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Jurnal 3
Jurnal 3
Jurnal 3
Christopher J. Skousen**
Assistant Professor
Department of Accounting
University of Texas at Arlington
College of Business, Room 409
701 S. West Street
Arlington, Texas 76019-0468
Phone: 817-272-3040
Fax: 817-272-5793
chris.skousen@uta.edu
and
Charlotte J. Wright
Wilton T. Anderson Professor of Accounting
School of Accounting
William S. Spears School of Business
Oklahoma State University
Stillwater, OK 74078
Phone: 405-744-8611
Fax: 405-744-5180
charlotte.wright@okstate.edu
*We thank Don Hansen, Carol Johnson, Dan Tilley, Derek Oler, Steven Kaplan,
and participants at the 2005 AAA Tenth Ethics Research Symposium, 2005
Brigham Young University 2nd Accounting Research Symposium, and 2006 AAA
Annual Meeting for comments and helpful suggestions.
** Corresponding Author.
CONTEMPORANEOUS RISK FACTORS AND THE PREDICTION OF
FINANCIAL STATEMENT FRAUD
ABSTRACT
Key words: Fraud prediction, fraud detection, risk factors, SAS No. 99
1
1. INTRODUCTION
financial statement fraud. For example, fraud has been linked to concentration of
power (Dunn 2004), CEOs serving on boards of directors (DeChow, et al. 1996),
(Beasley 1996), and the existence of audit committees (Beasley 1996). Fraud has
also been linked to financial-related factors, such as sales growth and leverage
(Beneish 1997), inventory and return on assets (Summers and Sweeney 1998),
and the desire to obtain low-cost financing (DeChow, et al. 1996). As was
factors related to fraud in various settings, we could find no studies that identify a
incidence of financial statement fraud. Further, using the identified fraud risk
2
financial statement fraud occurs. Cressy’s fraud risk factor framework is widely
statement fraud. Using the examples cited in SAS No. 99 and relying on prior
sample of fraud firms and a matched sample of no-fraud firms. This analysis
results indicate that (1) the proportion of independent audit committee members is
inversely related to the incidence of fraud; (2) when the proportion of ownership
held by managers already holding more than 5 percent of the outstanding shares
increases, the probability of fraud increases; (3) when the proportion of insider
increases; (4) the frequency of fraud is higher among firms that do not have an
audit committee; and (5) when one individual holds both the CEO and Chairman
3
of the Board positions, the incidence of fraud is significantly higher than when the
The second objective of this study is to determine whether the fraud risk
a fraud prediction model using the five significant fraud risk factors identified in
our initial analysis. Using publicly available information, our model correctly
classifies fraud and no-fraud firms approximately 69.77 percent of the time.
models.
financial statement fraud and by using these factors to develop a fraud prediction
model that out performs models previously reported in the literature. The
of the relevant fraud literature. Section III contains a description of the research
design and sample selection. Section IV contains the empirical results and
4
2. LITERATURE REVIEW AND EMPIRICAL PREDICTION
Cressy concludes that frauds generally share three common traits. First, the
involved in a fraud rationalized the fraudulent act as being consistent with their
personal code of ethics. Thus, Cressy concludes that a “fraud triangle” consisting
are, to some extent, always present in any given fraud. The AICPA adopted
Cressey’s fraud risk factor theory in SAS No. 99; however, according to the
AICPA, only one factor need be present in order for fraud to be committed. SAS
in SAS No. 99 and provides examples of situations and circumstances that are
5
research that comprehensively examines a broad range of fraud risk factors by
empirically testing. Our study utilizes Cressey’s (1953) theory in identifying and
empirically examining a broad range of potential fraud risk factors. We test the
EP: The fraud risk factors (pressure, opportunity and rationalization) are
positively related to financial statement fraud.
Since the fraud risk factors are not directly observable, it is first necessary
rationalization. For this we rely on the fraud risk factor examples cited in SAS
SAS No. 99 cites four general types of pressure that may lead to financial
6
personal financial situations, and meeting financial targets. Using these general
proxies, two personal financial need proxies and one proxy for financial targets.
