VOLUME 22 #3

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‘Lie detector’ pinpoints accounting fraud

RESEARCH | Nerissa Brown, associate professor of accounting and management information systems, has devised a new and more effective approach to identifying accounting fraud than traditional methods.

“There have been quite a few studies developing measures to help us predict which firms are fudging the numbers or trying to look better than they really are financially,” Brown says. These studies examine various measurements in the hopes that they will help predict if a firm is manipulating its accounting.

But Brown’s research uses a new variable to identify fraud: the number of topics that a firm discusses in its annual financial reports.

“You know how sometimes when people are lying they tend to talk a whole lot?” asks Brown. “In some ways, we’re trying to pick up instances like that. Firms who are engaging in fraud tend to talk about issues that are not important when compared to other firms in the industry. They also underreport important risk factors.”

Brown and colleagues at the University of Illinois found that an algorithm they developed and used in their model was highly successful, performing 2,083 percent better than traditional financial measurements at predicting accounting fraud between 2008 and 2012.

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