to raising new investment. Management may raise the growth bar to secure funding or increase the company's valuation, then find themselves required to prove the same story in every earnings release or new investment round.

When performance slows, acknowledging the decline is no longer just an announcement of weak results. It can threaten the stock price, weaken lender confidence, and affect management bonuses and the valuation the company previously obtained.

Over time, exaggeration shifts from a means of attracting investors to a means of protecting the valuation it helped create. The longer a company continues to present a picture better than reality, the higher the cost of admitting the truth, until management becomes preoccupied with defending the narrative rather than fixing the problem within the company.

It is natural for management to be optimistic about their company's future and set ambitious growth targets. But the problem begins when expectations shift from a goal the company strives to achieve into a story it cannot back away from, even when results no longer support it. Therefore, it is not enough for investors to look at revenue size or growth rate; they must understand how those numbers were achieved and whether they reflect real, sustainable activity or merely a better picture of the company.

A company may be able to protect its story for a while, but it cannot make the narrative a permanent substitute for performance. The most dangerous stage it reaches is when, in management's view, the collapse of the story becomes more serious than the continuation of the problem itself.

Writer and analyst in finance and business.