Financial stability
SAS No. 99 suggests that when financial stability and/or profitability are
pressure to commit financial statement fraud. Loebbecke et al. (1989) and Bell et
al. (1991) indicate that, in instances where a company is experiencing growth that
provide the appearance of stable growth. Accordingly, our proxy variables include
growth in sales (Beasley 1996; Summers and Sweeney 1998) and growth in assets
7
cash flows in light of reported earnings growth. We use the following financial
Albrecht (2002) and Wells (1997) conclude that financial ratios involving
key income statement and balance sheet figures are useful in detecting fraud.
Persons (1995) suggests that sales to accounts receivable and sales to total assets
are useful in fraud detection. We include the following financial security proxies:
External pressure
and Press and Weintrop (1990) report that, when faced with violation of debt
covenants, managers are more likely to utilize discretionary accruals. The extent
of leverage has also been associated with income increasing discretionary accruals
8
Dechow et al. (1996) note that when a firm has adequate internal funding,
managers are less likely to engage in fraud. We include free cash flow as an
Beasley (1996), COSO (1999), and Dunn (2004) indicate that when
Financial targets
shows how well assets have been employed. ROA is often used as a measure to
assess the performance of managers and thus potentially affects bonuses, wage
increases, etc. Summers and Sweeney (1998) report that ROA differs
9
ROA = Net Income before extraordinary items t-1
Total Assets t
SAS No. 99 cites four general categories of opportunities that may lead to
Nature of industry
SAS No. 99 and Albrecht (2002) indicate that when a firm has significant
Ineffective monitoring
Beasley et al. (2000), Beasley (1996), Dechow et al. (1996) and Dunn
(2004) observe that fraud firms consistently have fewer outside members on their
10
Beasley et al. (2000) observe a reduced incidence of fraud among those
are associated with a lower incidence of fraud (Beasley et al. 2000). Consistently,
Abbott and Parker (2001), Abbott et al. (2000), Beasley et al. (2000), and
member as a member who is not: a current employee of the firm, former officer or
interlocking director, and/or one who has no significant transactions with the firm
(Robinson 2002).
committee meetings.
11
AUDMEET = The number of audit committee meetings held per
year.
Organizational structure
al. (2000), and Dunn (2004) conclude that, as a CEO accumulates titles, he/she is
auditor (Stice 1991; St. Pierre and Anderson 1984; Loebbecke et al.1989).
Beneish (1997), Francis and Krishnan (1999), and Vermeer (2003) argue
12
insight into their financial reporting rationalizations. Francis and Krishnan (1999)
report that the excessive use of discretionary accruals may be cited in the audit
TATA = Total accruals divided by total assets, where total accruals are
calculated as the change in current assets, minus the change in
cash, minus changes in current liabilities, plus the change in
short-term debt, minus depreciation and amortization expense,
minus deferred tax on earnings, plus equity in earnings.
The full model that we use to test the empirical prediction is:
We test the model using both univariate analysis and logit regression.
Sample Selection
that had been accused of fraud by the Securities and Exchange Commission
(SEC). We define fraud firms as being those that were charged with violation of
13
Rule 10(b)-5 of the 1934 Securities Act or Section 17(a) of the 1933 Securities
Act and we examine the SEC Accounting and Auditing Enforcement Releases
(AAERs) issued between 1992 and 2001. Using this procedure we identified 113
fraud firms. Since it was necessary to obtain firms’ proxy and financial statement
data, it was necessary for firms’ financial data be available on the LexisNexis
SEC Filings & Reports website and COMPUSTAT for the year of the alleged
fraud as well as the two preceding years. This criterion resulted in elimination of
27 firms yielding a final sample of 86 fraud firms. The fraud firms come from a
5. The fraudulent activities these firms were accused of occurred fairly evenly
over the 10-year period with the largest number occurring in 1997-1999.
based on industry membership (4 digit SIC code), year, and size (Net Sales +/-
30%) in the year prior to fraud (Beasley 1996). We then searched the SEC
AAERs to verify that none of the match firms had been the subject of SEC fraud-
related actions. Table 6 reports sample statistics for the fraud and no-fraud firms
14
4. RESULTS
analysis. This analysis identifies eight pressure variables and five opportunity
variables that differ significantly between the fraud and no-fraud firms. No
rationalization proxy variables differed between the two groups. The univariate
used in the logit regression. The results of the univariate analysis for all variables
only the pressure and opportunity proxy variables identified in the univariate
analysis as having a p-value of 0.15 or less. The logit regression model is:
Table 8 lists, by type, the proxy variables that we use as explanatory variables in
The results of the logit analysis are reported in Table 9. The model is
15
p<0.01, respectively) and three opportunity variables (AUDCOMM, IND and
pressure and opportunity are consistently related to financial statement fraud and
comprise our comprehensive set of fraud risk factors. Rationalization is either not
critical or, more likely, we are unable to identify and measure appropriate proxies.
