0% found this document useful (0 votes)

429 views

Machine Learning Applications For Accounting Disclosure

Aplicaciones de aprendizaje automático para Contabilidad

Uploaded by

gaboarenas

Available Formats

Download as PDF, TXT or read online on Scribd

0% found this document useful (0 votes)

429 views

Machine Learning Applications For Accounting Disclosure

Aplicaciones de aprendizaje automático para Contabilidad

Uploaded by

gaboarenas

Available Formats

Download as PDF, TXT or read online on Scribd

You are on page 1/ 291

Machine Learning

Applications for
Accounting Disclosure
and Fraud Detection

Stylianos Papadakis
Hellenic Mediterranean University, Greece

Alexandros Garefalakis
Hellenic Mediterranean University, Greece

Christos Lemonakis
Hellenic Mediterranean University, Greece

Christiana Chimonaki
University οf Portsmouth, UK

Constantin Zopounidis
School of Production Engineering and Management, Technical University of
Crete, Greece & Audencia Business School, France

A volume in the Advances in Finance, Accounting,

and Economics (AFAE) Book Series
Published in the United States of America by
IGI Global
Business Science Reference (an imprint of IGI Global)
701 E. Chocolate Avenue
Hershey PA, USA 17033
Tel: 717-533-8845
Fax: 717-533-8661
E-mail: [email protected]
Web site: http://www.igi-global.com

Copyright © 2021 by IGI Global. All rights reserved. No part of this publication may be reproduced, stored or distributed in
any form or by any means, electronic or mechanical, including photocopying, without written permission from the publisher.
Product or company names used in this set are for identification purposes only. Inclusion of the names of the products or
companies does not indicate a claim of ownership by IGI Global of the trademark or registered trademark.
Library of Congress Cataloging-in-Publication Data
Names: Papadakis, Stylianos, 1970- editor.
Title: Machine learning applications for accounting disclosure and fraud
detection / Stylianos Papadakis [and four others], editor.
Description: Hershey, PA : Business Science Reference, [2021] | Includes
bibliographical references and index. | Summary: “This book covers the
application of machine learning models to identify “quality”
characteristics in corporate accounting disclosure, proposing specific
tools for detecting core business fraud characteristics. It uses machine
learning techniques in accounting disclosure (i.e. corporate financial
statements) and identifies methodological aspects revealing the
deployment of fraudulent behavior and fraud detection in the corporate
environment”-- Provided by publisher.
Identifiers: LCCN 2020018650 (print) | LCCN 2020018651 (ebook) | ISBN
9781799848059 (hardcover) | ISBN 9781799857853 (paperback) | ISBN
9781799848066 (ebook)
Subjects: LCSH: Auditing, Internal--Data processing. |
Corporations--Accounting--Data processing. | Fraud--Prevention. |
Machine learning.
Classification: LCC HF5668.25 .M33 2021 (print) | LCC HF5668.25 (ebook) |
DDC 657.0285/631--dc23
LC record available at https://lccn.loc.gov/2020018650
LC ebook record available at https://lccn.loc.gov/2020018651

This book is published in the IGI Global book series Advances in Finance, Accounting, and Economics (AFAE) (ISSN:
2327-5677; eISSN: 2327-5685)

British Cataloguing in Publication Data

A Cataloguing in Publication record for this book is available from the British Library.

All work contributed to this book is new, previously-unpublished material. The views expressed in this book are those of the
authors, but not necessarily of the publisher.

For electronic access to this publication, please contact: [email protected].

Advances in Finance,
Accounting, and Economics
(AFAE) Book Series
Ahmed Driouchi
Al Akhawayn University, Morocco
ISSN:2327-5677
EISSN:2327-5685
Mission
In our changing economic and business environment, it is important to consider the financial changes
occurring internationally as well as within individual organizations and business environments. Under-
standing these changes as well as the factors that influence them is crucial in preparing for our financial
future and ensuring economic sustainability and growth.
The Advances in Finance, Accounting, and Economics (AFAE) book series aims to publish com-
prehensive and informative titles in all areas of economics and economic theory, finance, and accounting
to assist in advancing the available knowledge and providing for further research development in these
dynamic fields.

Coverage
• E-finance
IGI Global is currently accepting manuscripts
• Macroeconomics
for publication within this series. To submit a pro-
• Ethics in Accounting and Finance
posal for a volume in this series, please contact our
• Economics Geography
Acquisition Editors at [email protected]
• Finance and Accounting in SMEs
or visit: http://www.igi-global.com/publish/.
• Accounting Standards
• Public Finance
• Economic Theory
• Evidence-Based Studies
• Finance

The Advances in Finance, Accounting, and Economics (AFAE) Book Series (ISSN 2327-5677) is published by IGI Global, 701 E. Choco-
late Avenue, Hershey, PA 17033-1240, USA, www.igi-global.com. This series is composed of titles available for purchase individually; each
title is edited to be contextually exclusive from any other title within the series. For pricing and ordering information please visit http://www.
igi-global.com/book-series/advances-finance-accounting-economics/73685. Postmaster: Send all address changes to above address. Copyright
© 2021 IGI Global. All rights, including translation in other languages reserved by the publisher. No part of this series may be reproduced or
used in any form or by any means – graphics, electronic, or mechanical, including photocopying, recording, taping, or information and retrieval
systems – without written permission from the publisher, except for non commercial, educational use, including classroom teaching purposes.
The views expressed in this series are those of the authors, but not necessarily of IGI Global.
Titles in this Series
For a list of additional titles in this series, please visit:
http://www.igi-global.com/book-series/advances-finance-accounting-economics/73685

Influence of FinTech on Management Transformation

Amira Sghari (Faculty of Economics and Management, University of Sfax, Tunisia) and Karim Mezghani (Al
Imam Mohammad Ibn Saud Islamic University, Saudi Arabia & University of Sfax, Tunisia)
Business Science Reference • © 2021 • 273pp • H/C (ISBN: 9781799871101) • US $215.00

Handbook of Research on Institutional, Economic, and Social Impacts of Globalization and Liberalization
Yilmaz Bayar (Bandirma Onyedi Eylul University, Turkey)
Information Science Reference • © 2021 • 699pp • H/C (ISBN: 9781799844594) • US $445.00

Bridging Microeconomics and Macroeconomics and the Effects on Economic Development and Growth
Pantelis C. Kostis (National and Kapodistrian University of Athens, Greece)
Business Science Reference • © 2021 • 340pp • H/C (ISBN: 9781799849339) • US $195.00

Corporate Governance and Its Implications on Accounting and Finance

Ahmad Alqatan (University of Portsmouth, UK) Khaled Hussainey (University of Portsmouth, UK) and Hichem
Khlif (University of Sfax, Tunisia)
Business Science Reference • © 2021 • 425pp • H/C (ISBN: 9781799848523) • US $195.00

Recent Applications of Financial Risk Modelling and Portfolio Management

Tihana Škrinjarić (University of Zagreb, Croatia) Mirjana Čižmešija (University of Zagreb, Croatia) and Bryan
Christiansen (Global Training Group, Ltd, UK)
Business Science Reference • © 2021 • 432pp • H/C (ISBN: 9781799850830) • US $195.00

Fostering Innovation and Competitiveness With FinTech, RegTech, and SupTech

Iustina Alina Boitan (Bucharest University of Economic Studies, Romania) and Kamilla Marchewka-Bartkowiak
(Poznan University of Economics and Business, Poland)
Business Science Reference • © 2021 • 313pp • H/C (ISBN: 9781799843900) • US $215.00

Bridging the Gender Gap in Digital Financial Inclusion

Puja Singhal (Sashakt-A Centre of Empowerment, India) and Rosy Kalra (Amity University Uttar Pradesh, India)
Business Science Reference • © 2021 • 300pp • H/C (ISBN: 9781799850120) • US $215.00

701 East Chocolate Avenue, Hershey, PA 17033, USA

Tel: 717-533-8845 x100 • Fax: 717-533-8661
E-Mail: [email protected] • www.igi-global.com
Table of Contents

Preface.................................................................................................................................................. xiv

Chapter 1
Corporate Governance as a Tool for Fraud Mitigation ...........................................................................1
Antonia Maravelaki, Hellenic Mediterranean University, Greece
Constantin Zopounidis, School of Production Engineering and Management, Technical
University of Crete, Greece & Audencia Business School, France
Christos Lemonakis, Hellenic Mediterranean University, Greece
Ioannis Passas, Hellenic Mediterranean University, Greece

Chapter 2
Corporate Sector Fraud: Challenges and Safety ...................................................................................16
Jay Prakash Maurya, Samrat Ashok Technological Institute, India
Deepak Rathore, LNCT University, India
Sunil Joshi, Samrat Ashok Technological Institute, India
Manish Manoria, Sagar Institute of Research and Technology, India
Vivek Richhariya, Lakshmi Narain College of Technology, Bhopal, India

Chapter 3
Corporate Governance: Introduction, Roles, Codes of Corporate Governance ....................................32
Marios Eugene Menexiadis, National and Kapodistrian University of Athens, Greece

Chapter 4
Fraud Governance and Good Practices Against Fraud .........................................................................49
Antonios Zairis, Neapolis University Paphos, Greece

Chapter 5
Theoretical Analysis of Creative Accounting: Fraud in Financial Statements .....................................58
Christianna Chimonaki, University of Portsmouth, UK

Chapter 6
Operational Risk Framework and Fraud Management: A Contemporary Approach ...........................75
Elpida Tsitsiridi, Technical University of Crete, Greece
Christos Lemonakis, Hellenic Mediterranean University, Greece
Constantin Zopounidis, School of Production Engineering and Management, Technical
University of Crete, Greece & Audencia Business School, France

Chapter 7
Current Trends in Investment Analysis .................................................................................................95
Marios Nikolaos Kouskoukis, European University Cyprus, Nicosia, Cyprus

Chapter 8
A Study on Various Applications of Data Mining and Supervised Learning Techniques in
Business Fraud Detection ...................................................................................................................108
Amit Majumder, JIS College of Engineering, India
Ira Nath, JIS College of Engineering, India

Chapter 9
Detection and Prevention of Fraud in the Digital Era .........................................................................126
Evrim Vildan Altuk, Trakya University, Turkey

Chapter 10
Downside Risk Premium: A Comparative Analysis ...........................................................................138
Kanellos Stylianou Toudas, National and Kapodistrian University of Athens, Greece

Chapter 11
Impact of Corporate Fraud on Foreign Direct Investment? Evidence From China ............................148
Radwan Alkebsee, Xi’an Jiaotong University, China
Gaoliang Tian, Xi’an Jiaotong University, China
Konstantinos G. Spinthiropoulos, University of Western Macedonia, Greece
Eirini Stavropoulou, University of Western Macedonia, Greece
Anastasios Konstantinidis, University of Western Macedonia, Greece

Chapter 12
Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units: A Literature
Review on Transition From In-House to Outsourcing ........................................................................166
Yasemin Acar Uğurlu, Istanbul Arel University, Turkey
Çağla Demir Pali, TYH Textile, Turkey

Chapter 13
Machine Learning Techniques and Risk Management: Application to the Banking Sector During
Crisis ...................................................................................................................................................185
Christos Floros, Hellenic Mediterranean University, Greece
Panagiotis Ballas, Hellenic Mediterranean University, Greece

Chapter 14
Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance ..................................201
Konstantina K. Ainatzoglou, School of Production Engineering and Management, Technical
University of Crete, Greece
Georgios K. Tairidis, School of Production Engineering and Management, Technical
University of Crete, Greece
Georgios E. Stavroulakis, School of Production Engineering and Management, Technical
University of Crete, Greece
Constantin K. Zopounidis, School of Production Engineering and Management, Technical
University of Crete, Greece & Audencia Business School, France

Chapter 15
Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe: A
Comparison of Statistical and Machine Learning Approaches...........................................................223
Marianna Eskantar, Technical University of Crete, Greece
Michalis Doumpos, Technical University of Crete, Greece
Evangelos Grigoroudis, Technical University of Crete, Greece
Constantin Zopounidis, School of Production Engineering and Management, Technical
University of Crete, Greece & Audencia Business School, France

Compilation of References ...............................................................................................................236

About the Contributors ....................................................................................................................264

Index ...................................................................................................................................................269
Detailed Table of Contents

Preface.................................................................................................................................................. xiv

Financial fraud through the falsification of financial statements is an evident problem. The restatement
is enormous, and there have been developed many approaches to confront it. Profits manipulation has
reached alarming proportions worldwide. The tendency of management to present a misleading image
based on accounting weaknesses and gaps, to present accounting results as it wishes and not as it should
according to the accounting standards, is essentially a key feature of profit manipulation. The executives’
motives to falsify financial results and creative accounting practices have concerned researchers and
their efforts to identify the necessary changes and improvements in accounting systems to protect the
stakeholders and the public from misleading information.

This chapter aims to possess a review of machine learning techniques for detection of corporate fraud in
modern era. Detecting company frauds using traditional procedures is time costly as immense volume
of information must be analysed. Thus, further analytical procedures should be used. Machine learning
techniques are most emerging topic with great importance in ﬁeld of information learning and prediction.
The machine learning (ML) approach to fraud detection has received a lot of promotion in recent years
and shifted business interest from rule-based fraud detection systems to ML-based solutions. Machine
learning permits for making algorithms that process giant data-sets with several variables and facilitate
realize these hidden correlations between user behaviors and also the probability of fallacious actions.
Strength of machine learning systems compared to rule-based ones is quicker processing and less manual

work. The chapter aims at machine-driven analysis of knowledge reports exploitation machine learning
paradigm to spot fraudulent companies.

Corporate governance is the cornerstone for the organization, when it comes to effective internal control
systems by modern organizations. Over the last 20 years, several business giants have collapsed under the
weight of illegalities and frauds, such as Enron, WorldCom, Guinness, Maxwell Group, Barings Bank,
etc. The impact of the failure of these organizations on the economies in which they were operating was
particularly significant and had a negative impact on those directly or indirectly associated with them.
The shareholders, as well as all stakeholders such as suppliers, customers, creditors, employees, and
governments of the countries where the above organizations were active, were adversely affected. The
failure of the organizations was attributed to the inadequacy of their boards and the lack of organized
and effective control mechanisms by their management.

Chapter 4
Fraud Governance and Good Practices Against Fraud .........................................................................49
Antonios Zairis, Neapolis University Paphos, Greece

Chapter 5
Theoretical Analysis of Creative Accounting: Fraud in Financial Statements .....................................58
Christianna Chimonaki, University of Portsmouth, UK

This chapter begins with the definitions of creative accounting, fraud and financial statement fraud and
explains the relationship between them. Next, it presents the classical theories on the determinants of
financial statement fraud. Section 1.4 presents the profile of accounting scandals. Section 1.5 presents the
components of financial report fraud as well as the parties involved in in creative accounting. Section 1.6
presents the reasons and motivations for creative accounting. Specifically, the authors analyse manipulation
practices, the methods and the opportunities for creative accounting and address why financial frauds
occur. Finally, they offer conclusions in Section 1.7.

