Title: An examination of the bankruptcy prediction model, in consideration of profit manipulation

Authors: Naoya Ishii; Ling Feng

Addresses: Midori Godo Keiei, KandaY5 Bld., Kandatacho, Chiyoda-ku, Tokyo, 101-0046, Japan ' Faculty of Science and Technology, Tokyo University of Science, 2641 Yamasaki, Noda, Chiba 278-8510, Japan

Abstract: Accounting information published by corporations impacts many stakeholders, as well as corporations' financing and manager's bonus. Thus, managers have a motivation to make a corporation's situation look better than it actually is, and will choose to change accounting policies or actual business transactions that would affect profitability. In other words, they engage in profit manipulation. In particular, the financial poverty companies in dire financial straits have a strong incentive to do optimistic profits manipulation. The purpose of this research is to first reveal profit manipulation in financial poverty companies, and then consider whether it is necessary to account for profit manipulation when building a bankruptcy prediction model. We use the models put forth by Jones (1991) and Roychowdhury (2006) in accounting activity manipulation and real activity manipulation in financial poverty companies. In addition, the study verifies changes in profit manipulation behaviour resulting from the SOX enacted in Japan in 2008. The results show a tendency to suppress fiscal discretionary behaviour among financial poverty companies, and we think the need to account for profit manipulation when determining the likelihood of bankruptcy, based on the cases of companies that have actually experienced bankruptcy.

Keywords: bankruptcy prediction models; modelling; profit manipulation; accounting manipulation; real activity manipulation; financial distress; accounting information; Japan; fiscal discretionary behaviour.

DOI: 10.1504/AJMSA.2015.071896

Asian Journal of Management Science and Applications, 2015 Vol.2 No.1, pp.48 - 60

Received: 22 May 2014
Accepted: 23 Apr 2015

Published online: 22 Sep 2015 *

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