Impact Of Financial Information Fraudulence To Financial Distress In Malaysia.

Dalila Binti Abu Bakar, Et Al

doi:10.17762/turcomat.v12i6.2367

Abstract

We investigate if Malaysian listed companies engaged in financial information fraud during financial distressed after two years of US subprime mortgage crisis.We also investigate the impact of financial information fraudulence in bankruptcy prediction and misclassification errors. This study used consumer product companies listed on the main board and the timeframe is from 2011 till 2015. The Altman Z score indicates that 37 out of 133 Malaysian consumer product companies are financially distressed. Meanwhile, the M score shows that 28 out of 224observations are engaged in financial information fraudulence. However, these results are relatively low because the samples are taken from the main board and fraudulence in their financial statements might be done in lower magnitude in order to avoid sanctions by the Security Exchange Commission. Logistic regression was used to measure the predicting accuracy. The result of the overall accuracy percentage slightly improved by 0.9 after eliminating fraudulent companies. The confusion matrix result i.e. before and after the removal of financial information fraudulent companies, the misclassification errors especially type one has improved. This finding satisfied objective three, whereby one of the reasons for the deterioration in financial distress prediction is due to the upward bias of financial information fraudulence.Governments, monitoring bodies, and all those involved in an insolvency process would benefit from this study.

Highlights

Financial distress can be described as a condition when a company is unable to honor its debt obligation (Lee and Yeh, 2004; Beaver, 1966), is incapable of conducting economic activities (Honjo, 2000), has low cash flow and facing financial complications (Ding, Song and Zen, 2008; Sun et al, 2014), recorded three consecutive years of negative net income (Youn and Gu, 2010), has low equity per share (Sun and Li, 2012) and has a net worth less than half of its capital stock (Lee and Yeh, 2004)
This study is an empirical investigation on the effect of financial information fraudulence on financial distress prediction in Malaysia
Pertaining to the first objective, the study is motivated by the lack of literatures that highlight the existence of established models that can be directly utilized in the main market instead of waiting for authoritative bodies to come out with investigation reports or rumors on company financial information fraudulence activities

Summary

Introduction

Financial distress can be described as a condition when a company is unable to honor its debt obligation (Lee and Yeh, 2004; Beaver, 1966), is incapable of conducting economic activities (Honjo, 2000), has low cash flow and facing financial complications (Ding, Song and Zen, 2008; Sun et al, 2014), recorded three consecutive years of negative net income (Youn and Gu, 2010), has low equity per share (Sun and Li, 2012) and has a net worth less than half of its capital stock (Lee and Yeh, 2004). The tightening of credit supply and increased interest rates exacerbate financial distress and hasten bankruptcy (Battiston, Delli Gatti, Gallegati, Greenwald, and Stiglitz, 2007) This situation lures them into behaving unethically such as engaging in financial information fraudulence (Flanagan, Muse, and O’Shaughnessy, 2008). The discovery of fraudulent companies always results in unfavorable outcomes such as losing investors’ confidence, decreasing market value, increasing cost of capital, and losing company and manager reputation (Flanagan et al, 2008).Agrawal and Chatterjee (2015) result indicated that the engagement in financial information fraudulence among low distressed companies are high compared to that of high distressed company and it is statistically significant at a 1 percent level.The corporate event for financial information fraudulence announcement reduces the company’s stock price by 8% on average (Ak, Dechow, Sun, and Wang, 2013). Perhaps healthy companies conceal their financial information fraudulence more successfully than distressed companies (Beaver, 1966)

Objectives

Methods

Findings

Discussion

Conclusion