Can Investors Detect Fraud Using Financial Statements: An Exploratory Study

Abstract

This study explores the question of whether investors can successfully detect management fraud using a firm's financial statements. Using financial ratios obtained from fraudulent companies’ financial statements, we examine the effectiveness of both logit and discriminant analyses in predicting the likelihood of fraud. Sixty-eight fraudulent companies used in the study are identified from the SEC's Accounting and Auditing Enforcement Releases. Our research design has addressed certain weaknesses present in prior fraud-detection studies. The empirical results suggest that ratio analysis is grossly ineffective in detecting financial statement fraud. We also discuss the implications of our findings on future research.

Citation

Guan, L., Kaminski, K.A. and Sterling Wetzel, T. (2007), "Can Investors Detect Fraud Using Financial Statements: An Exploratory Study", Lehman, C.R. (Ed.) Envisioning a New Accountability (Advances in Public Interest Accounting, Vol. 13), Emerald Group Publishing Limited, Leeds, pp. 17-34. https://doi.org/10.1016/S1041-7060(07)13002-9