The Research On Chinese Listed Companies’ Financial Reporting Fraud Detection And Its Regulatory Mechanisms

Credibility has a vital role for the economies in transition, especially for the transformation of the capital market in the economic like China.Capital markets have functions of resource allocation, price discovery and fund-raising. And the realization of these functions is heavily dependent on the effective implementation of information disclosure of listed companies. Stock price volatility, insider trading, market manipulation and other problems caused by listed companies’ financial reporting fraud had seriously damaged capital market, eroded investors’ confidence and undermined market efficiency, and it could even threaten the national economy and lead to certain political crisis. Therefore, a systematical study of listed companies’ financial reporting fraud and its regulatory mechanisms has its positive significance, from the macro view, it is beneficial to improving the efficiency of capital markets and maintaining investors’ interest in the market; from the micro view, it is beneficial to promoting the improvement of the governance structure of listed companies and improving the overall quality of listed companies.The introductory part of this paper presents the motivation and research significance of this study, defines the relevant concepts and points out the contents and research methods of this study. The study motivation stems from the widespread presence of financial reporting fraud and its enormous harm. From the research sense, the study of financial reporting fraud is significant to investors, creditors, regulators and financial report providers themselves. In this chapter, a precise definition of financial reporting fraud was made and this part summarizes the concepts which are related to financial reporting fraud, including earnings management, accounting errors and accounting information distortion. In order to define these concepts, this article refers to previous statements of the appropriate summaries of them. At the end of this chapter the writer describes the contents and research methods of this study.In the second part of this thematic study, this paper combs previous studies firstly. The review of the literature mainly focuses on causes of financial reporting fraud, detection identification and supervision of financial reporting fraud. From the existing research point of view, foreign countries, especially the United States have done more sophisticated study than China and have formed a more comprehensive theory of financial reporting fraud. Compared with the domestic study, the foreign research likes to use a combination of normative analysis and empirical analysis to make research while the domestic research is at the initial stage and the research methods are also more oriented to normative analysis. In addition, the comparative study of financial reporting fraud between the two countries in research is relatively rare in the existing research. Therefore, combing through the existing literature, this article decided to make recognition of financial reporting fraud from the perspective of financial indicators. Based on the angle of comparison with the United States, some regulatory thinking of financial reporting fraud for China’s listed companies is made.In the third chapter, the paper analyzes the classical theory of financial reporting fraud, including information asymmetry, profit-driven theory, property rights theory, game theory, Simon’s "bounded rationality" theory and other theories of financial reporting fraud. Asymmetric information theory and interest-driven theory points out that profit-driven is the motive of financial reporting fraud and information asymmetry is a necessary condition for financial reporting fraud; Property rights theory points out that the separation of ownership and management in listed companies may lead to the problem of "principal agent", and that is the root cause of the financial reporting fraud in listed companies, especially in state-owned listed companies, In order to clarify financial reporting fraud, game theory points out that different interests and aspirations between providers and demanders of financial reporting, coupled with the imperfections of related systems, makes providers and demanders game at the accuracy of information, and the authenticity of the information will depend on the final equilibrium reached by the two sides who join the game."Bounded rationality "comes from the perspective of process rationality and result rationality to analyze the occurrence of financial reporting fraud. Bounded rationality points out that the current financial evaluation index system is based on results-oriented, and this is the incentive to financial reporting fraud, In addition, this chapter also analyzes financial reporting fraud from the perspective of white-collar crime, rotten apple theory and externality theory.Chapter In studies the identification of financial reporting fraud. Section I of this chapter summarizes seven common means of financial reporting fraud and describes their specific operational methods; Section II describes the identification method of financial reporting fraud, including greater attention to the higher risk of accounting accounts audit, focusing on the external implementation of the financial reporting, the observation of financial reporting fraud on articulation report and early warning indicators of volatility. Section III describes the identification model of financial reporting fraud first, including the univariate