The next step in our analysis is to determine whether these fraud risk
1968; Allen and Chung 1998), it would permit the prediction of fraud based
entirely on publicaly available information. For this purpose we use both multiple
Fraud Prediction
the data set and finds a discriminant rule using the remaining observations (Jones
16
1987, Hair et al. 1995, and Kuruppu et al. 2003). This procedure develops a
developing the model. This process is repeated until all the firms in the sample
are used to assess the model’s accuracy. The cross-validation method is effective
1995) and is particularly useful in studies with small sample sizes since the entire
approximately 69.77 percent of the time (the overall misclassification rate of the
model is 30.23). As reported in Table 10, the model correctly classifies no-fraud
firms 74.42 percent of the time and correctly classifies fraud firms 65.12 percent
of the time. These results are notable. Person (1995) and Kaminski et al. (2004)
develop fraud prediction models using financial ratios. These models suffer from
high misclassification rates. For example, in Person (1995) and Kaminski et al.
(2004) fraud firms are misclassified between 58 and 98 percent of the time.
Sensitivity Analysis
relationship to the probability of being in the fraud group while holding the other
17
variables in the model at their mean. Figures 1 through 5 report the results of the
sensitivity analysis.
fraud decreases. This result, as reported in Figure 1, indicates that, when the
percent. On the other hand, when 78 percent of the audit committee members are
As IND increases to 100 percent, the probability of being in the fraud group
decreases to 9 percent.
probability of a firm being in the fraud group and the proportion of managers who
own more than 5 percent of their firm’s shares. These results are reported in
Figure 2. When the proportion of ownership held by managers who hold more
shares, the probability of a firm being in the fraud group is 7 percent. When
increases to 59 percent.
18
Insert Figure 2 about here
fraud group increases. When insiders own 75 percent of the firm’s outstanding
remainder of the firm’s stock ownership is diffused. Thus, the larger the
firm’s stock. In other words, when a large portion of a firm’s outstanding shares
situations where a single individual holds both the CEO and Chairman of the
Board positions (CEO). When the CEO holds the Chairman of the Board position
(CEO = 1), the probability of being in the fraud group is 15 percent; otherwise
19
The relationship between the occurrence of fraud and the existence of an
40 percent.
However, these risk factors do not appear to exist in isolation. In any given fraud,
multiple risk factors are typically present. In this study, we examine an array of
potential fraud risk factors and identify a comprehensive set of coexistent factors
that are consistently linked to the incidence of financial statement fraud. Further,
using the significant risk factors we are able to develop a fraud prediction model
that outperforms previously reported models that attempt to predict fraud using
comprehensive evaluation of firms’ fraud risk factors. Using the examples cited in
prior fraud research and in SAS No. 99, we develop proxy variables for pressure,
20
analysis and a sample of fraud firms (i.e., firms that were the target of SEC fraud
variables (AUDCOMM, IND, and CEO) as being significant fraud risk factors.
using the fraud risk factor framework. For this purpose we use both MDA and
accurately categorize firms into the fraud and no-fraud groups. Using a cross
validation procedure our model correctly classifies no-fraud firms 74.42 percent
of the time and correctly classifies fraud firms 65.12 percent of the time. Overall,
the model correctly classifies firms 69.77 percent of the time (the overall
substantial improvement over other fraud prediction models that have reported
significant fraud risk factor proxy variables. This analysis tests each variable’s
holding the other variables in the model at their mean. These results indicate that,
21
probability of financial statement fraud is reduced; (2) when the proportion of
ownership held by managers who hold more than 5 percent of the outstanding
shares increases the probability of fraud increases; (3) when the firm does not
have an audit committee, the likelihood of fraud increases; (4) when the
probability of being in the fraud group increases; and (5) when one individual
holds both the CEO and Chairman of the Board positions the incidence of fraud is
significantly higher than when the two positions are held by different individuals.
