ABSTRACT Comparing fraud firms to nonfraud firms within the same industry, prior research has documented that fraud firms have sustained long-term lower operating cash flows in the pre-fraud period. In this paper, we examine follow-on questions related to the pre-fraud period. First, do fraud firms experiencing operating cashflow shortages in the pre-fraud period manifest other risk factors? Second, we ask how fraud firms address those operating cashflow shortages? Our findings suggest that fraud firms (compared to nonfraud firms in the same industry) appear riskier and more financially constrained three to four years before fraud. Nevertheless, those same fraud firms maintain investment spending levels (research and development, capital expenditures and acquisition activity) that are comparable to nonfraud firms. To cover cashflows shortages in comparison to industry competitors, fraud firms conserve cash through real earnings management one to two years before the fraud, issue more debt and equity financing and reduce dividends. Data Availability: Data are available from public sources cited in the text. JEL Classifications: G30; G34; G38; G39.
Davidson et al. (Fri,) studied this question.