The universal financial shake of 2008 altered business and occupational circumstances and will
inevitably trigger the outbreak of new forms of operational risk. Under normal conditions, OR does not
cause significant losses; thus, severe damage is likely to occur when an operational miscarriage or an
unexpected event takes place. Under the Basel III context, the banking sector is trying to increase safety
and stability, by focusing on the quality of historical loss data, while cultivating an inside operational risk
awareness culture. One of the most perilous types of OR is fraud, and its effects are often dangerous and
may have long-term spillovers. In this chapter, an analysis of the meaning and the main characteristics of
fraud is provided, focusing on contemporary trends of the issue. Going further, the business anti-fraud
strategic plan is described along with how it maximizes its efficiency, while the chapter aims to analyze
the demands for an organization to pass through fraud-fragile to fraud-resistant.

The purpose of this chapter is to review the current trends in investment management and performance
research. The adaption of both the classic CAPM and the factor models seems to continue, with the realistic
factors playing a crucial role and best represent the drivers of investment performance. Another rising
area is the search for skill, which is based on the enhanced benchmarks. The availability of quantitative
and qualitative data in the academic community has allowed for these areas to evolve in recent years
and to emerge as expected in the next decade, as well as to be explored.

Data mining technique helps us to extract useful data from a large dataset of any raw data. It is used to
analyse and identify data patterns and to find anomalies and correlations within dataset to predict outcomes.
Using a broad range of techniques, we can use this information to improve customer relationships and
reduce risks. Data mining and supervised learning have applications in multiple fields of science and
research. Machine learning looks at patterns of data and helps to predict future behaviour by learning
from the patterns. Data mining is normally used as a source of information on which machine learning
can be applied to solve some of problems in our daily life. Supervised learning is one type of machine
learning method which uses labelled data consisting of input along with the label of inputs and generates
one learned model (or classifier for classification type work) which can be used to label unknown data.
Financial accounting fraud detection has become an emerging topic in the field of academic, research
and industries.

Chapter 9
Detection and Prevention of Fraud in the Digital Era .........................................................................126
Evrim Vildan Altuk, Trakya University, Turkey

It is essential for businesses to keep up with the technological advances. Today nearly all the businesses
depend on computer technologies and the Internet to operate as technological developments have
introduced many practical methods for businesses. Yet, transformation of businesses technologically also
presents new means for the criminals, which has led to new types of fraud. It is crucial for businesses to
take measures to prevent fraud. Traditional methods to prevent or to detect fraud seems to be ineﬀective
for new types of fraud in the digital era. Therefore, new methods have been used to prevent and detect
fraud. This chapter reviews fraud as a form of cybercrime in the digital era and aims to introduce the
methods that have been used to detect and prevent it.

The purpose of this chapter is to address the main developments and challenges on risk assessment and
portfolio management. The former innovation in modern portfolio theory, Markowitz, has been succeeded
from linear and non-linear optimization techniques that improve portfolio efficiency. Special emphasis is
given on Roy’s seminal work on “Safety First Criterion” which advocates that the safety of investments
should be prioritized. Thus, an investment should be chosen in a way that it has the lowest probability
of falling short of a required threshold of investors. This motivated Markowitz to advocate a downside
risk measure based on semivariance. It captures the notion of risk as failure to meet some minimum
target. It is influenced by returns below the target rate. It focuses on investors’ concern with downside
variability and loss reduction. This chapter offers a critical reflection of these recent developments and
could be of interest for individual and institutional investors.

The capital market reputation attracts foreign investment. Corporate fraud phenomenon is one of the
most crucial aspects that threaten foreign investors. This study investigates the impact of corporate fraud
on foreign direct investment FDI. Using data of Chinese listed firms, over the period 2009 to 2017, the
results show that corporate fraud is negatively associated with foreign direct investment. This suggests
that corporate fraud declines foreign shareholders ratio, and foreign investors avoid investing in a risky
environment where their wealth may be expropriated. Further, we explore the impact of having foreign
shareholders on corporate fraud. We find that increasing foreign shareholders may help in curbing
corporate fraud due to diversified corporate experience and risk-taking behavior. However, the findings
remain robust after controlling for the potential endogeneity problem. Our findings have important
implications for policymakers and governments as it shows that corporate fraud is a crucial determinant
to the cause of foreign direct investment.

The internal audit function traditionally establishes and continues its activities within the company, but
it can also be provided by professionals outside the organization. Therefore, internal audit activities can
be provided in three ways: the internal audit department established within the organization (in-house),
the internal audit service provided by an audit firm (outsourcing), the joint operation of the internal audit
department and the audit firm (co-sourcing). To choose the better approach for a company, the scale of
the organization, the attitude and understanding of the management, and industry in which the company
operates in must be taken into consideration. This study is a literature review that classifies the studies
carried out on these methods that are used in performing internal audit activities.

Crises around the world reveal a generally unstable environment in the last decades within which
banks and financial institutions operate. Risk is an inherent characteristic of financial institutions and
is a multifaceted phenomenon. Everyday business practice involves decisions, which requires the use
of information regarding various types of threats involved together with an evaluation of their impact
on future performance, concluding to combinations of types of risks and projected returns for decision
makers to choose from. Moreover, financial institutions process a massive amount of data, collected
either internally or externally, in an effort to continuously analyse trends of the economy they operate
in and decode global economic conditions. Even though research has been performed in the field of
accounting and finance, the authors explore the application of machine learning techniques to facilitate
decision making by top management of contemporary financial institutions improving the quality of
their accounting disclosure.

Credit insurance is of vital importance for the trade sector and almost every related business. Moreover,
every policy in credit insurance is tailor-made in order to suit in the best available way the unique
needs and demands of the insured business. Thus, pricing of such service can be tricky for an insurance

company. In the present chapter, this pricing problem in the field of credit insurance will be addressed
through the use of intelligent control mechanisms. More specifically, a way of calculating the price of
insurance policies that has to be paid by a prospective client of an insurance company will be suggested.
The model will be created and implemented with the use of fuzzy logic, and more specifically, through
the implementation of an adaptive neurofuzzy inference system. The training data that will be used for
the tuning of the system will be derived from real anonymous insurance policies of the Greek insurance
market.

The risk of bankruptcy is naturally faced by all corporate organizations, and there are various factors
that may lead an organization to bankruptcy, including microeconomic and macroeconomic ones. Many
researchers have studied the prediction of business bankruptcy risk in recent decades. However, the
research on better tools continues to evolve, utilizing new methodologies from various scientific fields
of management science and computer science. This chapter deals with the development of statistical
and artificial intelligence methodologies for predicting failures for small and medium-sized enterprises,
considering financial and macroeconomic data. Empirical results are presented for a large sample of
European firms.

Compilation of References ...............................................................................................................236

About the Contributors ....................................................................................................................264

Index ...................................................................................................................................................269
xiv

Preface

Nowadays, it is well known the need, which originates from the human character, controls every financial
management of the property. Even though science has evolved over the years, human error has not entirely
disappeared, as it is often done deliberately. A typical example is the dozens of corporate scandals that
are revealed and distract the academic and the research community’s interest. Some of the factors that
lead to these voluntary mistakes are the personal, team, or business benefits they are trying to achieve,
the stress in their work environment, and the competitive economic environment. These mistakes are a
scam and are made through Creative Accounting. Therefore, to deal with the phenomenon of falsification
of financial statements, it is considered necessary to apply methods and models and effective control
systems. This book presents issues of detecting accounting fraud, using machine learning techniques
based on international literature, and combining the theoretical background with modern reality. First of
all, however, the main definitions and some necessary information that the reader should know in order
to be able to understand the theoretical framework regarding the profile of the falsification of companies’
financial statements are listed.
Fraud is a phenomenon that has occupied many researchers’ categories and not only, as society shows
great interest in this field. Corporate scandals, unfortunately, are always up to date and pull it off the
attention of the world, as it is connected with the sinful nature of man and the narcissism that possesses
it. Finally, with various aspects, it is an area that is continually changing due to technological develop-
ment, adding new data, as a result of which it is of great interest.
According to the American Institute of Certified Public Accountants (A.I.C.P.A.), falsified financial
statements are defined as intentional misstatements or omissions in financial statements to deceive users.
As reported, falsified financial statements may include:

• The handling, falsiﬁcation, or modiﬁcation of accounting records or supporting documents used

to prepare financial statements.
• Distortions or deliberate omissions of significant events or transactions from the financial
statements.
• The intentional misapplication of accounting rules.

Ιn 1977, AICPA issued Auditing Standard No. 82 (SAS No. 82 “Consideration of Fraud in a Financial
Statement Audit”), through which it attempted to delimit the auditor’s responsibility for detecting Fraud
during the conduct of the audit of financial statements, always combining the Generally Accepted Ac-
counting Principles. Auditing Standard No. 82 sets out auditors’ responsibilities in detecting accounting

Preface

fraud but does not multiply them. Based on the above standard, the auditor both during the planning of
the audit and during its execution should:

• Assess the risk factors and any warning points to focus on during the audit.
• Develop appropriate tools for assessing these risks.
• Carry out audits and evaluate their results.

To transfer the results of the audit to the administration. Subsequently, in 2001, International Auditing
Standard No. 240 refers to the audit team’s responsibility in reviewing Fraud during the audit process
and clarifies the limitations that exist and that the auditor is required to address, in particular administra-
tive Fraud. Also, it distinguishes the definitions of administrative Fraud and Fraud among employees,
giving rise to further analysis of the issue of falsification of financial statements. Named falsification,
International Auditing Standard No. 240 refers to the voluntary action by one or more members of
management, employees or a third party of the audited company that results in the modification of the
accounting statements.
According to the same standard, Fraud consists of the following features: Forgery or alteration of
accounting records or documents, (b) Alteration of assets, (c) Concealment or omission of a report of
the effects of the above entries or evidence, (d) Registration of virtual transactions, and (e) incorrect
application of Accounting Standards and Principles.
The American Institute of Certified Public Accountants categorizes errors into those involving unin-
tentional acts and those aimed at Fraud, stressing that Fraud is the deliberate misappropriation of funds
or the falsification of information in corporate financial statements. Particular attention should be paid
to the fact that even now, the boundaries between Fraud and error are not very clear, and for this reason,
special attention needs to be paid. “In general, the falsification of financial statements involves the intent
and expediency of a group of smart actors, such as senior management, accountants, and auditors, who
act based on a well-designed technical deception.”
On the other hand, machine learning is one of the first research disciplines of Artificial Intelligence-
TN, which studies algorithms based on data observation. The object of machine learning is to create
machines capable of “learning,” that is, to improve their performance in certain areas by utilizing pre-
vious empirical data of knowledge and experience. One of the reasons that are considered necessary
for its further development is the possibility of solving complex problems in an automated way. Their
massive volume of data seems inaccessible to humans. Of course, this does not mean that science has
developed to such an extent that it can mimic the human learning process or capture it in an executable
program. However, various algorithms have managed to automate the construction of intelligent systems
using training data.
Machine learning problems are classified into the following categories depending on the output received:
Supervised learning: In this category, the learning process is “supervised,” in the sense that the
algorithms used to create a Function (target function), where a specific input corresponds to a strictly
defined output. Supervised learning is synonymous with classification and regression problems.
Unsupervised learning: It is a method where no experience is provided for guiding learning, but the
system itself seeks to estimate a distribution function for the whole education, based on appropriately
selected criteria. Thus, problems of this kind are more complicated. This category includes clustering,
which seeks to group the snapshots into classes that the algorithm will deduce based on the similarities

xv
Preface

of the members of each group, numerical prediction, where it is not the category of the snapshot that
matters but the arithmetic quantity, and the export of association rule mining.
The models used in learning methods are divided into descriptive modelling and predictive mod-
elling. The purpose of a prediction model is to predict a variable’s value using the values of already
known variables. In other words, having as a database with already known results, it tries to make some
prediction for the prices of new data. This category includes categorization and regression. A descriptive
model describes the data set, highlights patterns and relationships that coexist in the data, investigates
the data’s properties under consideration, and interprets their behavior without seeking to predict new
properties. A variety of methods are using for extracting knowledge from data. The use of machine
learning methods to detect accounting fraud takes into account the observations recorded in the auditors’
reports on the accuracy of accounting, the observations of the tax authorities affecting the balance sheets
and the income tax returns, the observations for negative net position under the relevant legislation, the
suspension of trading of the company’s shares or its placement in a supervised situation and finally the
existence of court cases related to tax issues or issues related to falsification of accounts. The selection
of criteria, which are used as “input vector” in the sample taken, are financial data and indicators that
reflect the analysis of financial statements over time because they help the analyst present concisely and
understandably and efficiently these statements.

VOLUME CONTRIBUTION

This volume contributes systematically to the development of modern financial research using machine
learning methods to identify cases of falsification of financial statements. The main contribution is un-
doubtedly in the way and the philosophy that the management of a company can operate, determining to
a large extent how to organize the company as an entity. Besides, with the use of new machine learning
techniques, the work becomes more systematic and supportive for a wide range of analysts, investors,
students, and auditing professionals who wish to adopt new techniques to identify falling data and data in
corporate Fraud. Therefore, the book tries to create that framework for a systematic and methodological
approach to corporate financial statements.
A description of the importance of each of the chapter submissions (this entails providing a paragraph
description of each chapter).

1. Corporate Governance as a Tool for Fraud Mitigation

Antonia Maravelaki, Constantin Zopounidis, Christos Lemonakis, Ioannis Passas

Financial Fraud through the falsification of financial statements is an evident problem. The restatement
is enormous, and there have been developed many approaches to confront it. Profits manipulation has
reached alarming proportions worldwide. The tendency of management to present a misleading image
based on accounting weaknesses and gaps, to present accounting results as it wishes and not as it should
according to the accounting standards, is essentially a key feature of profit manipulation. The execu-
tives’ motives to falsify financial results and creative accounting practices have concerned researchers
and their efforts to identify the necessary changes and improvements in accounting systems to protect
the stakeholders and the public from misleading information.

xvi
Preface

2. Corporate Governance: Introduction, Roles, Codes of Corporate Governance

Marios Menexiadis

Corporate Governance is the cornerstone for the organization, when it comes to effective Internal Con-
trol systems by modern organizations. Over the last twenty years several business giants have collapsed
under the weight of illegalities and frauds, such as Enron, WorldCom, Guiness, Maxwell Group, Barings
Bank, etc. The impact of these organizations’ failure on the economies in which they were operating was
particularly significant and had a negative impact on those directly or indirectly associated with them.
The shareholders, as well as all stakeholders such as suppliers, customers, creditors, employees and
governments of the countries where the above organizations were active, were adversely affected. The
failure of the organizations was attributed to the inadequacy of their Boards and the lack of organized
and effective control mechanisms by their management.

3. Downside Risk Premium: A Comparative Analysis

Kanellos Stylianou Toudas

The purpose of this paper is to address the main developments and challenges on risk assessment and
portfolio management. The former innovation in modern portfolio theory, Markowitz, has been suc-
ceeded from linear and non-linear optimization techniques that improve portfolio efficiency. Special
emphasis is given on Roy’s seminal work on “Safety First Criterion” which advocates that the safety of
investments should be prioritized. Thus, an investment should be chosen in a way that it has the lowest
probability of falling short of a required threshold of investors. This motivated Markowitz to advocate
a downside risk measure based on semivariance. It captures the notion of risk as failure to meet some
minimum target. It is influenced by returns below the target rate. It focuses on investors’ concern with
downside variability and loss reduction. This paper offers a critical reflection of these recent develop-
ments and could be of interest for individual and institutional investors.

