The Functional and Dysfunctional Effects of a Composite Fraud Indicator

• In Event: Continental Breakfast and Research & Education Forum
  In Paper Session: Table 19: Fraud Risk and Internal Contols

Abstract

Academics, regulators, and independent research firms have developed models which estimate the risk that a company’s financial statements contain aggressive or fraudulent accounting. These models can potentially be used by auditors and regulators to identify risky companies and to warn the public about companies with an increased risk of fraud. This study explores the potential effects of a publicly available measure of fraud risk, called a Composite Fraud Indicator (CFI), on the judgments and decisions of financial reporting managers. Using an experiment, we test whether aggressive accounting behavior is deterred when such behavior will be revealed to the public via a CFI. The results suggest that a CFI reduces a manager’s willingness to engage in income-increasing earnings management for fear of being associated with the stigma of fraud. However, the results show that managers might also make overly conservative accounting choices in an attempt to achieve a low risk CFI.

Authors

• Erin L Hamilton, University of Nevada-Las Vegas

• Rina Hirsch, Hofstra University

• Uday S Murthy, University of South Florida

• Jason T Rasso, College of Charleston