Do Analysts Anticipate Accounting Fraud?

Abstract

We examine whether analysts anticipate the public disclosure of accounting frauds by studying a sample of companies that have committed fraud as evidenced by the Security and Exchange Commission (SEC) issuance of an Accounting and Auditing Enforcement Release (AAER). We use survival analysis to determine when analysts drop coverage and revise their recommendations down prior to the public disclosure of fraud. Our analyses indicate some evidence that analysts anticipate fraud and use different signals to inform investors about different fraud types. For example, firms that commit larger frauds are significantly more likely to have analysts drop coverage earlier in the period preceding the public announcement, but are not significantly more likely to show downward revisions in recommendations. We also find that analysts appear to be fooled by fictitious frauds - they are no more likely to drop coverage or revise down earlier prior to public disclosure for firms that commit these frauds versus firms that do not commit fictitious frauds. Finally, our results show that the decision and timing of dropping coverage is not correlated with revision of forecasts, indicating that analysts consider different variables for the two decisions.

Keywords: Accounting fraud, analyst recommendations, analyst revisions, survival analysis

JEL Classification: M41, M45, G38, M49, G29