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[Podcast] Identifying Fraudulent Financial Reporting Behavior of Listed Enterprises on the Vietnamese Stock Exchange

21 August, 2024

Keywords: Financial Reporting Fraud, Earnings Management

Financial statements (FS) are a source of information for users to make economic decisions. Fraudulent financial statements create false information that will affect the decisions of information users, causing them to suffer losses in investing or lending, thereby affecting the operation of the stock market and the economy in general. Therefore, the study on financial reporting fraud by the author from University of Economics Ho Chi Minh City (UEH) is necessary to identify the characteristics of fraudulent enterprises, the methods of fraud as well as the goals of fraud.

Significance of the study

When a business falls into a difficult situation and may not meet the expectations of financial statement users, business leaders are likely to commit financial statement fraud to “beautify” the indicators that investors and creditors are interested in.

Previous studies have found that business characteristics listed as debt-to-asset ratio or debt-to-equity ratio have an impact on financial statement fraud. In addition, solvency indicators (current solvency, quick solvency and so on), profitability indicators (ROE, ROA, ROS, ROI, EPS and so on), or performance indicators (inventory turnover, growth rate, operating cash flow and so on) also affect financial statement fraud. These indicators are the target of fraud, to increase the solvency, profitability, or operation efficiency of the business.

Therefore, it is necessary to study the factors affecting financial statement fraud with the aim of fully addressing the above aspects. Moreover, the previous research results are also inconsistent across different models; it is impossible to conclude whether the impact of business characteristics on the possibility of financial statement fraud is non-linear or not. This study aims to gain comprehensive insights into the aspects of fraud (characteristics of fraudulent enterprises, fraud methods, and fraud objectives); concurrently, expanding the consideration of the non-linear impact of business characteristics (high debt and high equity) to explain the change in the direction of the impact on the possibility of financial statement fraud.

The Impact of Financial Reporting on Corporate Governance

When the agency contract is ineffective, managers will maximize their benefits, to enjoy contractual bonuses or to avoid risks, instead of maximizing the value for the business owners. Managers do this because they have more information and the ability to influence the operation of the business. This fact leads to the risk of fraud on financial statements.

In addition, because of the information asymmetry between managers and those outside the business, managers need to provide information (signals) to the market so that entities outside the business can evaluate and make investment decisions. Information on financial statements signals the fact that the business provides to entities using financial statements. Especially for listed businesses, information on financial statements has a clear impact on stock prices. Under the pressure of the business environment, managers are prone to providing “false signals” – financial statement fraud occurs. Specifically, managers will increase the adjustment of ratios that investors and creditors often use to evaluate the financial situation and performance of the enterprise to achieve their goals.

To create a good image with creditors, enterprises need to “beautify” indicators of payment capacity listed as current payment capacity, loan interest coverage, as well as “polish” indicators of profitability.

To meet investors’ expectations, enterprises will “beautify” indicators related to profitability, for example, ROA, ROE, ROS, EPS, ROI as well as operations indicators listed as revenue growth rate, asset growth rate, inventory turnover, receivable turnover, and asset turnover.

In order to receive bonuses or to maintain their job position (on the mandate contract), managers will manipulate performance-related indicators as well as profitability indicators.

Financial statement fraud will be carried out through techniques in revenue fraud and cost fraud, independently or in combination. The tendency to commit fraud will depend on the characteristics of the enterprise, for example, if a business has a high debt ratio, the enterprise will prioritize fraud to meet loan terms; or if a listed enterprise has a large equity scale, it will commit fraud to meet the expectations of the owner in order to maintain its job position on the mandate contracts.

Identifying fraudulent financial reporting behavior of listed enterprises

The results showed that fraudulent financial reporting behavior of listed enterprises originates and develops according to the following factors:

*Business fraud methods: overstating revenue and understating expenses, specifically the cost of goods sold. Therefore, both methods are used by enterprises to commit fraud.

*Fraudulent goals: enterprises commit financial reporting fraud to meet payment capacity, profitability goals, and business performance goals. The asset turnover ratio is statistically significant yet contrary to expectations, it is considered to have no impact on financial reporting fraud.

*Characteristics of fraudulent enterprises:

Enterprises with high debt ratios are less likely to commit financial reporting fraud. This is contrary to expectations that: enterprises with high debt pressure increase fraud to meet the terms of the loan contract. The reason may be that, although the enterprises in the research sample have high debt pressure, they have not encountered financial difficulties, they have not/reduced their fraudulent behavior. Moreover, according to capital theory, when the debt ratio is low, the enterprise has not encountered pressure, the fraudulent behavior may decrease; when the pressure increases, the enterprise faces insolvency, the enterprise may increase the fraud to meet the loan contracts. Therefore, the relationship between debt ratio and financial statement fraud may not be linear. Enterprises with a high equity ratio will be less likely to commit financial statement fraud. This is consistent with expectations because enterprises with high equity will accept the monitoring costs to monitor the principal, and limit the opportunity for fraud. In addition, in the context of the economy facing many difficulties due to the Covid-19 pandemic from 2019 to 2022, businesses might increase fraud in these years, not strong enough to form a trend.

The study showed that when the debt ratio is low, businesses limit or rarely commit financial statement fraud. When the debt ratio increases, businesses increase financial statement fraud. In addition to the debt ratio characteristics, the study also indicated that the purpose of businesses’ increasing fraud is to improve profitability indicators, payment ability and business performance indicators. The asset turnover ratio is statistically significant, yet opposite, to expectations.

In addition, when equity is low, businesses rarely commit fraud; when equity is high, pressure from owners increases, businesses increase fraud. With the characteristics of enterprises with high equity, fraud is carried out with the aim of beautifying the indicators of profitability, solvency, and business performance indicators.

The research article on Identifying Fraudulent Financial Reporting Behavior of Enterprises Listed on the Vietnamese Stock Exchange can be fully accessed on the UEH website.

Author: Ms. Pham Thi Ngoc Bich – University of Economics Ho Chi Minh City (UEH).

This article is part of the research series spreading applied knowledge from UEH with the message “Research Contribution For All”, UEH cordially invites the audience to read the next UEH Research Insights issue.

News, photos: Author, UEH Department of Marketing and Communication