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Volume 2: No. 3, Special Issue, 2010

JFIA

Volume 2: No. 3, Special Issue, 2010

Table of Contents:


Market Efficiency and Investor Reactions to SEC Fraud Investigations | Full Article (PDF)
Theodore E. Christensen
Daniel Gyung H. Paik
Christopher D. Williams
 
Abstract: This study investigates investor reactions to SEC fraud investigations in the 2001-2003 period when investors were especially sensitive to fraud allegations in the wake of large-scale frauds such as Enron and WorldCom. The results indicate that investors penalize fraud firms surrounding both the fraud discovery date and the SEC’s investigation announcement date. Specifically, we observe a 29 percent decline in cumulative abnormal returns during the three-day window surrounding the market’s discovery of the fraud. We also find that investors penalize fraud firms by an additional eight percent during the three-day window surrounding the SEC’s subsequent investigation announcement.  If markets were completely efficient, prices would fully adjust as soon as information about the fraud is made public.  These results suggest that investors do not fully realize the severity of a fraud (and prices do not fully adjust) until the SEC begins its formal investigation. Moreover, this result is consistent with the notion that an SEC fraud investigation confirms the suspicions of investors regarding the gravity of previously released public information about fraud firms. We also examine different types of violations that lead to fraud investigations and find that the market responds more negatively to investigations related to revenue recognition, asset overstatement, and insider trading allegations than other types of violations. Finally, we identify factors associated with the likelihood that a firm will be investigated by the SEC for financial statement fraud. 
 
Keywords: Fraud investigations, SEC disciplinary actions, market reactions. 

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Audit Committee Independence and Earnings Management: How Independent are Independent Directors? | Full Article (PDF)
Jerry L. Turner
Carol E. Vann
 
Abstract: This study investigates whether a significant correlation exists between evidence of earnings management and increases in the subsequent year value of stock and exercisable stock options held by independent directors serving on the audit committee. Results show that, on average, independent directors on the audit committee of companies exhibiting evidence of earnings management benefited from significantly greater cumulative percentage increases in the market value of stock and stock options owned either actually or beneficially than did independent directors on the audit committees of companies presenting no evidence of earnings management. These results hold regardless of whether the earnings management was income increasing or income decreasing. Similar results also hold for audit committee independent chairs. While these results should not be interpreted as clear evidence that independent directors act in their own self-interest, such potential benefits could result in independent directors either being inappropriately lax when reviewing and approving management actions involving earnings management or actively participating with management in earnings management schemes. It is recommended that independent directors, like independent auditors, be prohibited from owning stock or holding stock options of any company for which they serve.
 
Keywords: Board independence; corporate governance; earnings management; stock options.
 
Data Availability: All data are publicly available.

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The Bankruptcy Reform Act and Bankruptcy Fraud: Implications and Opportunities for CPAs | Full Article (PDF)
Katherine Barker
Nicole Forbes Stowell
Charlie Polansky
Daniel Kieffer
 
Abstract: With bankruptcy filings on the rise, it is not surprising that bankruptcy fraud is also increasing.  While the Executive Office for U.S. Trustees estimated that approximately ten percent of all bankruptcies contain some fraud, recent independent audits show that more than 25 percent of all audits contain some element of fraud. This paper presents a brief overview of the federal bankruptcy system and the most recent changes to bankruptcy law. Common bankruptcy fraud schemes are reviewed and the newly created Debtor Audit Program is discussed, which offers opportunities to independent CPA firms to participate in auditing bankruptcy filings.
 
CPAs who understand how the bankruptcy law has changed and the basic elements and types of bankruptcy fraud schemes being perpetrated have an advantage in being able to guide clients through the bankruptcy process, to help them steer clear of common pitfalls, and to avoid being made a party to any fraudulent activities themselves. Additionally, the bankruptcy law changes provide opportunities for CPAs to become bankruptcy ‘experts’ and in doing so to provide the best possible services for a variety of clients.
 
Keywords: Bankruptcy, Bankruptcy Fraud, Fraud, Debtor Audit Program.

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The Auditor’s Assessment of Fraud Risk: A Fuzzy Logic Approach | Full Article (PDF)
Christie L. Comunale
Rebecca L. Rosner
Thomas R. Sexton
 
Abstract: SAS No. 99 has limitations that may lead to ineffective implementation. Specifically, auditors use fraud risk indicators and judgment to decide whether a fraud risk factor exists. This implies a binary assessment of each fraud risk factor without consideration of the extent to which it exists. We believe that this is an oversimplification. In this paper, we describe a fuzzy logic expert system for the assessment of fraud risk. The system allows the auditor to input data regarding the presence or absence of each fraud risk indicator and employs the principles of fuzzy logic to evaluate the degree to which each fraud risk factor is present. Using the relative importance of each fraud risk factor, the system computes fraud risk associated with each type of fraud and with the six combinations of fraud type and condition. This approach has several advantages over the auditor’s current approach.
 
