The Relationship between Asset Sales and Fraudulent Revenue Manipulations

• In Event: Emerging Research Discussion Session II

Abstract

Even though considerable research has focused on the asset sale area, this research has not generally focused on asset sales that are significant, unanticipated, and outside normal business practices. The objective of this study is to investigate whether firms that manipulate revenues, an event that is outside normal business practices, will sell assets to divert attention from the revenue manipulation. This study also contributes findings regarding two competing theories of asset sales; the efficient deployment theory and the financing hypothesis.

The efficient deployment hypothesis theory of asset sales focuses on value creation for the buyer and seller. This theory assumes that management wants to maximize shareholder wealth by allocating assets to users who can better manage the assets. Managers will sell assets as soon as they recognize that another firm may be better able to more efficiently manage the assets providing gains to both the buyer and the seller.

The financing hypothesis states that management is reluctant to sell assets for efficiency because they value firm size and control. They must have a more compelling reason to sell assets. Reasons that have been investigated concern poor performance, high leverage, expensive sources of financing, and unattractive equity sales. These are also reasons that lead to fraudulent revenue manipulation by firms. The current study uses a sample of firms that have committed the specific type of fraud of manipulating revenues to determine if there is a relationship between asset sales and fraudulent revenue recognition. This is important to auditors, investors, regulators, and creditors since the manipulation of revenues is the form of financial statement fraud that is the most often used by management, and it is also the most expensive to stakeholders.

When stakeholders analyze financial statements, they may feel that the sale of assets is positive and value creating. In reality, management may sell assets because of declining performance measures or rising cost of debt and equity which may have led to the manipulation of revenues. They also may want to divert attention from the revenue manipulation. This follows the financing hypothesis for asset sales.

The results from the current research show that the probability that a firm will sell assets increases significantly when a firm fraudulently manipulates revenues. These findings contribute to previous research findings and support the financing theory of asset sales. They also add to previous research findings regarding characteristics of firms that commit financial statement fraud.

Author

• Irana J Scott, Elon University