4. Theoretical Analysis of Creative Accounting: Fraud in Financial Statements

Christianna Chimonaki

This aspect of the study reviews related works on creative accounting fraud and financial report fraud.
This chapter begins with the definitions of creative accounting, Fraud and financial statement fraud and
explains the relationship between them. It follows by presenting the classical theories on the determinants
of financial statement fraud. Furthermore, it presents the profile of accounting scandals and the com-
ponents of financial report fraud as well as the parties involved in in creative accounting. It introduces
the reasons and motivations for creative accounting. Specifically, this chapter analyses the manipulation
practices, the methods and the opportunities for creative accounting and address why financial frauds occur.

5. Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Konstantina Ainatzoglou, Georgios Tairidis, Georgios Stavroulakis, Constantin Zopounidis

xvii
Preface

Credit insurance is of vital importance for the trade sector and almost every related business. More-
over, every policy in credit insurance is tailor-made in order to suit in the best available way the unique
needs and demands of the insured business. Thus, pricing of such service can be tricky for an insurance
company. In the present chapter, this pricing problem in the field of credit insurance will be addressed
through the use of intelligent control mechanisms. More specifically, a way of calculating the price of
insurance policies, that has to be paid by a prospective client of an insurance company, will be sug-
gested. The model will be created and implemented with the use of fuzzy logic, and more specifically,
through the implementation of an adaptive neurofuzzy inference system. The training data that will be
used for the tuning of the system will be derived from real anonymous insurance policies of the Greek
insurance market.

6. Impact of Corporate Fraud on Foreign Direct

Investment? Evidence From China

Radwan Alkebsee, Gaoliang Tian, Konstantinos G. Spinthiropoulos, Eirini Stavropoulou, Anastasios

Konstantinidis

This study investigates the impact of corporate Fraud on foreign direct investment. Using data of Chinese
listed firms, we find that corporate Fraud is negatively associated with foreign shareholders’ ratio. This
finding suggests that foreign investors avoid investing in a risky environment where their wealth may be
expropriated. We also find that ownership of foreign shareholders may help in curbing corporate Fraud
due to diversified corporate experience and risk-taking behavior. However, the findings remain robust
after controlling for the potential endogeneity problem. Our findings have important implications for
policymakers and governments by showing that corporate Fraud is a severe determinant to the cause of
foreign investment.

7. Operational Risk Framework and Fraud

Management: A Contemporary Approach

Elpida Tsitsiridi, Christos Lemonakis, Constantin Zopounidis

The universal financial shake of 2008 altered business and occupational circumstances and will inevitably
trigger the outbreak of new forms of operational risk. Under normal conditions, OR does not cause sig-
nificant losses, thus severe damage is likely to occur when an operational miscarriage or an unexpected
event takes place. Under the Basel III context, the banking sector is trying to increase safety and stability,
by focusing on the quality of historical loss data, while cultivating an inside operational risk awareness
culture. One of the most perilous types of OR is Fraud and its effects are often dangerous and may have
long-term spillovers. In this Chapter, an analysis of the meaning and the main characteristics of Fraud is
provided, focusing on contemporary trends of the issue. Going further, the business anti-fraud strategic
plan is described and how it maximizes its efficiency, while the Chapter aims to analyze the demands
for an organization to pass through fraud-fragile to fraud-resistant.

xviii
Preface

8. Detection and Prevention of Fraud in the Digital Era

Evrim Vildan Altuk

It is essential for businesses to keep up with the technological advances. Today nearly all the businesses
depend on computer technologies and the Internet to operate as technological developments have in-
troduced many practical methods for businesses. Yet, transformation of businesses technologically also
presents new means for the criminals, which has led to new types of Fraud. It is crucial for businesses to
take measures to prevent Fraud. Traditional methods to prevent or to detect Fraud seems to be ineffective
for new types of Fraud in the digital era. Therefore, new methods have been used to prevent and detect
Fraud. This chapter reviews Fraud as a form of cybercrime in the digital era and aims to introduce the
methods that have been used to detect and prevent it.

9. Prediction of Corporate Failures for Small and Medium-Sized Enterprises

in Europe: A Comparison of Statistical and Machine Learning Approaches

Marianna Eskantar, Michalis Doumpos, Evangelos Grigoroudis, Constantin Zopounidis

The risk of bankruptcy is naturally faced by all corporate organizations and there are various factors
that may lead an organization to bankruptcy, including microeconomic and macroeconomic ones. Many
researchers have studied the prediction of business bankruptcy risk in recent decades. However, the
research on better tools continues to evolve, utilizing new methodologies from various scientific fields
of management science and computer science. This article deals with the development of statistical and
artificial intelligence methodologies for predicting failures for small and medium-sized enterprises,
considering financial and macroeconomic data. Empirical results are presented for a large sample of
European firms.

10. Fraud Governance and Good Practices Against Fraud

Antonios Zairis

11. Study on Various Applications of Data Mining and Supervised

Learning Techniques in Business Fraud Detection

Amit Majumder, Ira Nath

xix
Preface

Data Mining technique helps us to extract useful data from a large dataset of any raw data. It is used
to analyse and identify data patterns and to find anomalies and correlations within dataset to predict
outcomes. Using a broad range of techniques, we can use this information to improve customer relation-
ships and reduce risks. Data Mining and Supervised Learning have applications in multiple fields of
science and research. Machine Learning looks at patterns of data and helps to predict future behaviour
by learning from the patterns. Data Mining is normally used as a source of information on which Ma-
chine Learning can be applied to solve some of problems in our daily life. Supervised Learning is one
type of Machine Learning method which uses labelled data consisting of input along with the label of
inputs and generates one learned model (or classifier for classification type work) which can be used to
label unknown data. Financial accounting fraud detection has become an emerging topic in the field of
academic, research and industries.

12. Machine Learning Techniques and Risk Management:

Application to the Banking Sector During Crisis

Christos Floros, Panagiotis Ballas

Crises around the world reveal a generally instable environment in the last decades, within which banks
and financial institutions operate. Risk is an inherent characteristic of financial institutions and is a
multifaceted phenomenon. Everyday business practice involves decisions, which requires the use of
information regarding various types of threats involved together with an evaluation of their impact on
future performance, concluding to combinations of types of risks and projected returns for decision-
makers to choose from. Moreover, financial institutions process a massive amount of data, collected
either internally or externally, in an effort to continuously analyse trends of the economy they operate
in and decode global economic conditions. Even though research has been performed in the field of
accounting and finance, we explore the application of Machine Learning Techniques to facilitate deci-
sion making by top management of contemporary financial institutions improving the quality of their
accounting disclosure.

13. Current Trends in Investment Analysis

Marios Nikolaos Kouskoukis

The purpose of this book chapter is to review the current trends in investment management and per-
formance research. The adaption of both the classic CAPM and the factor models seems to continue,
with the realistic factors playing a crucial role and best represent the drivers of investment performance.
Another rising area is the search for skill, which is based on the enhanced benchmarks. The availability
of quantitative and qualitative data in the academic community has allowed for these areas to evolve in
recent years and to emerge as expected in the next decade, as well as to be explored.

14. Corporate sector Fraud: Challenges and Safety

Jay Prakash Maurya, Deepak Rathore, Sunil Joshi, Manish Manoria, Vivek Richhariya

xx
Preface

This chapter aims to possess a review of machine learning techniques for detection of corporate Fraud in
modern era. Detecting Company frauds using traditional procedures is time costly as immense volume
of information must be analysed. Thus further analytical procedures should be used. Machine learning
techniques are most emerging topic with great importance in field of information learning and prediction.
The machine learning (ML) approach to fraud detection has received a lot of promotion in recent years
and shifted business interest from rule-based fraud detection systems to ML-based solutions. Machine
learning permits for making algorithms that process giant data-sets with several variables and facilitate
realize these hidden correlations between user behaviors and also the probability of fallacious actions.
Strength of machine learning systems compared to rule-based ones is quicker processing and less manual
work. The proposed work aims at machine-driven analysis of knowledge reports exploitation machine
learning paradigm to spot fraudulent companies.

15. Outsourcing of Internal Audit Services Instead of Traditional Internal Audit

Units: A Literature Review on Transition From In-House to Outsourcing

Yasemin Acar Uğurlu, Çağla Demir Pali

The internal audit function traditionally establishes and continues its activities within the company but
it can also be provided by professionals outside the organization. Therefore internal audit activities can
be provided in three ways: the internal audit department established within the organization (in-house),
the internal audit service provided by an audit firm (outsourcing), the joint operation of the internal audit
department and the audit firm (co-sourcing). To choose the better approach for a company the scale of
the organization, the attitude and understanding of the management, and industry in which the company
operates in must be taken into consideration. This study is a literature review that classifies the studies
carried out on these methods that are used in performing internal audit activities.

xxi
1

Chapter 1
Corporate Governance as a
Tool for Fraud Mitigation
Antonia Maravelaki
Hellenic Mediterranean University, Greece

Constantin Zopounidis
School of Production Engineering and Management, Technical University of Crete, Greece &
Audencia Business School, France

Christos Lemonakis
Hellenic Mediterranean University, Greece

Ioannis Passas
Hellenic Mediterranean University, Greece

ABSTRACT
Financial fraud through the falsification of financial statements is an evident problem. The restatement
is enormous, and there have been developed many approaches to confront it. Profits manipulation has
reached alarming proportions worldwide. The tendency of management to present a misleading image
based on accounting weaknesses and gaps, to present accounting results as it wishes and not as it should
according to the accounting standards, is essentially a key feature of profit manipulation. The execu-
tives’ motives to falsify financial results and creative accounting practices have concerned researchers
and their efforts to identify the necessary changes and improvements in accounting systems to protect
the stakeholders and the public from misleading information.

1. CORPORATE GOVERNANCE MECHANISM

Since 1970 Friedman defined corporate governance (CG) as the firm managements’ effort to meet own-
ers or shareholders expectations, considering basic social rules, legal requirements, and native customs.
Elkington (1998), through its theory of “Triple Bottom Line”, highlights three key concepts that are at
the heart of the activities, which the firms should develop to ensure their viability. These are the profits
DOI: 10.4018/978-1-7998-4805-9.ch001

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Corporate Governance as a Tool for Fraud Mitigation

in the sense of the financial benefits that the company creates for society, the people by meaning the
human resources and the society where the business operates, and finally the planet (known as the 3Ps).
The company has to grow its activity by taking into account environmental protection at the same time.
Also, firms should maintain sustainability and operate in a social responsibility context. As Hemingway
and Maclagan (2004), argued even if firms do not work toward this direction, eventually, market demands
will lead them to adopt practices to improve their social and environmental efficiency while at the same
time being financially efficient.
Bibliography had suggested five elements of CG which unable firms to confront financial hazards:

1. Firm’s Culture, meaning the values, beliefs, concepts, and ways to act that an organization’s mem-
bers adopt and use in everyday procedures. Each organization is a smaller group of people who
interact with each other. Being such, it develops a culture framework that represents itself. A firm
that criticizes unethical behavior phenomena, or illicit internal competition, promotes feelings of
security and trust among its internal environment and set boundaries. All these principles shape
firm’s image also the external environment.
2. Leadership, referring to the management. Management defines the requirements of the employee’s
ethical behavior and promotes education on matters of corporate ethics. Managers on higher levels
may acknowledge and reward the employees who support firm’s values and operate in that framework.
On the other hand, top management sets the example and represents the organizational culture.
3. Co-operation among firms subgroups. Risk management, internal and external control, and guide-
lines compliance could be proven extremely difficult if not regulated by a system that organizes
and sets goal priorities on the various departments to avoid conflicts of interest. Managers are
necessary to pay attention to the internal cooperation and orientation of responsibilities.
4. Operational Systems developed to address organization needs. They need to be designed to support
the firm’s operations and be evaluated in regular intervals to support decision-making and strategic
planning. The appliance of operational systems ensures information credibility when combined
with control procedures providing constant data feed.
5. Organizational structure is the fundamental element for effective CG. When significant changes
in internal and external environments occur, firm’s structure should be revised and redesigned to
ensure that firm does not divert out of its objectives. The organizational change mainly refers to
human resources, operations, and technological issues. Top management needs to take vast deci-
sions in such cases in order to be adjusted to the competition.

Foerster and Huen (2004) supported the idea that CG shareholders try to ensure that managers achieve
satisfying returns on their invested capital. Corporate governance confronts the agency problem, which
refers to the shareholders’ need for assurance for their investment (Shleifer & Vishny, 1997). The Agents-
managers are the third parties, assigned to act in the best interests of the owners’ (Jensen & Meckling,
1979). There are conflicts of interests between principals-owners and agents; the phenomenon of infor-
mation asymmetry occurs. CG guidelines have been promoted, among other tools, in order for the firms
to provide essential and reliable information to the external parts of interest. The most common of them
involve financial reposting. Most companies have adopted and customized these guidelines to suit their
needs. It is commonly believed that firms in compliance with existing CG rules are positively evaluated
by the markets and investors (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000).

2

Corporate Governance as a Tool for Fraud Mitigation

2. THE ESSENCE OF ECONOMICAL FRAUD

There is a need here to define fraud from the corporate point of view. Albrecht et al. (2011) specified that
fraud could take place against a company, by its employees or on behalf of her, or it could be identified
as management fraud. There are three critical (key) elements for fraud to occur: pressure, opportunity,
and rationalization. Most of the studies examining corporate scandals referred to the managers and other
enmeshed parties, who had the opportunity to either falsify or conceal information and the pressure they
received from ownership to achieve particular financial performance results. To this rationale, Albrecht
et al. (2011) introduced the fraud Triangle’s well-known concept. In a few words, the Fraud Triangle
Theory suggests three requirements for fraud to occur: evident pressure, the realization of the opportu-
nity, and the invention of justifications that fraud is not against one’s values. One step further, Kassem
et al. (2012) suggested a new model for external auditors to detect the risk of fraud, the Fraud Diamond
Theory. According to them, four factors underlie the existence of fraud, the three aforementioned plus
one, the capability, which means a person’s ability to have a significant role in realizing the opportunity.
However, Indarto et al. (2016) applied the Fraud Diamond Theory to a sample of banking companies
listed on the Indonesian Stock Exchange. Their results show that capability is negatively correlated to
financial statement fraud.
For checking capability, they used the percentage of the number of an independent board. The con-
nection with the CG is evident. In their paper, Martins & Ventura Júnior (2020) consider CG practices
suggested by the literature to affect financial reporting, such as variables regarding the size of the board
(Anderson, Reeb, Upadhyay, & Zhao, 2011), 1) the composition of the board (like the participation of
independent members (Campbell & Minguez- Vera, 2007), the percentage of women (Hermalin & Weis-
bach, 2001; Adams & Ferreira, 2009) etc.), the compensation of the board (Lemonakis, Ballas, Balla,
& Garefalakis, 2018), the audit committee (Coram, Ferguson, & Moroney, 2006), and the independent
audits (Turley & Zaman, 2007). They use a sample of publicly-traded companies in the Brazil Exchange
Market. Their results show that half of the CG practices negatively affect the likelihood of fraudulent
financial reporting. The board of directors is more efficient in mitigating bankruptcy than those regard-
ing audit controls in mitigating earnings manipulation.