analysis, multivariate discriminate analysis, logistic regression models, linear probability models, expert systems, recursive partitioning algorithm, neural network model and logistic regression models, and than points out the advantages and disadvantages of these models. The final section of this chapter compares the pros and cons of these models and selected logistic regression model as an empirical model of this article.Chapter V makes a logistic regression analysis on financial reporting fraud. In this part, the paper makes an empirical research on the factors which related to financial reporting fraud and attempts to analyze which objective indicators lead to the financial reporting fraud. Samples of listed companies from China and the USA were analyzed to find differences of financial reporting fraud between the two countries. This paper uses the method of comparative analysis in the study, which means the sample is divided into fraud companies and Non-fraud Companies. Logistic regression analysis is based on the American sample of59fraud companies and51compared companies, the empirical results shows that the fluctuation of manipulative accruals accounts within three years (Which means the year when financial reporting fraud occurred and two years before the it.) has a positive relationship with financial reporting fraud. The results also shows that financial reporting fraud has relationship with deteriorated business conditions in the year which financial reporting fraud occurred and the former year. By a univariate analysis and a multivariate analysis respectively, the research generates a two-dimensional model and a four-dimensional model to determine and classify the samples of110companies and four-dimensional model outperforms the two-dimensional model. Similarly, Logistic regression analysis based on the Chinese sample of69fraud companies and58compared companies is also made and we find that the fluctuation of receivable accounts within three years has a positive relationship with financial reporting fraud, changes of inventories within three years and return on total assets ROA have a negative relationship with financial reporting fraud. By univariate analysis and multivariate analysis, the research generates a two-dimensional model and a three-dimensional model to determine the127samples and the three-dimensional models outperforms the two-dimensional model. According to Sino-US differences, we can see that U.S. firms tend to use false sales, confirming sales in advance, broadening the scope of credit to adjust the total profit while the Chinese companies tend to make financial reporting fraud by non-business activities to increasing the their profit.Chapter VI analyzes the factors of the generation of China’s listed companies’financial reporting fraud. In the first section, it is pointed out that the root cause of this fraud is the drive of interests, which mainly come from listed companies and accounting firms, securities companies and other intermediaries. Section II of this chapter points out that Chinese enterprises have the preference for equity financing,then the author discusses the reasons why listed companies in China prefer equity financing and the problem that while state-owned enterprise have resolved their thirst for fund rising, there comes a new problem of financing for small and medium-sized enterprises. At the same time, the article compares equity financing with debt financing and identified that it is the qualities of low-cost, low risk and non-reimbursement of equity financing that explained for the preference for it. Section III lists out the decisive factor in China’s listed companies’fraud, and points out that moral and system are decisive factors of the frauds.Chapter VII describes the regulatory path to financial reporting fraud. The first section of this chapter describes the listed company governable model of financial reporting fraud based on the main game participants, the broad financial reporting fraud management participants include regulators, external auditors, internal auditors, company executives, board of directors and the audit committee. Regulatory agencies include the Securities Commission and the Accounting Standards-setting bodies which play an important role on the company’s financial reporting fraud management, so this article analyzes the governance of listed companies’ financial reporting fraud on this perspective. Section II reviews the "Enron case" and its effects on the U.S. financial reporting fraud Regulatory policy. The third quarter analyzes the situation of China-based regulatory environment of listed companies by studying changes in China’s capital market environment and information disclosure problems which are happened after split share structure reform. This paper focuses on the information disclosure problems of listed companies including inadequate disclosure of information, late information, the disclosure of false information and the overall poor quality of information. Section IV puts forward to financial reporting fraud control strategy based on the American experience and the listed companies in Chinese national conditions. China should learn from American experience to establish and improve the security rating system, to strengthen information disclosure system of listed companies and to improve the integrity of the mechanism. Through these measures, we believe we can strengthen supervision of financial reporting fraud in Chinese capital markets.This final chapter points out the conclusions and limitations of this study and puts forward to future research.