Keywords: Fraud; SAS No. 99; Fuzzy Logic; Expert Systems; Audit Effectiveness.
 
Data Availability: Data is available from the authors upon request.

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The Implications of Auditors’ Dispositional Trust and Career Advancement Opportunities for the Detection of Fraud | Full Article (PDF)
Anna M. Rose
Jacob M. Rose
Mark Dibben
 
Abstract: This research reports on the results of measurements of professional auditors’ dispositional trust as it may relate to the propensity for an auditor’s career advancement.  Under controlled conditions, we collected dispositional trust scores from 216 practicing auditors at Big 4 firms.  In addition, to develop a more complete picture of trust in the audit profession, we collected dispositional trust measures from 53 graduate accounting students who planned to enter the auditing profession upon graduation.  The results of the analyses indicate that auditors in manager and partner positions in audit firms are significantly more trusting than are auditors at staff and senior levels and auditing students.  Given that dispositional trust is a stable personality trait, there is evidence that the organizational structure of audit firms promotes the advancement of highly trusting individuals, while forcing out less trusting auditors.  Prior experimental research finds that more trusting auditors are less likely to detect fraud and errors, and more trusting auditors evaluate audit evidence less thoroughly than do less trusting auditors.  Based on the findings of prior dispositional trust research and the results of the current study, it appears that the advancement of highly trusting individuals could result in the promotion of effective client management at the expense of detecting fraud and other irregularities.
 
Keywords: Auditor; Career Advancement; Dispositional Trust.

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Are You Really Someone Else? Determining the Credibility of Identity Documents | Full Article (PDF)
Kenneth R. Henry
Ronald M. Lee
 
Abstract: Currently, about 10 million people are victimized by identity theft each year. Annual losses exceed US $50 billion. Identity theft exists because of the impersonalization of institutions. Institutions know their clients not by recognizing their faces, but by their documents. Especially on the first encounter with a new client, how can the institution know the documentation is to be believed? This paper is about the acquisition of expert knowledge to answer the question, "What attributes make identity documents seem credible?" This study employs the repertory grid technique to explore that issue, and to provide a method for other institutions to gather expert knowledge about identity documentation policies.
 
Keywords: Identity fraud; identity theft; identity documents; document breeding.

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Online Auction Fraud: An Empirical Analysis of Shill-bidding Practice | Full Article (PDF)
Alexey N. Nikitkov
Darlene Bay
 
Abstract: This paper investigates shill bidding in online auctions. We apply a five stage algorithm for identifying cases of shill bidding to a sample of eBay transactions in order to determine how often shill bidding happens, whether professional sellers or hobby sellers are more likely to engage in this practice and what strategies are used. We find that shill bidding happens often (18% - 28% of the time) across a variety of products. In the product categories examined, professional sellers engage in this practice more often than hobby sellers. Both competitive bidding and bid encouragement strategies are commonly but unequally used across product categories and by professional versus hobby sellers.
 
Keywords: Electronic markets and auctions; electronic commerce; deception; shill-bidding.

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A Classification Tree Approach for Identifying Potentially Delisting Firms from the Corporate Governance Perspective: Evidence from Taiwan | Full Article (PDF)
Yuh-Jiuan Parng
Chung-Jen Fu
Hsi-Cheng Li
 
Abstract: Identifying potentially distressed corporations is a challenge for most financial professionals. Besides the financial reporting, the evaluation of corporate governance (CG) mechanisms constitutes an alternative strategy for singling out these companies. In this paper, we first extract relevant information on both delisting firms and listing firms with similar profiles between 2000 and 2008 from the Taiwan Stock Exchange database. Then, a logistic regression model is applied to identify the factors that are related to board composition and ownership structure. Finally, a classification and regression tree (CART) analysis is conducted to estimate the cutoff values of these factors. Our empirical analysis shows that after controlling for financial ratios, the significant CG variables leading to delisting include board size, percentage of independent directors, and percentage of shares pledged. The decision tree analysis has an 80% success rate in identifying potential delisting firms from the test data set. The utility and contribution in accounting practice from this study is threefold: 1) successful provision of an intuitive, user-friendly decision tree layout with critical indices for internal examination system, 2) the warning signals with corresponding threshold values for investors, and 3) the monitoring references for the supervisory commissions.
 
Keywords: Corporate Governance; BOD Composition; Logistic Regression; Decision Tree; CART.
Data Availability: Data are available from sources identified in the paper.

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