3. CREATIVE ACCOUNTING TECHNIQUES

Methods or practices in accounting are used to change a firm’s economical picture, including the mis-
representation or oversight of facts, transactions, accounts, or other financial information. Elements
are crucial for the preparation of the financial statements. The accounting principles, guidelines, and
standards are formed to operate tools for the measurement, recognition, and disclosure of financial state-
ments and transactions. When they are not applied or applied in part, they distort the real picture of the
firm’s financial statements and the firm in general. To all the above, one can add financial information,
the alteration, and handling of critical financial documents and transactions.
Financial scandals that have occurred in the US, EU, East Asia, and South Africa prove the pressure
on managers, and the gaps in corporate governance mechanisms that allow falsification of corporate
financial results (Felix, 2018). Gray, Frieder, and Clark (2005) mentioned in their book that fraud could
be considered as ‘an action or event regarded as morally or legally wrong and causing general public
outrage’ (by the Oxford English Dictionary). The literature identifies three key factors that encourage

3

Corporate Governance as a Tool for Fraud Mitigation

fraud. First, the management pressure or motivation when managers’ compensation is commensurate
with the firm’s profit. Second, the opportunity to imply the inability of internal mechanisms to detect
and detect fraud. Third, financial provisions allow the misrepresentation of financial results without a
clear breach of accounting rules. Here follows some of the most severe accounting tricks towards the
falsification and misrepresentation of a firm’s financial performance and position.

3.1 Tangible Fixed Assets

A common way to affect the results on a fiscal year is the depreciation or not on property, plant and
equipment. This practice modifies the outcome on the Income Statement and Assets value since the
depreciation as an expense does not appear. Specifically, the income statement profits and the value
of fixed assets; consequently, the hole Balance Sheet is modified. It is worth mentioning that financial
indexes are affected, such as ROI (Return on Investment) by this method. If a company wishes to show
increased profits, it will either not depreciate or use reduced depreciation rates. The freedom of judg-
ments, calculation, and choices about a fixed asset’s useful life and the depreciation methods allow
firms to “beautify” their image. However, suppose a firm decides to not depreciate in a fiscal year. In
that case, it loses the depreciation expense this year, as it cannot carry out double depreciation in the
following years. The fixed assets depreciation procedure is a source of firm’s funding, meaning that the
depreciated value is not taxed and remains in the form of reserves.

3.2 Intangible Items/Assets

According to financial standards, intangible assets may be depreciated either once in one fiscal year or
equally in 2, 3, or 5 years. Firms that manipulate their profits often break the law and adjust the amortiza-
tion period to their interest. Thus, if an intangible asset is depreciated for five years instead of one, the
Income Statement will be well improved. Keeping in mind that the value of intangible assets includes
patents, the firm’s reputation, and value, and customer loyalty, elements that are accountable and their
value are left to the management and the executives to determine or falsify in this case.

3.3 Off-balance-sheet Elements

Firms use creative accounting techniques to exclude in their balance sheet fixed assets of great value,
leading to lower depreciation, which translates to lower expenses and higher profits. By the same rationale,
long-term liabilities with higher risk do not appear in the balance sheet to conceal their negative impact
from the investors during the evaluation of firm’s performance possibilities. Thus, the firm could be as-
sessed as a low-risk investment opportunity, and it can grave low-cost capitals and loans with favorable
terms. The creation of Special Purpose Enterprises (SPE) is another accounting trick. Setting up those
companies usually aims at reducing financial risk from long-term projects concerning the construction
or the research and development of a product. Holding less than 50% of the shares, the SPE assumes
the risk, and the Holding company does not refer in the consolidated statements its participation in the
SPE and its results. Another simple case of using the SPE is the transfer to them from the Holding of
fixed assets and high loans to cover them. The Holding augments its liquidity ratio due to its sale and
minimizes costs by having less depreciation. After that, the Holding may lease the asset as an operating
lease, neither showing it in the balance sheet as an asset nor referring to the liabilities concerning the

4

Corporate Governance as a Tool for Fraud Mitigation

lease. As a result, there is an artificial expansion of profits and revenues and a reduction of long-term
liabilities. The external user receives this information from the financial statements and evaluates the
holding company’s financial credibility as low-risk and reliable.

3.4 Assets Under Construction

In the field of fixed assets, there is another trick, when the firm constructs on its own an asset, and while
it is completed, it does not transfer its value from the account of “Fixed Assets under Construction” to
the “Fixed Assets”. The firm is not obliged to carry out the corresponding depreciation, which translates
to profits increase and improvement of the Income Statement.

3.5 Debt Instruments or Participations

The account of “Participations in Companies” contains shares of subsidiaries or related firms. Thus,
firms that aim to manipulate their results may show these shares in their acquisition value and not trading
on the Stock Exchange (for the listed ones) or the actual value at the end of the fiscal year. Therefore,
Income Statement does not include gains or losses by the over or under evaluation of subsidiaries and
participations’ shares. In addition to that, firms may transfer their holdings of debt instruments that
belong to the current assets to improve their liquidity ratios. However, ROI index is also affected, and
the securities do not correspond to sales and are not included in the Operating Assets as the participa-
tions do. Thus, the denominator of ROI is reduced, and the company will show increased profitability.

3.6 Capitalized Costs

On this occasion, there is a reckless capitalization of expenses that do not meet the necessary capitaliza-
tion criteria. These are operating expenses such as advertisement, research, and development, repair,
and maintenance costs, which are eventually transferred in the balance sheet as multi-year depreciation
expenses. As a result, there is an overestimation of profits this fiscal year, as the capitalized assets are
paid off. In this case, capitalized costs are subjective and subject to the flexibility provided by the ac-
counting rules and the financial standards.

3.7 Inventories Sales – Channel Stuffing

The concept of inventories sales had been developed creative accounting techniques that affect the
Income Statement and the Balance Sheet. Some tricks directly alter the Sales and, consequently firm’s
income and results. Initially, there is the evaluation of obsolete merchandise at its acquisition price and
not at its now-trading lower selling price. Thus, the firm may conceal possible losses and improve its
result, while at the same time, it increases its balance sheet with a higher final stock. Again, the overall
liquidity is positively affected, and the ROI negatively.
Alternatively, the goods’ valuation method may be changed (Last- In-First-Out to First-In-First-Out)
to suit the firm’s “needs” when a price increase is noted. However, the statutory auditor will eventually
observe and reveal this manipulation. If the company has obtained a permit for this change, the auditor
must mention the effects on his report. Also, all the company’s stocks are valued at their last buying
price. Thus, firms, especially the smaller ones, increase their balance sheet and income statement be-

5

Corporate Governance as a Tool for Fraud Mitigation

cause they appear to have a higher stock of goods than they do. The liquidity ratio is positively affected,
and so does the ROI, since the net profits increase in a higher percentage than the total operating assets.
Another form is the method of so-called “Channel Stuffing”. The firm tries to persuade and motivate
its customers to buy goods on a higher level than it can sell in a certain period. It uses various forms of
promotion, such as discounts and favorable buying conditions. This method allows firms to appear sta-
bilized revenues in lean periods. Another practice in this section is sales, where the company keeps the
goods in its warehouses to facilitate its customer temporarily. The customer agrees to buy the goods by
signing a contract, but the owner retains possession and ownership of the goods until the buyer requests
delivery. Violation of the contract involves recording income by the seller company before the transfer
of ownership to the buyer.
Finally, there are the fictitious sales, a well-known form of falsification of the balance sheet and
Income Statement, which is achieved by recording fictitious sales to other related companies. In some
cases, the sales do not correspond to existent economic organizations with fake invoices recorded in one
fiscal year and canceled the following one. They are carried out mainly between related or subsidiary
firms. Holding buys goods or raw materials from the rest to increase sales and show lower profits and,
consequently, lower taxes.

3.8 Customer Claims- Promissory Notes

Financial statements’ restatement may include the omission of provisions for doubtful claims or lower
provisions than expected. Accounting rules allow companies to make provisions of 50% for doubtful
receivables. Firms cannot proceed with the cumulative amortization of customers who cannot pay their
debts if they have not previously made provisions for this purpose. Similarly, a firm cannot transfer its
customer to the doubtful ones when a provision has not been made in previous years. The result of this
practice is the amelioration of the quality of current assets. The liquidity ratio also improves on this
case, but not the profitability index, as the sizes on which it depends are not affected. In addition to that,
there is the virtual transfer of long-term claims to short ones. The balance sheet is improved qualitatively
and the liquidity ratios, while the efficiency one does not change. We can also avoid valuing foreign
currency receivables that create losses and hide them, the manipulation and separation of accrued and
non-accrued interests. The deterioration of the result and the balance sheet is done by making provisions
for doubtful claims, despite the usual firm’s tactics and the omission of foreign currency claims that
generate profits for the company or the omission to divide the interest accruals and not. The profits are
not presented in the financial statements. Thus the latter is adjusted according to the executive’s wishes.
The firm presents the whole interest in the fiscal year, and the profits have deteriorated.

3.9 Revenue Recognition

Lastly, there is the revenue and profits inflation and the recognition of revenue before it happens. The
company’s revenue record is of great concern since the sale has not been completed, or the product has
not been delivered, or while the customer may cancel or delay the transaction. Accounting guidelines
suggest that the principle of revenue recognition is summarized with a contract conducted orally or in
write, the transfer of good ownership where the claim from the selling firm is created, and the collection
or pay off the total good’s value. Mainly, revenue recognition occurs when the ownership is transferred
to the buyer, and there is a payment claim. Many firms violate this principle and record revenues before

6

Corporate Governance as a Tool for Fraud Mitigation

they become accrued, which lead to fictitious results. We must note that many firms conduct various
agreements to motivate the other party to change the recording time of the revenue by providing financial
facilities such as discounts, free shipping, and installation.
The report of the creative accounting techniques shows that how a firm can distort the information
given by the financial statements is numerous and varied. That shows the researchers’ restatement’s
importance to prevent the implementation of such practices and protect the investors and the stakehold-
ers in general.

4. RESEARCHERS SUGGESTIONS ON CG MECHANISMS TO ANSWER FRAUD

Awolowo et al. (2018) noticed that even though numerous guidelines and regulations had been issued
over the last century, financial scandals have not ceased to occur. Corporate governance has been the
key mechanism through which states and institutions tried to moderate fraud incidents, neglecting audit
control’s crucial role. Even though a financial scandal had occurred, the weight had been lent to each
firm’s auditors. McMahon et al. (2016) refer in their research that CG attributes, like the Board of direc-
tors and the Audit Committee, are of great importance for preventing and detecting fraud. The following
analysis attempts to show how a confined CG framework affects the occurrence of fraud and to detect
those characteristics that connect CG and fraud.
Farber (2005) examined a sample of 87 firms identified by SEC as committed manipulation of their
financial reports. After examining a control sample, he found that restating firms had poorer CG. They
had fewer outside board members; fewer audit committee meetings, fewer financial experts on the audit
committee, smaller percentage of Big 4 auditing firms, and a higher percentage of CEOs being also
chairmen of the BoD. He points out that the restating firms, three years later, from committing restate-
ments, they are found to adopt CG principles in higher levels of the control sample. In’airat (2015),
following the CG literature, used three key CG components to investigate their role in reducing fraud.
Those are internal audits, internal controls, and external audits. He developed a questionnaire to examine
the impact on the appearance of fraud as perceived by accounting and financial information in the Saudi
corporate environment. He found that only when all three components are implemented effectively, there
is a significant reduction in fraud’s perceived probability.
Agrawal et al. (2017) examined the consequences of accounting scandals on two important corporate
governance internal mechanisms the management and the auditor, the two parties closest to the financial
reporting process. They used a sample of 518 U.S.A. public firms, and the logistic regression shows that
in the years followed the accounting fraud, the CEOs and CFOs are more likely to be replaced in restated
firms. Also, as the gravity of the restatement augments, so does the probability of top management turn-
over. On the other hand, when examining the external auditor turnover and other CG variables, they found
little evidence that it is higher in firms committed restatements, which let them argue that internal CG
mechanisms were functioning effectively in those firms. Conyon and He (2016) mainly investigate the
relationship between CEO compensation in China and corporate fraud. Their results consistent with the
rationale that firms usually reduce CEO’s pay as a penalty for fraud, indicate a negative correlation. They
also investigate certain CG variables such as the differentiation of the CEO position and the Chairman,
private controlled firms, and firms located in more developed regions of China, and find higher payment
reductions when fraud occurs. From 2005 until 2010, their data date as in 2005 for the first time Chinese
reporting requirements included CEO compensation. They developed their hypothesis and used panel

7

Corporate Governance as a Tool for Fraud Mitigation

data fixed effects and propensity score methods to test the correlation. An important parameter here is
that firms committing fraud are more likely to fire their CEO. The authors investigated the hypothesis,
and their results confirmed previous research as regards private-owned firms. They indicate that restate-
ments malpractices and fraud are a critical ethical issue.
Considering that CG is highly connected to firm’s culture, the next researchers focused on other
information given through financial reports. Seguí-Mas et al. (2018) based on the concept. External and
independent assurance of CG reports it mitigated the potential risk of misconduct developed a research
strategy to identify CG assurance statements’ strengths and weaknesses by examining three listed Span-
ish firms, who had been involved in recent scandals. As KPMG (2015) reports, two-thirds of the largest
250 global companies have the independent assurance of their corporate social responsibility reports.
The benefits they embraced include reduced capital cost and reduced analysts’ forecast errors. However,
as Seguí-Mas et al. pointed out, little research has been taken to focus on the assurance of CG reports.
They used a case-study methodology to examine only three Spanish firms who assured their reports
through worldwide audit firms (PriceWaterhouseCoopers, Deloitte etc.). Firms’ Assurance reports in-
clude responsibilities of reporting organization, along with a reference of the objectives, a summary of
the work done, and mention of materiality. In their reports, they also ensure the codes and CG guidelines
they obey when composed the reports. The restatement of their reports puts on question CG principals
as transparency, due to the management malpractices, indicates a lack of control and criticizes the top
management turnover.
CG mechanisms enhanced a crucial variable that is transparency. As Hung et al. (Hung & Cheng,
2018) pointed o, honest accounting statements reduce firms’ possibility of committing fraud. Gulati et
al. (Gulati, Gupta, & Gupta, 2020) conducted a Meta-analysis of the CG research progress during 2008-
2018 by examining 115 studies and classified them into seven categories regarding CG the following:
independent and control variables used, financial ratios used to measure performance, the statistical
methodologies, the industry-wise and country-wise analysis, and the market index. Their findings indi-
cate that most commonly, researchers studied endogenous variables as the Board size, CEO duality, or
independent director to evaluate firm performance.
Recent researchers have indicated the need to integrate quantitative and qualitative data and methods
to produce an outcome. The Ethics surrounding firm’s personnel in higher positions and, by extension
firms’ culture is immensely vital for developing fraudulent behavior.

