The Economics of Fraudulent Accounting

Kedia, Simi; Philippon, Thomas

doi:10.3386/w11573

Cited by 44 publications

(54 citation statements)

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“…Our work is also related to a large empirical literature in accounting and finance that investigates various aspects of corporate fraud (e.g., Richardson, Tuna, and Wu (), Burns and Kedia (), Kedia and Philippon (), Efendi, Srivastava, and Swanson (), Dyck, Morse, and Zingales (), Wang, Winter, Yu (), Wang ()). It is further connected to work in law and economics that focuses on securities fraud litigation (e.g., Choi, Nelson, and Pritchard (), Griffin, Grundfest, and Perino ()) .…”

Section: Discussionmentioning

confidence: 99%

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

Piskorski¹,

Seru²,

Witkin

2015

The Journal of Finance

212

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We quantify the extent to which buyers received false information about the true quality of assets in contractual disclosures by intermediaries during the sale of mortgages in the $2 trillion nonagency market. We construct two measures of misrepresentation of asset quality --misreported occupancy status of borrower and misreported second liens --by comparing the characteristics of mortgages disclosed to the investors at the time of sale with actual characteristics of these loans at that time that are available in a dataset matched by a credit bureau. About one out of every ten loans has one of these misrepresentations. These misrepresentations are not likely to be an artifact of matching error between datasets that contain actual characteristics and those that are reported to investors. At least part of this misrepresentation likely occurs within the boundaries of the financial industry (i.e., not by borrowers). The propensity of intermediaries to sell misrepresented loans increased as the housing market boomed. These misrepresentations are costly for investors, as ex post delinquencies of such loans are more than 60% higher when compared with otherwise similar loans. Lenders seem to be partly aware of this risk, charging a higher interest rate on misrepresented loans relative to otherwise similar loans, but the interest rate markup on misrepresented loans does not fully reflect their higher default risk. Using measures of pricing used in the literature, we find no evidence that these misrepresentations were priced in the securities at their issuance. A significant degree of misrepresentation exists across all reputable intermediaries involved in sale of mortgages. The propensity to misrepresent seems to be largely unrelated to measures of incentives for top management, to quality of risk management inside these firms or to regulatory environment in a region. Misrepresentations on just two relatively easy-to-quantify dimensions of asset quality could result in forced repurchases of mortgages by intermediaries up to $160 billion.Acknowledgments:

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Section: Discussionmentioning

confidence: 99%

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

Piskorski¹,

Seru²,

Witkin

2015

The Journal of Finance

212

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“…This result is consistent with bottom performers accumulating more risky assets during the run‐up that precedes a crisis. Interestingly, the model of Kedia and Philippon (2009) shows another potential channel through which asset growth could affect crisis performance. In their signaling model, firms of low quality want to mimic firms of high quality, and decide to also grow quickly although they lack positive NPV projects.…”

Section: Discussion and Interpretationmentioning

confidence: 99%

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis

Fahlenbrach¹,

Prilmeier²,

Stulz

2012

The Journal of Finance

422

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Are some banks prone to perform poorly during crises? If yes, why? In this paper, we show that a bank's stock return performance during the 1998 crisis predicts its stock return performance and probability of failure during the recent financial crisis. This effect is economically large. Our findings are consistent with persistence in a bank's risk culture and/or aspects of its business model that make its performance sensitive to crises. Banks that relied more on short‐term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.

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“…Pinnuck and Lillis () demonstrate a discontinuity around zero in the level of net hiring between small profit and small loss firms, but they do not examine the specific issues of accounting quality and investment efficiency. Kedia and Philippon () suggest that firms engaged in fraudulent reporting may mimic the investment and hiring practices of other firms to conceal their misreporting. In contrast, we study accounting quality in a broader context, using a more general sample of firms, and our evidence suggests that hiring behavior varies with accounting quality, which is not consistent with similar hiring practices across firms with higher‐ and lower‐quality accounting.…”

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confidence: 99%

Financial Reporting Quality and Labor Investment Efficiency

Jung

Lee

Weber³

2014

Contemporary Accting Res

277

303

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While similar arguments can be made about other, nonlabor investments (e.g., Biddle et al. 2009), an examination of labor is of particular interest in this context for two primary reasons. First, labor is an important factor of production, with labor costs typically representing roughly two-thirds of economy-wide value added (Hamermesh 1993;Bernanke 2004). For example, the U.S. Census Bureau's Annual Survey of Manufacturers reports that payroll and employee benefits in the manufacturing sector totaled $784 billion for 2008, compared to $166 billion in capital expenditures. 3 Clearly, labor investments are economically significant. Second, while evidence from prior research suggests that accounting quality improves the efficiency of capital expenditures by reducing financing frictions, it is not obvious that this result extends to labor. The adjustment costs associated with labor tend to be relatively low compared to capital expenditures (Dixit and Pindyck 1994), and traditional economic models have often treated labor as a variable factor of production. To the extent that labor costs are variable, they are paid out of current revenues and do not require financing (and by extension do not face the financing frictions that highquality accounting mitigates). Thus, whether high-quality accounting improves the efficiency of investments in labor is an open question.Despite the economic importance and distinguishing features of labor, prior literature (reviewed in section 2) relates financial reporting quality primarily to capital expenditures, without examining the effects on labor. The lack of attention to labor in this setting is noteworthy, particularly given that human capital is increasingly viewed as one of the most important factors for a firm's competitive success (e.g., Pfeffer 1996). This study addresses that gap in the literature.Our examination requires measures of both labor investment efficiency and accounting quality. We use firms' net hiring (percentage change in the number of employees) to proxy for investment in labor, and we create an inverse measure of investment efficiency using the absolute deviation of actual net hiring from its expected level. For our primary analyses, the expected level of net hiring is based on the model of Pinnuck and Lillis (2007), which includes economic variables that explain normal hiring practices, such as sales growth, liquidity, leverage, and profitability. Thus, our measure of abnormal net hiring captures the amount of net hiring not attributable to underlying economic factors. In sensitivity tests, we use the industry median to estimate expected net hiring and also consider several modifications of the baseline Pinnuck and Lillis model, including adding controls for labor power and for other concurrent investments.Our empirical proxies for financial reporting quality are drawn from prior literature. Our primary measure is based on a cross-sectional version of the Dechow and Dichev (2002) model, as modified by McNichols (2002) andSchipper (2005). In sensitivity tests,...

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The Economics of Fraudulent Accounting

Cited by 44 publications

References 0 publications

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis

Financial Reporting Quality and Labor Investment Efficiency

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