Income Statement Fraud and Balance Sheet Fraud: Different Manipulations, Different Incentives

Robert H Davidson
McCombs School of Business, The University of Texas at Austin

January 2017

Abstract

I find managers commit income statement fraud (fraud in which manipulations increase net income) when market price sensitivity to earnings news is high and their firms’ stock price is relatively more sensitive to idiosyncratic earnings performance. Managers commit balance sheet fraud (fraud in which manipulations increase net assets but do not affect net income) when market-wide default risk is high and their firms have greater financial constraints. The results hold in samples of fraud firms derived from SEC enforcements, class action lawsuits, and a subsample in which fraud was detected internally or by employee whistleblowers.

JEL Classification Codes: G30; G34; G38; G39

I am grateful to my dissertation committee: Abbie Smith (chair), Ray Ball, Ryan Ball, and Christian Leuz. I would also like to thank Jon Karpoff, Zoe-Vonna Palmrose, and participants in seminars at the University of Chicago, Georgetown University, The University of Texas at Dallas, The University of Illinois at Urbana-Champaign, Purdue University, Florida International University, and the Trans-Atlantic Doctoral Conference.

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