set of risk factors that are contemporaneously related to the incidence of fraud and
fraud prediction model based upon the fraud risk factors is of interest to
academics, standard setters, and users of financial statement data since, similar to
bankruptcy prediction research (Altman 1968; Allen and Chung 1998), it permits
22
ENDNOTES
1
In tests involving small to moderate samples the likelihood ratio test is appropriate for
23
REFERENCES
Abbott, L., Y. Park, and S. Parker. 2000. The effects of audit committee activity
and independence on corporate fraud. Managerial Finance 26 (11): 55-67
Abbott, L. and S. Parker. 2001. Audit committees and auditor selection. Journal
of Accountancy 191 (6): 95-96
Beasley, M., J. Carcello, and D. Hermanson. 1999. COSO's new fraud study:
What it means for CPAs. Journal of Accountancy 187 (5): 12-14.
24
Beneish, M. 1997. Detecting GAAP violation: Implications for assessing
earnings management among firms with extreme financial performance. Journal
of Accounting and Public Policy 16 (3): 271-309.
Greene, W. 2000. Econometric Analysis, Prentice Hall, Upper Saddle River, New
Jersey, 256
Kaminski, K., T. Wetzel, and L. Guan. 2004. Can financial ratios detect
fraudulent financial reporting? Managerial Auditing Journal 19 (1): 15-28.
25
Kuruppu, N., F. Laswad, and P. Oyelere. 2003. The efficacy of liquidation and
bankruptcy models for assessing going concern. Managerial Auditing Journal 18
(6/7): 577-590.
Press, E. and J. Weintrop. 1990. Accounting constraints in public and private debt
agreements: Their association with leverage and impact on accounting choice.
Journal of Accounting and Economics 12:65-95.
St. Pierre, K., and J. Anderson. 1984. An analysis of the factors associated with
lawsuits against public accountants. The Accounting Review 59 (2): 242-263.
26
TABLE 1
Examples of Fraud Risk Factors from SAS No. 99 Relating to Financial Statement
Misstatements
27
TABLE 2
Fraud Risk Factor Proxies for Pressure
28
TABLE 3
Fraud Risk Factor Proxies for Opportunity
29
TABLE 4
Fraud Risk Factor Proxies for Rationalization
30
TABLE 5
Industry Representation of Fraud Firms
Number of Percent of
SIC Code Industry Title Fraud Firms Sample
13 Crude Petroleum & Natural Gas 1 1.16%
15 Operative Builders 1 1.16%
16 Heavy Construction Other Than Building Construction 1 1.16%
20 Food and Kindred Products 1 1.16%
22 Knitting Mills 1 1.16%
23 Apparel & Other Finished Products of Fabrics 4 4.65%
27 Periodicals: Publishing or Publishing & Printing 1 1.16%
28 Chemicals & Allied Products 3 3.49%
31 Footwear 1 1.16%
34 Metal Products 3 3.49%
35 Computers & Communication Equipment 10 11.63%
36 Electrical Equipment 6 6.98%
37 Truck & Bus Bodies, Transportation Equipment 2 2.33%
38 Controlling, Surgical, & Photographic Devices 7 8.14%
50 Wholesale-Computers, Electrical, & Software 4 4.65%
51 Wholesale-Drugs & Petroleum Products 2 2.33%
53 Retail-Variety Stores 1 1.16%
56 Retail-Shoe Stores 1 1.16%
58 Retail-Eating Places 1 1.16%
59 Retail- Catalog, Drug Stores and Proprietary Stores 5 5.82%
73 Services-Business, Computer, & Equipment 24 27.91%
79 Services-Miscellaneous Amusement and Recreation 2 2.33%
80 Services-Health Services 4 4.65%
TOTAL 86 100.00%
31
TABLE 6
Sample Statistics
($ in hundreds of thousands)
Fraud Firms No-Fraud Firms
Mean Mean
[Median] [Median]
(Standard Deviation) (Standard Deviation)
Note: Paired t-tests and Wilcoxon matched-pair sign-rank tests indicated no significant differences
(p=0.10) between the fraud and no-fraud firms based on total assets and net sales.
