Aggregate Financial Misreporting and the Predictability of U.S. Recessions

60 Pages Posted: 12 Mar 2021

See all articles by Messod D. Beneish

Messod D. Beneish

Indiana University - Kelley School of Business - Department of Accounting

David B. Farber

Indiana University Kelley School of Business Indianapolis

Matthew Glendening

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy

Date Written: February 23, 2021

Abstract

We rely on the theoretical prediction that financial misreporting peaks before economic busts to examine whether aggregate ex ante measures of the likelihood of financial misreporting improve the predictability of U.S. recessions. We consider six measures of misreporting and show that the Beneish M-Score significantly improves out-of-sample recession prediction at longer forecasting horizons. Specifically, relative to leading models based on yield spreads and market returns, M-Score increases the average probability of a recession across forecast horizons of six-, seven-, and eight-quarters-ahead by 56 percent, 79 percent, and 92 percent, respectively. These findings are robust to alternative definitions of interest rate spreads, and to controlling for the federal funds rate, investor sentiment, and aggregate earnings growth. We show that the performance of M-Score likely arises because firms with high M-Scores tend to experience negative future performance. Overall, this study provides novel evidence that accounting information can be useful to forecasters and regulators interested in assessing the likelihood of U.S. recessions a few quarters ahead.

Keywords: Recessions, Prediction, Financial Misreporting

JEL Classification: M41

Suggested Citation

Beneish, Messod Daniel and Farber, David B. and Glendening, Matthew and Shaw, Kenneth W., Aggregate Financial Misreporting and the Predictability of U.S. Recessions (February 23, 2021). Kelley School of Business Research Paper No. 2021-15, Available at SSRN: https://ssrn.com/abstract=3790566 or http://dx.doi.org/10.2139/ssrn.3790566

Messod Daniel Beneish

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2628 (Phone)
812-855-4985 (Fax)

David B. Farber (Contact Author)

Indiana University Kelley School of Business Indianapolis ( email )

801 W Michigan Ave
Indianapolis, IN 46202
United States

Matthew Glendening

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business ( email )

331 Cornell Hall
Columbia, MO 65211
United States

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy ( email )

420 Cornell Hall
Columbia, MO 65211
United States
573-882-5939 (Phone)
573-882-2437 (Fax)

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