The Role that Fraud has on Bankruptcy and Bankruptcy Emergence

摘要

We examine a set of bankrupt firms from 1989-2005 and test the role fraud has on bankruptcy and the emergence from bankruptcy. Since most bankruptcies are adversarial, whereby stakeholders attempt to force changes in management and/or management's business plan, managers have incentives to take actions in an ongoing attempt to cover up the deteriorating financial condition of the firm in order to avoid going concern modifications of audit opinions, debt covenant violations, and bankruptcy. Our results indicate that fraud is positively associated with bankruptcy, indicating that managers use fraudulent financial reporting to avoid bankruptcy. The fraudulent reporting likely delays the bankruptcy, allowing the asset base of the firm to further deteriorate, which also would reduce the likelihood of a favorable emergence from bankruptcy. Consistent with this expectation, we find that fraudulent financial reporting prior to bankruptcy is negatively associated with bankruptcy emergence. We expect this finding to be of great interest to stakeholders, auditors, and the Public Company Accounting Oversight Board (PCAOB).