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

Posted: 10 Nov 2015

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

University of Virginia

Rick C. Warne

University of Cincinnati - Department of Accounting

Date Written: November 9, 2015

Abstract

We surveyed 194 experienced, nonprofessional investors to examine the relations between their perceptions of the frequency of financial reporting fraud, 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 investors’ perceptions of the frequency of fraud and their use of financial statement information positively influence the importance they place on conducting their own fraud risk assessments. Investors who place importance on assessing fraud risk make greater use of fraud red flags to avoid fraudulent investments. Red flags commonly relied upon include SEC investigations, pending litigation, violations of debt covenants, and high management turnover. Investors 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.

Keywords: Financial statements, Fraud red flags, Fraud risk, Investors

JEL Classification: M40, M41, M48

Suggested Citation

Brazel, Joseph F. and Jones, Keith Lamar and Thayer, Jane M. and Warne, Rick C., Understanding Investor Perceptions About Financial Statement Fraud and Their Use of Red Flags: Evidence from the Field (November 9, 2015). Review of Accounting Studies, Vol. 20, No. 4, 2015, Available at SSRN: https://ssrn.com/abstract=2688283

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

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Rick C. Warne

University of Cincinnati - Department of Accounting ( email )

Cincinnati, OH 45221-0211
United States

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