Detecting Cosmetic Earnings Management Using Benford’s Law: Evidence From Iran

Abstract

Cosmetic earnings management (CEM) is a way of manipulating financial results through small upward rounding of reported earnings. As a result, there will be more than expected zeros and less than expected nines as second digit of earnings numbers. Previous studies showed that cosmetic earnings management has occurred before implementation of Sarbanes-Oxley Act in the U.S and there has been a tendency to exercise it worldwide. This paper investigates the occurrence of CEM in the companies listed in Tehran stock exchange (TSE) during 1999 to 2013 by comparing observed distribution of earning numbers with a standard distribution, called Benford’s law. The results show that CEM has not occurred in TSE for the period 1999 to 2009. We suggest users of financial statements to pay attention to earning numbers as a start point for further investigations.

Keywords: Cosmetic Earnings Management (CEM), Benford’s Law, Earnings Management