Understanding Investor Perceptions of Financial Statement Fraud and Their Use of Red Flags: Evidence from the Field

59 Pages Posted: 24 Aug 2009 Last revised: 25 Nov 2014

See all articles by Joseph F. Brazel

Joseph F. Brazel

North Carolina State University - Poole College of Management - Department of Accounting

Keith L. Jones

University of Kansas

Jane M. Thayer

Georgia Institute of Technology

Rick C. Warne

University of San Diego

Date Written: December 1, 2014

Abstract

We surveyed 194 experienced, nonprofessional investors to examine the relations between their perceptions of the frequency of financial statement fraud in the economy, 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 both investors’ perceptions of the frequency of fraud in the economy and their use of financial statement information positively influence the importance they place on conducting their own fraud risk assessments. In turn, investors who place importance on conducting fraud risk assessments make greater use of fraud red flags to avoid potentially fraudulent investments. In terms of red flags commonly relied upon, investors tend to focus on SEC investigations, pending litigation, violations of debt covenants, and high management turnover. In contrast, they 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. In addition to their own assessment of fraud risk, investors in our sample report relying more on analysts, regulators, and external auditors to detect and report fraud, while relying less on low- and mid-level employees, upper management, the media, and short-sellers for fraud detection and reporting.

Keywords: financial statements; fraud red flags; fraud risk; investors

JEL Classification: M40

Suggested Citation

Brazel, Joseph F. and Jones, Keith Lamar and Thayer, Jane M. and Warne, Rick C., Understanding Investor Perceptions of Financial Statement Fraud and Their Use of Red Flags: Evidence from the Field (December 1, 2014). Available at SSRN: https://ssrn.com/abstract=1460820 or http://dx.doi.org/10.2139/ssrn.1460820

Joseph F. Brazel (Contact Author)

North Carolina State University - Poole College of Management - Department of Accounting ( email )

Campus Box 8113
Nelson Hall
Raleigh, NC 27695
United States
919-513-1772 (Phone)

Keith Lamar Jones

University of Kansas ( email )

1654 Naismith Drive
MS 5F4
Lawrence, KS 66045
United States
785-864-6997 (Phone)
785-864-5328 (Fax)

Jane M. Thayer

Georgia Institute of Technology

Atlanta, GA 30332
United States

Rick C. Warne

University of San Diego ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States

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