5. THE CASE STUDY OF FOLLI FOLLIE

To this section, we will present the case study of a Greek firm Folli Follie whose financial scandal had
recently come to light. Folli Follie was founded in 1982 in Athens and operated since then as an inter-
national fashion brand that manufactures and distributes jewelry and accessories. It has been trading to
over 30 countries and accounts 550 retail stores worldwide, as mentioned on its website (Folli Follie
Online, 2020). A brief overview of the firm’s history indicates its expansion dynamics to new markets
and high financial growth. Folli Follie first listed on the Athens Stock Exchange in 2007 after-acquired
two other companies Elmec Sports Co and Hellenic Duty Free Shops Co.
As mentioned by Kourtis et al., the merge facilitated the tendency of the top management to manipu-
late the reported information. At the same time, the vast growth of commercial activity in Asia started
to appear. Quintessential Capital Management (QCM) a USA fund, published in May of 2018 its inves-

8

Corporate Governance as a Tool for Fraud Mitigation

tigation regarding the operations of Folli Follie (FF) in Asia. Primarily, it mentioned that the FF sales
network did not correspond to reality. According to the functional POS, the investigators assumed that
the operational stores were just 289 compared to the 630 that the firm claimed. There were only two of
its related Chinese firms, and they account 50 active POSs in total with actual revenues of $ 40 million.
The estimations were referring to $1bn of fictitious sales (McCrum, 2018). Also, QCM disagreed upon
the real value of FF’s assets. FF’s stores in strategic locations, as mentioned from FF’s site, did not exist,
or they had sat down. QCM pointed out that official financial data are presented relatively prosperous,
while liquidity is weak. According to the investigations, the sales network is falsified, and so do the
sales and the financial results. The cash flows are frequently negative. That is partly explained by the
growth of the working capital of its related companies in Asia. The receivable accounts’ value and the
Asian subsidiaries’ stocks that do not correspond to the competitors.
QCM questioned the audit firm’s credibility appointed by the owners of FF in Greece and in Asia,
which had recently been replaced. After the exposition, the chairman and vice president of FF resigned
their positions, but the main CEO retained his. Table 1 shows the findings of Alvarez & Marsal about
the restatements.

Table 1. Alvarez & Marsal’s findings of restatement (millions of $)

Main Accounts Financial Statements 2017 Alvarez & Marsal 2017

Inventories 581.7 33.9
Trade receivables 719.0 99.1
Other receivables and prepayments 310.7 7.6
Bank and Cash balances 296.8 6.4
Trade and other payables 144.6 260.9
Revenues 1112.3 116.8
Profits 316.4 (44.7)
Retained earnings 1831.9 (180.6)
(Mpellos, 2018)

Asian subsidiary stocks’ value is only $ 33.873.632 and not $581.681.095, as declared in 2017. The
trade receivables are $ 99.125.013 and not 718.957.460, and the bank and cash balances are only $
6.400.473. Trade and other payables are $ 260.932.940 and not 144.561.043. The revenue is $ 116.847.155
compared to $ 1.112.348.021 recorded in the financial statements. As a result, the net profit is losses
that reach $(44.702.304). Taken into consideration the conversion of the values from dollar to euro and
the indicative reduction to the overall size of the group, we conclude that the sales are less than the half
reported in 2017 as we have to exclude € 850 million from Asia and € 252 million cash equivalents do
not correspond. According to Alvarez & Marsal, FF loans reach € 610 million exceed by far the € 570
millions of sales, as the total liabilities are even higher regarding the disputed balance sheet of 2017 to
be € 100 millions more cause to the trade liabilities found in Asia. It is noted that FF announced that
Athens Stock Exchange based on Alvarez & Marsal report, has not found any embezzlement or misuse of
the company’s assets. The financial prosecutor went one step further and suggested strong indications of
FF’s attempt to falsify balance sheets, reported profits, cash, sales, and stocks since 2007. However, the

9

Corporate Governance as a Tool for Fraud Mitigation

investigation did not cause the complex legal procedures that had to be carried out for 45 FF’s subsidiaries
in 26 countries. Also, the Hellenic Capital Market Commission (HCMC) has requested for audit control
of the firm, where there was a delay in the audit firm’s appointment. Other factors that contributed to
that were FF group’s complexity and the cost that was now prohibiting liquidity problems.
Eventually, PwC reports significant omissions in operational and control procedures and complete
inability to control the transactions between the related parties, which characterizes as “chaotic”. They
highlight unjustified money transactions between the subsidiaries without a recorded procedure. The
main shareholder of FF Group Sourcing in Asia, where the restatement took place, claims the amount
of € 40 million he had loaned to a related company in the past. The same person, the founder of FFG,
claims that there is a company debt to him against salaries for years paid, but he did not receive it. PwC
found relevant accounting entry in the revised balance sheet, which it was not possible to verify. Besides,
after the audit control, there are missing € 41 million from the firm’s fund in 2018 to non-existed or
bankrupt subsidiaries for which there are no documents to justify.
On top of that, it is not mentioned if that took place before revealing the scandal or after. We have
to add that executives have received loans € 11 million high, which is considered doubtful. The report
highlights an issue in an earlier time, a transaction of € 10 million for the acquisition of Landocean In-
dustrial Limited. HCMC had investigated this subsidiary when a loan had been granted to it without any
collateral or interest rate. The PwC raise a concern about the FF’s viability. They suggest that all assets
and liabilities should have been valued at net realizable value, meaning the amounts to be collected or
due to be paid if the liabilities are more significant than the existing assets, at the time of liquidation
and the firm’s closing.
The case of FF group indicates a typical agency problem. As the founders of FF stated, they were
unable to control the business of the Asian group. They did not have the necessary information in order
to monitor the agent’s behavior. The malpractices of FF group raise awareness about the transparency of
the available data in the financial reports. This concern had preoccupied scientists and state regulators
since the well-known case of Enron in 2001. Kourtis et al. (2019) carried out an integrated analysis of
the financial reports of FF group in order to identify if it is possible to detect restatement. They exam-
ined how the reported financial information formed throughout 2008 -2017. They aim to verify their
hypothesis by elaborating on the financial analysis of the reports. Firstly, they examined the formation
of financial data over this period. They observed that the higher increase of the retained earnings, the
equity capital, total current assets, and the earnings after taxes were noticed in 2017, in which the FF
reports were disputed. The interesting point here is that the total reported earnings were 1188.5 million
euros higher than the total cash flows from operations.
On the other hand, the total profit share that period was under 10% of the total earnings. On a second
level, they used the Cash Conversion Cycle (CCC) tool to evaluate the reported earnings’ quality. The
CCC is the period needed for a company to convert current assets and short-term liabilities to cash flows.
They observed a 164.5% increase, from 2017 to 2008, which indicates that cash is bonded to receivables
and inventories for longer than a year. They also used the DuPont Model to analyze the fluctuations of
sales, as they are the most crucial effect size. They find evidence that firm’s profitability should be ex-
tensively examined, given that only the net profit margin was improved during the past ten years. They
conclude their research by implicating Cash Flows from Operations (CFFO)/Earnings ratio to investigate
the reported data’s trustworthiness further. Over the examined period, earnings do not correspond to
equivalent CFFO as they are expected to be. Kourtis et al.’s results indicate that a financial statement
analysis could be used as a tool in order to uncover possible malpractices. They pointed out the gaps

10

Corporate Governance as a Tool for Fraud Mitigation

in CG mechanisms and the problems following them, the agency problem and information asymmetry,
which lead to fraudulent accounting practices.
In conclusion, FF group’s operation synopsized to the following: the FF group produced goods of
high added value which she sold to its subsidiaries; the subsidiaries placed the products in the sales
network, and that was the turnover, regardless of the goods ended up to the consumer or not; thus, FF
increased its turnover, it got loans based on its turnover, and it inflated the “intrinsic value” of shares;
the principal shareholders sold their shares in high added value and graved the profits.

6. CONCLUSION

Financial fraud through the falsification of financial statements is an evident problem. The restatement
is enormous, and there have been developed many approaches to confront it. Profits manipulation has
reached alarming proportions worldwide. The tendency of management to present a misleading image
based on accounting weaknesses and gaps, to present accounting results as it wishes and not as it should
according to the accounting standards, is essentially a key feature of profit manipulation.
The executives’ motives to falsify financial results and creative accounting practices have concerned
researchers and their efforts to identify the necessary changes and improvements in accounting systems
to protect the stakeholders and the public from misleading information. However, the complexity and
diversity characterized the business transactions make it difficult to handle. Future approaches on restate-
ments may include a group of parameters such as sector, stock market data, the appointed audit firm, the
auditors’ opinion, the independent members of the BoD, the frequency of changes on BoD executives,
the size and complexity of transactions with related firms, as well as the accounting methods used. That
is CG elements promoted and implemented from the firm’s ethics.
The audit control is a necessary complement to any financial management of the foreign property.
Certified auditors should act ethically, independently, and thoroughly check each firm in order for the
external control to be reliable, impartial, and provide objective information to interested users. That
will lead to the future improvement, development, and sustainability of the firm. In many cases of the
restatement, the impact affects the investors as the firm lost investors’ confidence. The information of
the audit reports users to realize the extent of the auditors’ responsibility. The continuous improvement
and enrichment of the institutional guidelines and financial codes and the exemplary punishment for no
compliance will contribute to the audit work quality.

REFERENCES

Adams, R. B., & Ferreira, D. (2009). Women in the boardroom and their impact on governance and
performance. Journal of Financial Economics, 94(2), 291–309. doi:10.1016/j.jfineco.2008.10.007
Agrawal, A., & Cooper, T. (2017). Corporate governance consequences of accounting scandals: Evidence
from top management, CFO and auditor turnover. Quarterly Journal of Finance, 1.
Aguilera, R. V., & Cuervo-Cazurra, A. (2009). Codes of good governance. Corporate Governance, 17(3),
376–387. doi:10.1111/j.1467-8683.2009.00737.x

11

Corporate Governance as a Tool for Fraud Mitigation

Al-ahdal, W. M., Alsamhi, M. H., Tabash, M. I., & Farhan, N. H. (2020). The impact of corporate gov-
ernance on financial performance of Indian and GCC listed firms: An empirical investigation. Research
in International Business and Finance, 51(101083), 101083. doi:10.1016/j.ribaf.2019.101083
Albrecht, S. (2014, July/August). Iconic Fraud Triangle Endures. Fighting a Culture of Fraud, 4, 46–52.
Albrecht, W. S., Albrecht, C. O., & Zimbelman, M. F. (2011). Fraud examination. Cengage Learning.
Anderson, R. C., Reeb, D. M., Upadhyay, A., & Zhao, W. (2011). The Economics of Director Hetero-
geneity. Financial Management, 40(1), 5–38. doi:10.1111/j.1755-053X.2010.01133.x
Awolowo, I. F., Garrow, N., Clark, M. C., & Chan, D. (2018). Accounting scandals: Beyond corporate
governance. 9th Conference on Financial Markets and Corporate Governance (FMCG).
Cadbury, A., & Cadbury, C. A. (2002). Corporate governance and chairmanship: A personal view.
Oxford University Press on Demand. doi:10.1093/acprof:oso/9780199252008.001.0001
Cadbury, S. A. (2000). The Corporate Governance Agenda. Corporate Governance, 8(1), 7–15.
doi:10.1111/1467-8683.00175
Campbell, K., & Minguez-Vera, A. (2007). Gender Diversity in the Boardroom and Firm Financial
Performance. Journal of Business Ethics, (83), 435–451.
Ciftci, I., Tatoglu, E., Wood, G., Demirbag, M., & Zaim, S. (2019). Corporate governance and firm
performance in emerging markets: Evidence from Turkey. International Business Review, 28(1), 90–103.
doi:10.1016/j.ibusrev.2018.08.004
Conyon, M. J., & He, L. (2016). Executive compensation and corporate fraud in China. Journal of Busi-
ness Ethics, 134(4), 669–691. doi:10.100710551-014-2390-6
Coram, P., Ferguson, C., & Moroney, R. (2006). The value of internal audit in fraud detection. Journal
of Accounting and Finance, 48(4), 543–559.
Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation:
An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research,
13(1), 1–36. doi:10.1111/j.1911-3846.1996.tb00489.x
Driel, H. v. (2018). Financial fraud, scandals, and regulation: A conceptual framework and literature
review. Business History.
Elkington, J. (1998). Partnerships from cannibals with forks: The triple bottom line of 21st‐century
business. Environmental Quality Management, 8(1), 37–51. doi:10.1002/tqem.3310080106
Farber, D. B. (2005). Restoring trust after fraud: Does corporate governance matter? The Accounting
Review, 50(2), 539–561. doi:10.2308/accr.2005.80.2.539
Felix, L. (2018). Auditing, Assurance Services, and Forensics. Springer International Publishing.
Foerster, S. R., & Huen, B. C. (2004). Does corporate governance matter to Canadian investors. Cana-
dian Investment Review, (17), 19–23.

12

Corporate Governance as a Tool for Fraud Mitigation

Folli Follie Online. (2020). Retrieved 8 10, 2020, from www.follifollie.com: https://www.follifollie.com/
gr-el/follifollie/our-history
FRC. (2018). ICAEW. Retrieved July 2020, from icaew.com: https://www.icaew.com/technical/corporate-
governance/codes-and-reports/uk-corporate-governance-code
Fung, B. (2014). The demand and need for transparency and disclosure in corporate governance. Uni-
versal Journal of Management, 2(2), 72–80.
Governance, K. C., & King, M. (2016). King IV Report on Corporate Governance for South Africa.
Institute of Directors in Southern Africa.
Gray, K. R., Clark, G. W. Jr, & Frieder, L. A. (2005). Corporate scandals: The many faces of greed.
Paragon House.
Gray, R., Laughlin, R., Milne, M., & Owen, D. (2002). Of messiness, systems and sustainability: To-
wards a more social and environmental finance and accounting. The British Accounting Review, 34(4),
357–386. doi:10.1006/bare.2002.0217
Gulati, K., Gupta, S., & Gupta, C. (2020). The Transformation of Governance System: A Decade Long
Experience of Corporate Governance Using Meta-analysis. Global Journal of Flexible Systems Man-
agement, 1-30.
Hemingway, C., & Maclagan, P. (2004). Managers’ personal values as drivers of corporate social respon-
sibility. Journal of Business Ethics, 50(1), 33–44. doi:10.1023/B:BUSI.0000020964.80208.c9
Hermalin, B. E., & Weisbach, M. S. (2001). Boards of directors as an endogenously determined institu-
tion: A survey of the economic literature. National Bureau of Economic Research. doi:10.3386/w8161
Hung, Y. S., & Cheng, Y. C. (2018). The impact of information complexity on audit failures from corporate
fraud: Individual auditor level analysis. Asia Pacific Management Review, 23(2), 72–85. doi:10.1016/j.
apmrv.2017.09.002
In’airat, M. (2015). The Role of Corporate Governance in Fraud Reduction-A Perception Study in the
Saudi Arabia Business Environment. Journal of Accounting & Finance, 15(2), 2158–3625.
Indarto, S. L., & Ghozali, I. (2016). Fraud diamond: Detection analysis on the fraudulent financial re-
porting. Risk Governance & Control: Financial Markets and Institution, 6(4), 116–124. doi:10.22495/
rcgv6i4c1art1
Jensen, M. C., & Meckling, W. H. (1979). Theory of the firm: Managerial behavior, agency costs, and
ownership structure. In Economics social institutions. In In Economics social institutions (pp. 163–231).
Springer. doi:10.1007/978-94-009-9257-3_8
John, K., & Senbet, L. (1998). Corporate governance and board effectiveness. Journal of Banking &
Finance, 22(4), 371–403. doi:10.1016/S0378-4266(98)00005-3
Kassem, R., & Higson, A. (2012). The new fraud triangle model. Journal of Emerging Trends in Eco-
nomics and Management Science, 3(3), 191–195.

