Understanding investor perceptions of financial statement fraud and their use of red flags: evidence from the field

Joseph F. Brazel (), Keith L. Jones (), Jane Thayer () and Rick C. Warne ()
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Joseph F. Brazel: North Carolina State University
Keith L. Jones: George Mason University
Jane Thayer: University of Virginia
Rick C. Warne: University of Cincinnati

Review of Accounting Studies, 2015, vol. 20, issue 4, No 5, 1373-1406

Abstract: Abstract We surveyed 194 experienced, nonprofessional investors to examine the relations between their perceptions of the frequency of financial reporting fraud, their use of financial statement information, the importance they place on conducting their own fraud risk assessments, and their use of fraud red flags. We find that investors’ perceptions of the frequency of fraud and their use of financial statement information positively influence the importance they place on conducting their own fraud risk assessments. Investors who place importance on assessing fraud risk make greater use of fraud red flags to avoid fraudulent investments. Red flags commonly relied upon include SEC investigations, pending litigation, violations of debt covenants, and high management turnover. Investors rely less on company size and age, the need for external financing, and the use of a non-Big 4 auditor. We also find evidence of positive associations between the use of specific red flags and investors’ portfolio returns.

Keywords: Financial statements; Fraud red flags; Fraud risk; Investors; M40; M41; M48 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s11142-015-9326-y

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