Revenue Manipulation for Valuation Purposes

Publication Type

Journal Article

Publication Date

2008

Abstract

This paper investigates the relation between the extent of a firm's past and expected future losses or negative cash flows and the ex anteprobability that it will manipulate revenues. When a firm has a string of losses or negative cash flows, traditional valuation models do not yield reliable estimates of firm value, and traditional price-earnings ratios are not meaningful. Evidence suggests that market participants tend to value loss firms on the basis of the level and growth in revenues, rather than cash flows and earnings, thereby motivating these firms to overstate revenue. In fact, empirical results indicate that there is a positive relation between the number of years that firms exhibit and/or anticipate losses or negative cash flows andinvestment in receivables after controlling for credit policy. We further show that the ex ante likelihood that firms manipulate revenue in violation of GAAP is positively associated with the history of past and expected future losses or negative cash flows, as well as with the investment in accounts receivable (adjusted for credit policy). Our results suggest another indicator of manipulation that may be used by auditors and regulators in identifying firms that are more likely to overstate revenues.

Discipline

Accounting | Corporate Finance

Research Areas

Financial Performance Analysis

Publication

Auditing: A Journal of Practice and Theory

Volume

27

Issue

2

First Page

1

Last Page

29

ISSN

0278-0380

Identifier

10.2308/aud.2008.27.2.1

Publisher

American Accounting Association

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