32
TABLE 7
T-tests and Wilcoxon Sign-Rank Tests
NO-FRAUD Wilcoxon t
FIRMS FRAUD FIRMS t-statistic Approximation
Variable Mean Std Dev Mean Std Dev T Value Pr > |t | Z Pr > |Z|
NICFOTA -0.04 0.15 -0.03 0.28 -0.290 0.772 -1.824 0.034
SGROW -39.17 362.12 81.87 1250.00 -0.860 0.391 -1.429 0.077
AGROW 155.30 663.76 333.56 1679.90 -0.920 0.362 -1.814 0.035
SALAR 11.78 25.99 20.02 113.07 -0.660 0.511 2.075 0.019
SALTA 1.42 1.49 1.19 0.88 1.250 0.214 1.983 0.024
FREEC 15.89 170.69 -9.16 112.47 1.140 0.258 3.236 0.001
LEVERAGE 0.20 0.25 0.21 0.22 -0.220 0.826 -0.785 0.216
OWNERSHIP 0.23 0.20 0.20 0.19 0.950 0.345 1.069 0.143
5%OWN 0.21 0.21 0.32 0.23 -3.040 0.003 -3.173 0.001
ROA -4.25 34.23 -9.40 42.61 0.870 0.383 0.522 0.301
FOROPS -0.02 0.37 0.04 0.18 -1.170 0.245 0.664 0.254
BOUTP 0.69 0.18 0.64 0.19 1.510 0.132 1.717 0.043
AUDCOMM 0.99 0.11 0.88 0.32 2.850 0.005 2.793 0.003
AUDCSIZE 2.84 0.99 2.64 1.29 1.130 0.262 1.173 0.121
IND 0.88 0.25 0.68 0.39 3.880 <0.001 3.719 <0.001
AUDMEET 2.04 1.81 1.86 1.70 0.650 0.515 0.646 0.259
CEO 0.59 0.49 0.71 0.46 -1.600 0.111 -1.593 0.056
AUDCHANG 0.09 0.29 0.12 0.32 -0.500 0.621 -0.494 0.311
AUDREPORT 0.19 0.39 0.26 0.49 -1.030 0.304 -0.814 0.208
TATA -3.57 22.69 -93.85 851.02 0.980 0.328 -0.801 0.212
33
TABLE 8
Fraud Risk Factor Variables (p<0.15)
34
TABLE 9
Logit Regression: Fraud Risk Factor From Univariate Analysis
Standard
Variable Estimate Error Chi-Square Pr > ChiSq
35
TABLE 10
Discriminate Analysis and Fraud Prediction
Cross-validation Method
No-Fraud % Fraud % Total Error
36
FIGURE 1
Effect of Independent Audit Committee Membership on the
Probability of Fraud
40%
Probability of Being in the
35%
30%
Fraud Group
25%
20%
15%
10%
5%
0%
0% 20% 40% 60% 80% 100%
Proportion of Audit Committee Members that are
Independent of the Firm
37
FIGURE 2
Effect of Management Ownership on the Probability of Fraud
100%
Probability of Being in the
80%
Fraud Group
60%
40%
20%
0%
0% 20% 40% 60% 80% 100%
Proportion of outstanding shares held by managers
holding at least 5 percent of the outstanding shares
38
FIGURE 3
Effect of Ownership on the Probability of Fraud
40%
Probability of Being in the
35%
30%
Fraud Group
25%
20%
15%
10%
5%
0%
0% 20% 40% 60% 80% 100%
Proportion of Outstanding Shares Held by Insiders
(Directors, Managers, etc.)
39
FIGURE 4
Effect of CEO/Chairman of the Board Positions on the Probability of Fraud
50%
Probability of Being in the
40%
Fraud Group
30%
20%
10%
0%
0 1
Dummy Variable, where a value of 1 indicates the CEO
holds the Chairman of the Board title and a value of 0
indicates the title is not held.
The Effect of holding both the CEO and Chairman of the Board
Position at the same time on the probability of Fraud
40
FIGURE 5
Effect of having an Audit Committee on the Probability of Fraud
50%
40%
Group
30%
20%
10%
0%
0 1
Dummy Variable, where a value of 1 indicates existence of
an Audit Committee and a value of 0 indicates no audit
committee.
41