Revenue Manipulation and Restatements by Loss Firms

46 Pages Posted: 18 Feb 2005

See all articles by Jeffrey L. Callen

Jeffrey L. Callen

University of Toronto - Rotman School of Management

Sean W.G. Robb

University of Central Florida

Dan Segal

Interdisciplinary Center (IDC) Herzliyah

Date Written: January 2005

Abstract

This paper investigates the relation between the extent of a firm's past and expected future losses or negative cash flows and the ex ante probability that it will manipulate revenues. When a firm has a string of losses or negative cash flows, traditional valuation models do not yield reliable estimates of firm value, and traditional price-earnings ratios are not meaningful. Evidence suggests that market participants tend to value loss firms on the basis of the level and growth in revenues, rather than cash flows and earnings, thereby motivating these firms to overstate revenue. In fact, empirical results indicate that there is a positive relation between the number of years that firms exhibit and/or anticipate losses or negative cash flows and investment in receivables after controlling for credit policy. We further show that the ex ante likelihood that firms manipulate revenue in violation of GAAP is positively associated with the history of past and expected future losses or negative cash flows as well as with the investment in accounts receivable (adjusted for credit policy). Our results suggest another indicator of manipulation that may be used by auditors and regulators in identifying firms that are more likely to overstate revenues.

Keywords: Restatements, Revenue Manipulation, two-stage probit model, partial observability

JEL Classification: M41, G14, C25, M43

Suggested Citation

Callen, Jeffrey L. and Robb, Sean W.G. and Segal, Dan, Revenue Manipulation and Restatements by Loss Firms (January 2005). Auditing: A Journal of Practice & Theory, Forthcoming, Available at SSRN: https://ssrn.com/abstract=390600

Jeffrey L. Callen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-946-5641 (Phone)
416-971-3048 (Fax)

Sean W.G. Robb

University of Central Florida ( email )

University of Central Florida
P.O. Box 161400
Orlando, FL 32816-1400
United States
407-823-4414 (Phone)

Dan Segal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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