13

Corporate Governance as a Tool for Fraud Mitigation

Kourtis, E., Kourtis, G., & Curtis, P. (2019). An Integrated Financial Ratio Analysis as a Navigation
Compass through the Fraudulent Reporting Conundrum: A Case Study. International Journal of Finance.
Insurance and Risk Management, 9(1-2), 3–20.
KPMG. (2015). The KPMG survey of corporate responsibility reporting 2015. Retrieved 8 3, 2020, from
https://home.kpmg/xx/en/home/insights/2015/11/kpmg-international-survey-of-corporate-responsibility-
reporting-2015.html
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2000). Investor protection and corporate
governance. Journal of Financial Economics, 58(1), 3–27. doi:10.1016/S0304-405X(00)00065-9
Law, P. (2011). Corporate governance and no fraud occurrence in organizations. Managerial Auditing
Journal, 26(6), 501–518. doi:10.1108/02686901111142558
Lee, E. M., Park, S.-Y., & Lee, H. J. (2013, October). Employee perception of CSR activities: Its antecedents
and consequences. Journal of Business Research, 10(66), 1716–1724. doi:10.1016/j.jbusres.2012.11.008
Lemonakis, C., Ballas, P., Balla, V., & Garefalakis, A. (2018). Audit fees and pricing strategy: Do
restatements of internal control reports and earnings matter? Risk Governance and Control: Financial
Markets & Institutions, 8(2), 63–73. doi:10.22495/rgcv8i2p4
Limei, C., Wanfu, L., & Limin, Z. (2015). Audit mode change, corporate governance and audit effort.
China Journal of Accounting Research, 8(4), 315–335. doi:10.1016/j.cjar.2015.05.002
Martins, O. S., & Ventura Júnior, R. (2020). The Influence of Corporate Governance on the Mitigation
of Fraudulent Financial Reporting. Revista Brasileira de Gestão de Negócios, 22(1), 65–84. doi:10.7819/
rbgn.v22i1.4039
McCrum, D. (2018). Folli Follie: $1bn of fake sales, and what to learn from the debacle. Financial Times.
McMahon, R., Pence, D., Bressler, L., & Bressler, L. S. (2016). New tactics in fighting financial crimes:
Moving beyond the fraud triangle. Journal of Legal. Ethical and Regulatory Issues, 19(1), 16.
Mpellos, I. (2018). Πόρισμα-κόλαφος για τη Folli Follie. Athens: Academic Press.
Rehman, A., & Hashim, F. (2018). Literature review: Preventive Role of Forensic accounting and Cor-
porate Governance. Journal of Governance and Integrity, 1(2), 68–93.
Seguí-Mas, E., Bollas-Araya, H. M., & Polo-Garrido, F. (2018). Assurance on corporate governance
reports in Spain: Towards an enhanced accountability or a new form of public relations? Administrative
Sciences, 8(3), 32. doi:10.3390/admsci8030032
Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2),
737–783. doi:10.1111/j.1540-6261.1997.tb04820.x
Snell, R. S., & Herndon, N. C. Jr. (2000). An evaluation of Hong Kong’s corporate code of ethics initia-
tive. Asia Pacific Journal of Management, 17(3), 493–518. doi:10.1023/A:1015846617296
Tan, D. T., Chapple, L., & Walsh, K. D. (2017). Corporate fraud culture: Re‐examining the corporate
governance and performance relation. Accounting and Finance, 57(2), 597–620. doi:10.1111/acfi.12156

14

Corporate Governance as a Tool for Fraud Mitigation

Turley, S., & Zaman, M. (2007). Audit committee effectiveness: Informal processes and behavioural ef-
fects. Accounting, Auditing & Accountability Journal, 20(5), 765–788. doi:10.1108/09513570710779036
Zhou, H., Owusu-Ansah, S., & Maggina, A. (2018). Board of directors, audit committee, and firm per-
formance: Evidence from Greece. Journal of International Accounting, Auditing & Taxation, 31, 20–36.
doi:10.1016/j.intaccaudtax.2018.03.002

15
16

Chapter 2
Corporate Sector Fraud:
Challenges and Safety

Jay Prakash Maurya

https://orcid.org/0000-0002-5574-5822
Samrat Ashok Technological Institute, India

Deepak Rathore
LNCT University, India

Sunil Joshi
Samrat Ashok Technological Institute, India

Manish Manoria
Sagar Institute of Research and Technology, India

Vivek Richhariya
Lakshmi Narain College of Technology, Bhopal, India

ABSTRACT
This chapter aims to possess a review of machine learning techniques for detection of corporate fraud
in modern era. Detecting company frauds using traditional procedures is time costly as immense volume
of information must be analysed. Thus, further analytical procedures should be used. Machine learning
techniques are most emerging topic with great importance in field of information learning and prediction.
The machine learning (ML) approach to fraud detection has received a lot of promotion in recent years
and shifted business interest from rule-based fraud detection systems to ML-based solutions. Machine
learning permits for making algorithms that process giant data-sets with several variables and facilitate
realize these hidden correlations between user behaviors and also the probability of fallacious actions.
Strength of machine learning systems compared to rule-based ones is quicker processing and less manual
work. The chapter aims at machine-driven analysis of knowledge reports exploitation machine learning
paradigm to spot fraudulent companies.

DOI: 10.4018/978-1-7998-4805-9.ch002

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Corporate Sector Fraud

INTRODUCTION

Fraud has become the most viable threat in global economy that needs maximum attention of the forensic
accountants and traditional auditors, as well as anti-graft bodies worldwide. It is indeed discovered that
fraud and its various natures continuously growing in frequency and severity (Hajeka & Henriquesb,
n.d.). Fraud is considered as a global phenomenon, since it has universally penetrates both the private
and public sectors to the extent that no country is protected from it, although developing countries suffer
the most (Mangala & Kumari, n.d.).
A corporate fraud comes in existence when a company or anyone deliberately changes and conceals
sensitive information which then apparently makes it profitable. Companies use various methods to com-
mit corporate frauds, which may include miss-information and manipulation in accounting information.
The aim of falsification of financial information includes misleading accounting entries, wrong trades
for inflation of profits, disclosure of price sensitive information which comes under the range of trading
and showing false transactions which aims to attract more investors and lenders for funding (Gupta &
Gupta, 2015).
There will be many reasons cited that firms commit such frauds like creating a lot of falsified money,
making a false image of the corporate for the market situation and misguiding Governmental authorities
for nonpayment. In India, the Commission on ‘Prevention of Corruption’, in its report, observed, “The
advancement of technological and scientific development is conducive to the emergence of mass society
with an oversized rank in file and small dominant elite, encouraging the expansion of monopolies, the
increase of a managerial category and complicated institutional mechanisms. There’s a necessity for a
strict adherence to high standards of ethical behavior for even the honest functioning of the new social,
political and economic processes. The report of the Vivian Satyendra Nath Bose Commission inquiring
into the affairs of the Dalmia jain cluster of firms in 1963, highlighted on however the large industries
cherish frauds, falsification of accounts and record change of state for private gains and nonpayment
etc(Penyelenggara, 2019).
The first self-made trial of a monetary scandal in freelance Asian country was the Mundhra Scam,
within which Hon’ble Justice M.C. Chagla created bound important observations regarding the large
business power Mundhra WHO needed to make associate degree industrial empire entirely out of dubi-
ous suggests that.

TYPES OF FRAUD

There are many varieties of frauds like fraudulent financial Statements, employee Fraud, vendor Fraud,
customer Fraud, Investment Scams, Bankruptcy frauds and miscellaneous. a number of the common
varieties of frauds are:

1. Financial frauds - Manipulation, falsification, alteration of accounting records, deception or inten-

tional omission of amounts, misapplication of accounting principles, intentionally false, misleading
or omitted disclosures.
2. Misappropriation of Assets - theft of tangible assets by internal or external parties, sale of pro-
prietary data, inflicting improper payments.

17

Corporate Sector Fraud

3. Corruption - creating or receiving improper payments, providing bribes to public or non-public

officers, receiving bribes, kickbacks or different payments, aiding and abetting fraud by others.

Generally, fraud occurs because of a combination of opportunity, pressure and rationalization. An

opportunity arises; the person feels that the act is not entirely wrong, and has pressure pushing them to
commit the fraud.
Opportunity- An opportunity is likely to occur when there are weaknesses in the internal control
framework or when a person abuses a position of trust. For example:

• Organizational expediency – ‘it was a high profile rush project and we had to cut corners’;
• Downsizing meant that there were fewer people and separation of duties no longer existed; or
• Business re-engineering brought in new application systems that changed the control framework,
removing some of the key checks and balances.

Pressure-The pressures are usually financial in nature, but this is not always true. For example,
unrealistic corporate targets can encourage a salesperson or production manager to commit fraud. The
desire for revenge – to get back at the organization for some perceived wrong; or poor self-esteem - the
need to be seen as the top salesman, at any cost; are also examples of non-financial pressures that can
lead to fraud.
Rationalization- In the criminal’s mind rationalization usually includes the belief that the activity
is not criminal. The often feel that everyone else is doing it; or that no one will get hurt; or it’s just a
temporary loan, I’ll pay it back, and so on.

Figure 1. Corporate Fraud Triangle.

The factors and conditions that enable an individual or group to have the opportunity include – the
knowledge of the weaknesses of the company’s internal control systems, access to accounting records
or assets, lack of supervision, unethical “Tone at the Top” and belief that the person will not get caught
(Smith & Smith, n.d.). Opportunity and motivation for fraud, makes to rationalize their actions as the
last and final step in the fraud triangle. Those who have no need to rationalize, and they know what they

18

Corporate Sector Fraud

are doing, and whatever the motive, they do not need to attempt to hide their criminal activity from their
soul (ACFE, 2007). Quoted factors for rationalization include poor compensation, no or less recognition,
need for more money, etc. Duffield and Grabosky (2001) have defined fraud as an act involving deceit
(such as intentional distortion of the truth or misrepresentation or concealment of a material fact) to gain
an unfair advantage over another to secure something of value or deprive another of a right.

Fraud Detection

Fraud detection means the identifying the actual or expected fraud to take place within an organization.
An organization needs to have implemented proper systems and method to detect frauds at an early stage
or even before it occurs. Fraud detection consists of the following techniques

• Proactive and Reactive

• Manual and Automated

An organization should include these Fraud detection techniques in its anti fraud strategy

Fraud Prevention

Your optimal model of prevention should encompass both the steadfast, traditional measures of separa-
tion of duties, segregating bank accounts, secure access, positive pay and tiered authorizations, to name
a few. However, it also needs to include new controls that add those extra layers of security needed to-
day (Gottlieb et al., 2006). According to BAML’s best practices for preventing fraud, a good corporate
security model entails four segments as shown in the Figure 2.

Figure 2. Techniques for Fraud Prevention.

As the Figure 2 shows, the new layers of security include employee education and raised awareness
of types of fraud attacks, particularly when using online systems and more importantly, when using them
outside of the office. Mobile device tracking and usage is also creating the need for a whole new area
for prevention management and is further discussed below.

19

Corporate Sector Fraud

Additionally there needs to be a clear plan for how treasury and the company as a whole reacts to a
security breach, as well as a communication vehicle for reporting suspect fraudulent activity, internal
and external, anonymously and confidentially. An optimal plan for prevention will also revisit, re-educate
and measure compliance often. While 75 percent of organizations that see fraud threats do not suffer
actual losses from fraud, breaches and other things like hacking can create havoc and certainly open the
door and provide opportunity for theft. Now is the time to incorporate a good model of fraud prevention.
Look deeper into what would constitute a good model from your treasury operation’s perspective; talk
to both your banks and other industry experts about their approach to fraud prevention.

Literature Review

Fraud occurrences are related to environmental conditions – inside the organization and the outside
operating environment either a micro or a macro organization. Fraud have been done for visionary and
historically as a violation of trust, and the classic triangle of smuggling, contraband and enforcement
sheds light on developments in the financially. Little information about the organization that can reduce
the cost of white-collar crimes (Schnatterly, 2003).
Alexander and Cohen (1996) checks weaker support for the notion that prior performance affects the
occurrence of other types of corporate crime, particularly fraud. Mongie (2009) gives idea that when tough
economic times impact the company financially, it usually increases the opportunity to commit fraud.
Bratton and Wachter (2011) justified on fraud of the market circulating in the wake of the failure of
the original justifications – that fraud on the market litigation enhances the operation of the corporate
governance system.
Chen et al. (2011) finds whether the effect of financial analysts mitigates corporate frauds among
Chinese listed firms. They test the hypothesis that a negative relationship exists between analyst coverage
and corporate frauds among non-state-owned enterprises (NSOE) but not among state-owned enterprises,
as NSOEs are more dependent on external capital. Results confirm the predictions that financial analysts
contribute to corporate frauds prevention, but this effect is moderated by Chinese state ownership.
Individual person who is the part of any fraud is motivated based on number of factors and should
be able to rationalize their action so that action can be acceptable to offender, generally they feel that
they are not doing immoral Job (Liska and Messner, 1999).
ASIS International (2007) examined that because of the losses in the organisation, it can also have
an impact on the confidence of the local, state or national economic conditions based on the size of the
business affected by corporate frauds.
Many researchers have proposed various parameters to reduce the intensity of frauds. These are broadly
classified into governance structures, modification in the legal and reporting systems and self-correction
exercise within the organisation. Corporate frauds are easy to commit, but prevention or detection of
corporate crime is not an easy task (Seetharaman et al., 2004).
The Rapid developments in information technology (IT) have also induced frauds. Vasiu and Vasiu
(2004) have proposed taxonomy of IT fraud with respect to the perpetration platform and method. For
Internet fraud, Baker (1999, 2002) discriminates fraud into fraud in securities sales and trading, fraud
in electronic commerce and fraud by Internet companies.
Accoring to MacInnes et al. (2005) categorise IT fraud into five major causes:

1. Incentives of criminals

20

Corporate Sector Fraud

Figure 3. Steps for fraud detection on corporate data (E-commerce).

2. Characteristics of victims
3. The role of technology
4. The role of enforcement
5. System-related factors.

Methodology Safety

• Whether the corporate perception on relative importance of fraud types is same across various
company types.
• Publication of fraud prevention policy statement is uniform across companies.
• The people responsible for corporate frauds are same as those for post-fraud action.
• Present fraud prevention regulatory and action mechanism.

Research Methodology

This Chapter aims to classify the fraud and non fraud Transaction in corporate industry using machine
learning Techniques like Decision Tree, Naive Baiyes, Random Forest, and Neural Network. The clas-
sification techniques makes feature selection process in the dataset and then preprocessing of data using
PCA is done. The process is carried out by transformation, normalization, and scaling of features so that
the features obtained can be used. The SMOTE (Synthetic Minority Oversampling Technique) process
is very useful for dealing with data imbalance problems in fraud cases, because fraud cases are usu-

21

Corporate Sector Fraud

ally below 1 percent, so as to reduce the majority class in the dataset. The majority class can make the
classification more directed to the majority class so that the predictions of the classification are not as
expected; the results of the SMOTE dataset transaction fraud process will be balanced. Figure 3 shows
the actual steps of experiments done on ecommerce data for fraud detection

1. Preprocessing: - The steps involved converting the raw data into quality data by extraction
Transforming, normalizing, and scaling new features. This step is a very initial and important in
machine learning approach. The PCA (Principle Component Analysis) is used for preprocessing
the raw data into quality data. PCA calculations involve calculations of covariance matrices to
minimize reduction and maximize variance.
2. Decision Tree: - Decision trees explore fraud data, find hidden relationships between a number of
potential input variables and a target variable. Decision tree (Saputra & Suharjito, 2019) combines
fraud data exploration and modeling, so it is very good as a first step in the modeling process even
when used as the final model of several other techniques (Roy, 2018). Decision tree divides the input
dataset into several branching segments based on decision rules, this decision rule is determined
by identifying a relationship between input and output attributes.
a. Root Node: Entire population or sample, and this are further divided into two or more.
b. Splitting: This is the process of dividing a node into two or more sub-nodes.
c. Decision Node: When a sub-node is divided into several sub nodes.
d. Leaf / Terminal Node: Unspecified nodes are called Leaf or Terminal nodes.
e. Pruning: The Sub-node is removed from a decision.
f. Branch / Sub-Tree: Subdivisions of all trees are called branches or sub-trees.
g. Parent and Child Node: A node, which is divided into sub-nodes .

