Investor Reaction to the Discovery of Accounting Fraud: The Period from the Discovery of the Fraud to the Completion of the Correction

Syed Raziuddin  Ahmad; Nabil Ahmed Mareai  Senan; Ijaz  Ali; Kashif  Ali; Imran Ahmad  Khan; Asif  Baig

doi:10.36941/ajis-2021-0163

Authors

Syed Raziuddin Ahmad Department of Accounting, Faculty of Business Studies, Arab Open University, Saudi Arabia
Nabil Ahmed Mareai Senan Associate Professor, Department of Accounting, College of Business Administration, Prince Sattam bin Abdul Aziz University, Saudi Arabia; Administrative Science College, Albaydha University, Yemen
Ijaz Ali Assistant Professor, College of Business and Management, Fahad Bin Sultan University, Tabuk, Saudi Arabia
Kashif Ali Ulster University, Birmingham, United Kingdom
Imran Ahmad Khan Researcher and Consultant, Creative Heads Consultants, India
Asif Baig Assistant Professor, Jubail University College, Jubail Industrial City, Jubail, Saudi Arabia

DOI:

https://doi.org/10.36941/ajis-2021-0163

Keywords:

Fraud, Profit, Information, Correction, Investors, Disclosure

Abstract

This paper examines the period from the discovery of accounting fraud to the completion of correction and examines the reaction of investors on the date of the first news release suggesting accounting manipulation, the date of the subsequent release of information related to the amount of profit correction that was not disclosed on the date of the first news release, and the date of the submission of the correction report. The verification results show that the stock price falls sharply on the day of the first news release and the day when the information about the amount of profit revision is disclosed, that when the amount of profit revision is large and it takes time to disclose information about the amount of profit revision, there is a rebound in the stock price on the day when the correction report is submitted because investors like the resolution of uncertainty, and that there is a relationship between the amount of profit revision and the size of stock price decline. However, when there is no information about the amount of correction on the first day of the news release, investors react uniformly, and the reaction to a large (small) amount of correction is underreaction (overreaction). These results indicate that investors were misled by the misstatements until the fraud was discovered and made decisions based on overestimates of future cash flows, so they suffered unexpected losses when the fraud was discovered, and during the period from the fraud discovery to the completion of correction.

Received: 3 August 2021 / Accepted: 6 October 2021 / Published: 5 November 2021