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Corporations and Investment Firms

Corporate misconduct and financial statement manipulation are prominent topics in forensic finance

 

Extensive literature examines the roles of corporate culture, executive ethics, and CEO incentives in these practices.

 

Research also highlights the manipulation of valuations in private markets and other investment areas, where firms and fund managers often inflate valuations and misreport credit ratings to attract investments and charge higher fees, ultimately misleading investors.

Overview

Corporate Misconduct and Financial Fraud: Key Insights

 

Overview of Financial Reporting Fraud​

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  • Comprehensive Survey: Amiram et al. (2018) provide an extensive survey on corporate financial reporting fraud.​

  • Trends in Financial Fraud: Karpoff (2021) explores whether financial fraud is increasing or decreasing over time.

  • Hidden Corporate Fraud: Dyck, Morse, and Zingales (2023) estimate that two-thirds of corporate fraud remains undetected, using the downfall of Arthur Andersen as a case study.

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Emerging Trends in Research​

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  • Contagion Effects: Earnings management can spread to peer firms.​

  • Corporate Culture: Research is examining how corporate culture influences misconduct.​

  • Executive Ethics: The ethical behaviors of individual executives play a significant role in mitigating or perpetuating fraud.​​​

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Manipulation in Private Markets Fraud

 

Private Firm Valuations​

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  • Misstated IRRs: Private equity funds may inflate valuations, especially underperforming funds, as shown by Brown, Gredil, and Kaplan (2019).​

  • Unicorn Overvaluation: Gornall and Strebulaev (2020) highlight that venture capital firms overvalue different share classes, significantly inflating unicorn valuations and misleading investors.

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Misreporting in Other Investment Areas​​
 

Bond Credit Ratings​

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  • Overstated Ratings: Chen, Cohen, and Gurun (2021) reveal that managers often overstate high-rated bonds in their portfolios, misleading investors and enabling higher fee charges.​

  • Economic Risks: Misclassified funds underperform during junk bond crashes, causing substantial harm to investors.

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Mutual Fund Benchmarks
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  • Historical Benchmark Manipulation: Mullally and Rossi (2023) find that mutual funds frequently alter their historical benchmarks to inflate benchmark-adjusted returns.​

  • Targeted Funds: This practice is most common among high-fee funds, which still attract inflows despite underperformance.

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The Literature

There is a large literature on corporate misconduct and culture that has been active for a long time and spans finance, economics, law, and accounting. Some of the most highly cited papers in Table 2 are from this literature.

Table 2

This table presents the top 5 forensic finance papers which have the highest Google Scholar citations in each 5-year window. Top forensic word is the forensic word used the most in the paper. The full sample is used, which includes 6334 published and forthcoming papers in the top three finance journals between 2000 and April 2023. The Google Scholar citations, SSRN downloads, and press mentions are collected in 2023. Press data are obtained from Altmetric and include news articles from various media outlets.

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Examples of Corporate Misconduct

Leuz, Nanda, and Wysocki, 2003

Earnings management and investor protection: an international comparison

This study finds that stronger investor protections are associated with reduced earnings management. This is because robust legal protections increase the costs and risks of manipulating financial reports. As a result, companies in countries with better investor protections tend to provide more accurate and transparent financial statements.

Dyck, Morse, and Zingales, 2010

Who Blows the Whistle on Corporate Fraud?

This paper finds that employees, media, and industry regulators play a more crucial role in exposing corporate fraud than the SEC and auditors. These smaller players are often more effective in identifying and reporting fraudulent activities. The study highlights the significant impact of non-traditional actors in the detection of corporate misconduct.

Relevant Papers

Financial Reporting Fraud and Other Forms of Misconduct: A Multidisciplinary Review of the Literature

Amiram Et Al.

(2018)

Proxies and Databases in Financial Misconduct Research

Karpoff Et Al.

(2017)

Do Private Equity Funds Manipulate Reported Returns?

Brown Et Al.

(2019)

Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds

Chen Et Al.

(2020)

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