Figure 4 shows an example of how decision tree used as a classifier on e-commerce data.

Figure 4. Architecture of Decision Tree on e- Commerce data.

22

Corporate Sector Fraud

Figure 5. Architecture of Random Forest.

3. Naïve Bayes: - Naïve Bayes is works for future prediction based on past experience . The probability
is used to calculate next prediction class on basis of following formulas

P (B | A) * P (A)
P (A | B ) = (1)
P (B )

Where
B: Unknown Class Data
P(B): Probability of B
A: Hypothesis for specific class
P(A): Hypothesis Probability
P(A|B): Hypothesis probability based on conditions (posterior probability)
P(B|A): Probability-based on conditions on the hypothesis

4. Random Forest: - Due to large data set received from corporate transactional data every hour, random
forest is used for classification. The random forest is an extension of classification and regression
tree. The bootstrap aggregation and random feature selection from dataset is based on following
architecture given in figure 5. Random Forest works on a random vector value with equal distribu-
tion on trees, each decision tree in e-commerce fraud detection which has a maximum depth. The
class produced from the classification process is chosen from the most classes produced by tree.

23

Corporate Sector Fraud

5. Neural Network: - A neural network works similarly to the human brain’s neural network. A “neuron”
in a neural network is a mathematical function that collects and classifies information according
to a specific architecture. The Neural Network architecture is given in figure 6. This forecasting is
as follows:

a. Initialization count = 0, fitness = 0, number of cycles

b. Early population generation. Individual chromosomes are formulated as successive gene
sequences, each encoding the input.
c. Suitable network design
d. Assign weights
e. Conduct training with back propagation. Cumulative errors and fitness values are checked.
Decide fitness
f. If the previous fitness <current fitness value, save the current value
g. Increase Count by 1
h. Selection: Two mains are selected using a wheel roulette mechanism
i. Genetic Operations: crossover, mutation, and reproduction to produce new feature sets
j. If (number of cycles <= count) return to number four
k. Network training with selected features
l. Study performance with test data.

Figure 6. Architecture of Neural Network.

6. 6. Confusion Matrix: - Classification method performance measurement is necessary for model

performance analysis and improvements. True Positive (TP) and True Negative (TN) are the number
of positive and negative classes that are classified correctly, False Positive (FP) and False Negative
(FN) is the number of positive and negative classes that are not classified correctly. Based on the
confusion matrix, performance criteria such as Accuracy, Precision, Recall and F-Measure can be
determined.

24

Corporate Sector Fraud

Table 1. Confusion matrix.

Class Predictive Positive Predictive Negative

Actual Positive TP TN
Actual Negative FP FN

Figure 7. Ratio of fraud.

TP + TN
Accuracy = (2)
TP + TN + FN + FP

TP
Recall = (3)
TN + FP

TP
Precesion = (4)
TP + FP

2 * Precesion * Recall
F 1 − Score = (5)
Precesion + Recall

25

Corporate Sector Fraud

Figure 8. Ration of fraud after oversampling.

Table 2. Confusion matrix decision tree without SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 38792 38792
Actual Negative 1736 2585

Table 3. Confusion matrix decision tree with SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 38661 2332
Actual Negative 1734 2607

Result and Discussion

Table 4. Confusion matrix Naïve Bayes without SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 40764 235
Actual Negative 1993 2342

Table 5. Confusion matrix Naïve Bayes with SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 40754 243
Actual Negative 1994 2343

26

Corporate Sector Fraud

Table 6. Confusion matrix random forest without SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 40891 122
Actual Negative 1964 2357

Table 7. Confusion matrix random forest with SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 40393 630
Actual Negative 1810 2501

Table 8. Confusion matrix neural network without SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 41103 24
Actual Negative 1942 2265

Table 9. Confusion matrix neural network with SMOTE

Class Predictive Positive Predictive Negative

Actual Positive 36466 2236
Actual Negative 5485 1147

Table 10. Experimental study between the existing and proposed techniques.

Accuracy Recall Precision F1-Score

NN 90.71 92 93 92
NN+SM 85.37 87 89 88
NB 90.43 93 94 93
NB+SM 90.4 91 93 92
RF 90.46 92 94 93
RF+SM 90.49 83 85 84
DT 94.72 96 95 95
DT+SM 90.4 92 94 93

The dataset have been taken from kaggle e-commerce fraud dataset having 151000 transaction records.
The dataset classified as fraud are 14000 records, and ratio of fraud data is 0 .0927. The SMOTE (Syn-
thetic Minority Oversampling Technique) minimize class imbalance by generating synthesis data.

27

Corporate Sector Fraud

Figure 9. Comparative experimental analysis between the existing and proposed method for the perfor-
mance parameters like accuracy and recall.

Figure 10. Comparative experimental analysis between the existing and proposed method for the per-
formance parameters like accuracy and precision.

Figure 11. Comparative experimental analysis between the existing and proposed method for the per-
formance parameters like accuracy and F-1 score.

28

Corporate Sector Fraud

Figure 12. Comparative experimental analysis between the existing and proposed method for the per-
formance parameters like precision, F-1 score and recall.

Figure 13. Comparative experimental analysis between the existing and proposed method for the per-
formance parameters like precision and recall.

CONCLUSION

Now a day’s internet has changed the human life and internet becomes a very research interest among
the researchers, the demand of internet and their devices is increasing day by day and changed the hu-
man life completely, as we know that the internet is a very easy tool and platform for the business like
e-commerce, m-commerce and banking etc. Business growth is increasing through the internet in a very
fast manner but we also facing some challenges during the electronic business, corporate fraud is one of
them. Corporate fraud is occurred by the unauthenticated and fraud user who misuse the information and
mislead the business activity without any permission, in this paper we present the experimental corporate
fraud study between the existing and proposed methods and gives the solution as our proposed method
is better than the previous methods, here the performances are measured by some standard parameters
like the accuracy, precision, recall and F1-score by predicting the confusion matrix value, the confusion
matrix contain the true positive, true negatives, false positives and false negatives value.

29

Corporate Sector Fraud

Figure 14. Comparative experimental analysis between the existing and proposed method for the per-
formance parameters like accuracy, recall, precision and F1- score.

REFERENCES

Abdullahi & Mans. (n.d.). Fraud prevention initiatives in the Nigerian public sector: understanding the
relationship of fraud incidences and the elements of fraud triangle theory. Journal of Financial Crime.
doi:10.1108/JFC-02-2015-0008
13Gottlieb, Salisbury, Shek, & Vaidyanathan. (2006). Detecting Corporate Fraud: An Application of
Machine Learning. Academic Press.
9Gupta, P. K., & Gupta, S. (2015). Corporate frauds in India –perceptions and emerging issues. Journal
of Financial Crime, 22(1), 79–103. doi:10.1108/JFC-07-2013-0045
6Hajeka & Henriquesb. (n.d.). Mining Corporate Annual Reports for Intelligent Detection of Financial
Statement Fraud – A Comparative Study of Machine Learning Methods. Mining Corporate Annual
Reports for Intelligent Detection of Financial Statement Fraud Ð A Comparative Study of Machine
Learning Methods. doi:10.1016/j.knosys.2017.05.001
Halbouni, S. S., Obeid, N., & Garbou, A. (2016). Corporate governance and information technology
in fraud prevention and detection. Managerial Auditing Journal, 31(6/7), 589–628. doi:10.1108/MAJ-
02-2015-1163
Indonesia, A. P. J. I. (2019). Mengawali integritas era digital 2019 - Magazine APJI. Asosiasi Peny-
elenggara Jasa Internet Indonesia.
Lakshmi, S. V. S. S., & Kavilla, S. D. (2018). Machine Learning For Credit Card Fraud Detection System.
International Journal of Applied Engineering Research: IJAER, 13(24), 16819–16824.
8Mangala, D., & Kumari, P. (n.d.). Corporate Fraud Prevention and Detection: Revisiting the Literature,
Corporate Fraud Prevention and Detection: Revisiting the Literature. http://cbi.nic.in/fromarchives/
satyam/satyam.php

30

Corporate Sector Fraud

3Penyelenggara, A. (2019). Jasa Internet Indonesia. Magazine APJI.

Pumsirirat & Yan. (2018). Credit card fraud detection using deep learning based on auto-encoder and
restricted Boltzmann machine. International Journal of Advanced Computer Science and Application,
9(1), 18-25.
Randhawa, K., Loo, C. K., Seera, M., Lim, C. P., & Nandi, A. K. (2018). Credit card fraud detection using
AdaBoost and majority voting. IEEE Access: Practical Innovations, Open Solutions, 6, 14277–14284.
doi:10.1109/ACCESS.2018.2806420
Renjith, S. (2018). Detection of Fraudulent Sellers in Online Marketplaces using Support Vector Machine
Approach. International Journal of Engineering Trends and Technology.
16Roy, A. (2018). Deep learning detecting fraud in credit card transactions. In 2018 Systems and Infor-
mation Engineering Design Symposium (SIEDS). IEEE. 10.1109/SIEDS.2018.8374722
Sadasivam, G. S., Subrahmanyam, M., Himachalam, D., Pinnamaneni, B. P., & Lakshme, S. M. (2016).
Corporate governance fraud detection from annual reports using big data analytics. Int. J. Big Data
Intelligence, 3(1), 51. doi:10.1504/IJBDI.2016.073895
1Saputra, A., & Suharjito. (2019). Fraud Detection using Machine Learning in e-Commerce. Interna-
tional Journal of Advanced Computer Science and Applications, 10(9). Advance online publication.
doi:10.14569/IJACSA.2019.0100943
5Schnatterly, K. (2003). Increasing firm value through detection and prevention of white- collar crime.
Strategic Management Journal, 24(7), 587–614. doi:10.1002mj.330
Siringoringo, R. (2018). Klasifikasi Data Tidak Seimbang Menggunakan Algoritma Smote Dan K-Nearest
Neighbor. Journal Information System Development, 3, 1.
11Smith, L. M., & Smith, K. T. (Eds.). (n.d.). The Journal of Legal, Ethical and Regulatory Issues, 19(1).
statista.com. (2018). Retail e-commerce revenue forecast from 2017 to 2023 (in billion U.S. dollars).
Retrieved April 2018, from Indonesia: https://www.statista.com/statistics/280925/e-commerce-revenue-
forecast-in-indonesia/
Zhao, J., Lau, R. Y. K., Zhang, W., Zhang, K., Chen, X., & Tang, D. (2016). Extracting and reasoning
about implicit behavioral evidences for detecting fraudulent online transactions in e-Commerce. Deci-
sion Support Systems, 86, 109–121. doi:10.1016/j.dss.2016.04.003

31
32

Chapter 3
Corporate Governance:
Introduction, Roles, Codes of
Corporate Governance

Marios Eugene Menexiadis

National and Kapodistrian University of Athens, Greece

ABSTRACT
Corporate governance is the cornerstone for the organization, when it comes to effective internal control
systems by modern organizations. Over the last 20 years, several business giants have collapsed under
the weight of illegalities and frauds, such as Enron, WorldCom, Guinness, Maxwell Group, Barings Bank,
etc. The impact of the failure of these organizations on the economies in which they were operating was
particularly significant and had a negative impact on those directly or indirectly associated with them.
The shareholders, as well as all stakeholders such as suppliers, customers, creditors, employees, and
governments of the countries where the above organizations were active, were adversely affected. The
failure of the organizations was attributed to the inadequacy of their boards and the lack of organized
and effective control mechanisms by their management.

CORPORATE GOVERNANCE

1.1 Introduction to Corporate Governance

Corporate Governance is the cornerstone for the organization, when it comes to effective Internal Control
systems by modern organizations. Over the last twenty years several business giants have collapsed under
the weight of illegalities and frauds, such as Enron, WorldCom, Guiness, Maxwell Group, Barings Bank,
etc. The impact of the failure of these organizations on the economies in which they were operating was
particularly significant and had a negative impact on those directly or indirectly associated with them.
The shareholders, as well as all stakeholders such as suppliers, customers, creditors, employees and
governments of the countries where the above organizations were active, were adversely affected. The

DOI: 10.4018/978-1-7998-4805-9.ch003

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Corporate Governance

failure of the organizations was attributed to the inadequacy of their Boards and the lack of organized
and effective control mechanisms by their management.

1.2 Importance of Corporate Governance

Corporate Governance System means the framework of the statutory and non-statutory rules governing
the governance of an organization. More simply, it is the system or the way with which organizations
are guided and managed.
A key element of Corporate Governance is the way the organization is governed by the competent
management teams and their impact on results. The most important reason for implementing effective
Corporate Governance practices, is the necessity of subjecting specific interests that characterize individual
stakeholder groups (eg executives, shareholders, Board of Directors, etc.) to the general interest of the
organization and of its shareholders. Corporate Governance is mainly practiced by the Board of Directors
of organizations, whose operations are restricted by those who have a direct or indirect interest in them.
It is important to separate those who are interested in the organization’s progress within it and those
outside it. The second category concerns stakeholders. Specifically within the organization the stakehold-
ers is the management, which is responsible for the Corporate Governance process and its effectiveness,
the shareholders associated with management, among other ways and through the financial statements,
while outside the organization are employees, customers, creditors, banks, public bodies etc.
The day-to-day management of the organization is in the hands of the directors appointed by it and
for whom it has delegated responsibilities. The results are submitted for approval to the shareholders at
the General Meeting.
It is important to have structures in place, as well as procedures to ensure that those concerned with
the organization are not offended by the actions or omissions of their managers. As it is the manage-
ment of corporate affairs, so does the burden of implementing sound corporate governance rules. It is
important to manage the organization in the best possible way for the benefit of the shareholders, but
also for the benefit of employees and other interested parties.

1.3 The Shareholders’ Role

By definition, shareholders have the most significant interest in the decisions of the Board of Direc-
tors. The basic right of the shareholders is to participate in the General Assembly of the shareholders
in order to receive information on the activities of the invested organizations and to ask any questions
to their directors.
Shareholders exercise their rights at the Annual General Assembly of shareholders. Each share
represents one vote and there should be no multiple voting shares. Organizations should ensure that the
rights of minority shareholders are secured by using a representative, in case they are unable to attend.
The General Assembly of shareholders approves the preparation of the financial statements as well
as the distribution of profits, following a proposal by the Board of Directors of the organization. Share-
holders of the organization should be adequately and timely informed by management for issues that
will be required to make decisions such as approval of statutes, share capital increases and issuance of
new shares, major decisions such as mergers, acquisitions, approvals and revocation of members of the
Board of Directors, etc.

33

Corporate Governance

A very important decision within the General Assembly is the approval for the appointment or dis-
missal of the Chief Executive Officer, that comes as a proposal by the Board of Directors. Shareholders
are informed for the details of the general assembly as date, time, place and the respective agenda.
Sound Corporate Governance practices require organizations to treat their shareholders on an equal
basis and not to discriminate them, based on the volume of shares held by each physical or legal per-
son. Each category of shares, should have the same voting rights. In cases of proxy voting, it should be
ensured that the latter acts in consultation with the legal holder of the shares. Transactions and actions
based on internal information should also be prohibited.
Finally, members of the Management Board and executive directors should report future actions in
good time that may affect the organization.
Many times, the decisions of the Board of Directors of organizations related to Corporate Gover-
nance are influenced by the potential impact they may cause either to their partners or to the entities
with legitimate interests in them.
Sound Corporate Governance practices require organizations to ensure that the rights of their partners
are respected. Entities with legitimate interests in the organization, should be fully informed about their
rights and obligations.

1.4 The Role of the Board of Directors

It is the Board of Directors that determine the governance of organizations at all times within the laws and
regulations of the countries in which the organizations they operate. They are responsible for managing
the risks inherent in the organization, as well as for taking or avoiding them. Their actions should be
characterized by honesty and transparency towards shareholders and other stakeholders in the organization.
Some of the duties and responsibilities of the Boards are as following:

• Defining operational policy and strategy,

• Recruitment and monitoring of the executives in the organization,
• Overview of the organization’s progress in relation to the goals set,
• Responsibility to shareholders and other stakeholders for the organization’s activities,
• Advisory role in management,
• Management monitoring and control,
• Defining the purpose and code of ethics of the organization,
• Audit of executives and committees of the Board of Directors,
• Reporting to shareholders,
• Maximizing shareholder’s wealth,
• Successful planning of CEOs,
• Assessing the executives’ performance,
• Determining executives’ remuneration,
• Securing shareholders’ interests,
• Developing and improving strategic planning,
• Election of new directors,
• Defining the authority of the top management,
• Ensuring the reputation of the organization,
• Control over the decisions of top management,

34

Corporate Governance

• Protecting senior management from external pressures.

On the other hand, it is important to report on pressures received by the Board, both physical and
external, which affect the performance, operation and behavior of the Board itself. These are:

• Governments,
• Trade unions,
• Technology and population,
• Productivity,
• Customer and society,
• Competitors,
• Shareholders,
• Debtors and lenders,
• Staff.

The success or failure of the Board of Directors is judged by its ability to achieve the desires financial
results by operating within a frame of ethics, fairness and integrity. Many Boards of Directors fail in this
dual role as often as the ease of production through illegal procedures become attractive.
The Boards of Directors are elected by the General Assemblies of the shareholders and are responsible
for managing the organizations. Boards of Directors with more than five hundred employees may have
to include in their composition employee representatives at a fixed percentage within the Board. The
Board should take decisions and exercise control over the activities of the organization. It is responsible
for the supervision of the executive management of the organization.
The Boards of organizations are responsible for the Internal Control systems. Boards should set up
appropriate policies to ensure the more efficient functioning of Internal Control systems and to ensure
more effective management of risks that characterize their activities.
The following suggested thoughts may be the future of a profitable board (“Corporate Governance
as it should be”):

• Councils with a majority of non-executive members,

• Independent directors responsible for all Board processes,
• Chairman of the Board of Directors elected by non-executive members,
• New directors to be elected by the Board (and not the Chairman),
• The Board should have an understanding of all long-term strategies,
• Non-executive members must have specific abilities,
• Encouraging direct communication between independent directors and management,
• Members with specific time service,
• Members – investors in the organization,
• Written criteria for the selection of directors,
• Members specializing in strategic issues,
• Board meetings on new strategic and operational changes,
• Managers to have better access to all types of information,
• Members to spend a lot of time within the organization,
• Members’ motivations are related to stock performance.

35

Corporate Governance

1.5 The Role of the Executive Members of the Board

Executives who may or may not be members of the Board of Directors play an important role in effec-
tive Corporate Governance.
Organizational executives are those who manage the organization’s resources in their individual
activities and functions such as finance, sales, procurement, information systems, marketing, general
management, etc. e.g. For these services, they are remunerated separately by the organization in relation
to the remuneration they receive for their actions as members of the Board of Directors. The risk that
exists is related to their commitment to the activity or function they manage, rather than to other issues
related to Board decisions.
According to sound Corporate Governance principles, executives of the organization should express
an independent opinion on any matter that comes up for discussion on the Board of Directors. Should the
executive directors of the Board of Directors who are members of the Board differ from those expressed
by the CEO of the organization, they should be able to express it freely.
The remuneration of executives should be linked to the organization’s profitability and overall
performance in order to create incentives to improve their performance. Their remuneration is a good
practice to make it public and reasoned in the financial statements of the organization and to be audited
by a relevant Remuneration Committee.

1.6 The Role of Non-Executive Members of the Board

Non-executive members of the Board of Directors play a very important role in their operation, as their
independent affiliation with the activities and functions of the organization offers greater independence
and impartiality in their opinion and therefore in their decisions. In particular, non-executive members
of the Boards of Directors may contribute by:

• Providing their specialized or broader experience at Board meetings to help developing a sound
strategy.
• Taking responsibility for reviewing the performance of executives and monitoring the results.
• Ensuring that the Board of Directors has established appropriate systems to safeguard the interests
of the organization and that there are no conflicts arising from the personal interests of executive
directors.
• Ensuring that proper and appropriate information is presented to the Board of Directors.

It is a sound practice for Boards to act independently, to be composed by a sufficient number of

non – executives and in many cases independent non – executive members. Due to the difficulty of non
– executive members of the Board of Directors, in having access to information relevant to the orga-
nization and possibly affecting their decisions, the organizations themselves should provide sufficient
information to them in order to form independent assessments regarding issues such as the strategy of
the organization, its performance, etc.

36

Corporate Governance

1.7 Voluntary Implementation of Corporate Governance Principles

An important question is whether the way that organizations run, is the best way for every organization.
The answer is clearly no. Organizations differ and operate internationally in different legal systems,
regulatory frameworks, as well as in different traditions and cultures. It would not be possible for a
common way of governance for all to be at the same time the best practice for all.
The key point of Corporate Governance is to prioritize the interests of shareholders who trust or-
ganizations to use their invested funds, in order to manage them prudently and effectively. However,
shareholders in an organization may be family members, may be the general investing public, or they
may be institutional investors who effectively represent the savings of a broad public. These shareholders
differ in the extent to which they deal with the organization.
In this context in which the great diversity of key characteristics of organizations and shareholders is
given, the Organization for Economic Co-operation and Development (OECD) has established a number
of Corporate Governance principles, which are intended to serve as a point of reference for state legisla-
tors (in order for them to develop corporate governance codes if they so wish) and for organizations.
In addition to the OECD, various committees have so far adopted principles and recommendations
on sound Corporate Governance practices, such as the Cadbury, Greenbury, Combined, Turnbull, FRC
codes, the COSO (Committee on Sponsorship Organizations) framework. It is noteworthy that these
codes, despite the voluntary basis of compliance of agencies with their principles, have been amended
and developed, making it compulsory on a country-by-country basis to comply with their principles.
Here are briefly the main points of each code:

1.7.1 Cadbury Code (Committee Report 1992)

The Cadbury Committee drafted the Code of Good Practice in 1992, as a result of an overview of cor-
porate governance issues that are directly related to the financial reporting framework and management
that is accountable to shareholders and stakeholders. The Cadbury Code set out a number of suggested
actions and suggestions to set corporate governance standards. Let’s have a look at some of the sound
Corporate Governance issues.
With regard to the Internal Control system, the management of each organization is responsible for
maintaining accurate and accurate accounting books - financial statements. It should therefore have a
financial management control system in place including procedures to minimize fraud. In addition, a
set of criteria should be defined in order to evaluate the effectiveness of the control system. So once the
control system is installed, which is very important, the certified auditors should express their opinion
on the proper functioning of the audit system.
Concerning Audit Committees, it is suggested that Audit Committees be set up by independent mem-
bers of the Board of Directors whose relationship with the management of each organization is clear,
written communication and meetings held at least twice a year. The members of the Audit Committee
should be at least three.
The certified auditors should be present at the meetings of the Audit Committee since its main concern
is the proper view of the financial statements as well as present. The Chief Financial Officer may also
be present. The purpose of the meeting is to eliminate any cases that have not been resolved.

37

Corporate Governance

The Supervisory Board’s access to all information is assumed to be granted and in the event of failure
to perform a task due to a lack of know-how, the Committee will have the right to invite external partners.
The main tasks of the Audit Committee are as follows:

• Overview of the financial statements for the purpose of verifying their true and fair view,
• Improving the quality of financial statements reporting,
• Strengthening the independence of the independent non-executive members of the Board of
Directors,
• Strengthening the position of certified auditors, through communication channels,
• Strengthening the position of Internal Auditors by providing a high degree of independence;
• Increasing public confidence by ensuring the objectivity of the financial statements;
• Recruitment - removal of statutory auditors and determination of their remuneration;
• Determining the purpose of the audit,
• Overview of financial statements,
• Solve audit problems in collaboration with external auditors,
• Compliance with capital market regulations,
• Overview of audit programs and coordination of internal and external auditors’ efforts,
• Purpose and system of Internal Audit,
• Internal Audit program approval and discussion-analysis of results,
• Answering relevant questions to the boards,
• Defining efficiency standards,
• Management’s view of profitability,
• Maximizing shareholder wealth,
• Communicate with those who have a significant stake in the organization.

As far as internal control is concerned, it is a good practice for organizations to set up Internal Au-
dit services that will monitor the operation of the installed safety valves and procedures. The Internal
Auditors will act on behalf of the Audit Committees and will have access to the Chairman of the Audit
Committee as a means of maintaining their independence.

1.7.2 Greenbury Code

The Greenbury Code was drafted in January 1995 as a result of a study group chaired by Sir Richard
Greenbury, developing issues of good practice regarding the remuneration of executives. The final ver-
sion of the code, published in July 1995, is referred to as the “Greenbury report”.

1.7.3 Combined Code (2000)

The consolidated code was issued in the year 2000 and is the response to, or rather the evolution of, the
demands for a combination of good practices in the Cadbury and Greenbury commission codes, as well
as changes made by the London Stock Exchange to listed companies, on disclosing the latter in corporate
governance matters. We will focus on issues related to control.
Regarding the - Internal Audit- Audit Committee - External Auditors, the Board of Directors should
maintain an Internal Control system in order to safeguard investor interests and the funds of the or-

38

Corporate Governance

ganization. The Internal Control system should be reviewed at least annually for its effectiveness and
shareholders should be given an overview. The review should include all risk management, financial,
operational, and compliance regulations and legislation. Organizations that do not have Internal Control
system, should review the need to establish one, at least annually.
Concerning Audit Committees, these should consist of independent non-executive members whose
relationship with the management is clear with written communication and meetings to be held at least
twice a year. The members of the Audit Committee should be at least three and their names should be
mentioned in the annual report.

1.7.4 Turnbull Code (Financial Reporting Council 2005)

The Turnbull Code was originally published in 1999 setting out best practices for the Internal Control
system of companies listed on the London Stock Exchange. In October 2005 it was updated with a new
publication entitled “Internal Values: Managing Managers in the Consolidated Code”.
With regards to Internal Audit and risk management, the control system of each organization plays
an important role in managing risk in order to achieve corporate goals. A sound control system protects
the interests of investors and protects the capital of the organization. Internal controls serve the effective-
ness of corporate operations, enhance the reliability of financial statements, and assist in compliance
with applicable legislation.
Effective financial security controls, including proper bookkeeping, reinforce the fact that the orga-
nization is not unnecessarily exposed to financial risks and that the financial information used in the
statements is reliable and accurate.
Control systems depend on the risks the organization is exposed to. For this reason, risks can change.
The following should be taken into account when defining policies and procedures regarding the Internal
Control system:

• The nature and extent of the risks faced by the organization,

• The risks and extent to which they are considered acceptable by the organization;
• The likelihood of risks occurring and their impact on the organization,
• The ability of the organization to mitigate significant risks,
• The cost of implementing the system in terms of potential benefits.

It is the responsibility of the Management to implement the control system, as well as the employ-
ees, as part of achieving the corporate objectives. The Internal Audit Control system includes policies,
procedures, controls and behaviors that, taken together, should:

• Operate effectively responding to financial, operational and compliance risks in order to achieve
corporate objectives;
• Enhance the objectivity and quality of internal and external reporting. This requires processes that
aim to produce relevant and reliable information internally and externally from the organization.
• Enhance compliance with existing legislation and corporate regulations and policies.

In addition the internal control system should:

39

Corporate Governance

• Be part of the philosophy and culture of the organization,

• Apply to the activities of the organization,
• Respond rapidly to risks and,
• Include reporting procedures to the relevant executives of the organization.

Last but not least, no matter how sound a control system may be, it can never be said that it protects
the organization from any kind of risk. It will therefore provide a reasonable but not absolute assurance,
in other words the control system should provide adequate assurance.

1.7.5 FRC Guidance for Boards and Board Committees

The guidelines issued by the FRC (Financial Reporting Council) are intended to support their boards of
directors and committees in matters of efficiency, risk management and financial reporting related issues.
On the effectiveness of the Boards, the role of the Chairman of the Board, which creates the condi-
tions for the effectiveness of the Board as a whole, is analyzed. It should be characterized by integrity,
set clear expectations about the organization’s culture of values, style of conversation and behavior.
His duties should include the following:

• Ethics-driven guidance.
• Gathering the board on strategy, performance and value.
• The board of directors is accountable for its decisions.
• Timely and reliable provision of supportive information.
• Clearly identify the risks that the organization will make board decisions.
• Plan to replace board members.
• An effective decision-making process.
• Effective staffing of board committees.
• Encouraging the participation of members in board committees based on their knowledge and
skills.
• Encourage open communication and respect within and outside boards and between executive and
non-executive members.
• Develop productive relationships with CEOs.
• Development of programs for new board members.
• Evaluating the effectiveness of the board.
• Effective communication with shareholders and stakeholders.

Significant reference is made to the role of the independent non – executive directors / members of the
board, who can play the role of an intermediary member and chairman of the board, with duties such as:

• Mediation between chairman and chief executive in case of disagreement.

• Mediation in matters raised by non-executive members whose voice is disregarded by the Chairman
or Managing Director.
• Strategy mediation not supported by the entire board.
• Mediation of decisions not taken by the whole board.

40

Corporate Governance

With regards to the Board of Directors’ Audit Committee, there are no significant changes in the
composition of the committee, the frequency of meetings and the remuneration of the members.
The tasks of the Audit Committee should include:

• Overview of security issues related to financial issues, with the aim of identifying, evaluating,
managing and monitoring financial risks.
• Promote and manage effective Internal Control systems and take corrective action where required.

There are no significant changes in the functioning of Internal Audit, however, the involvement of
the Audit Committee in selecting external auditors, in determining their remuneration and in evaluating
their work should result in a proposal. continued cooperation or replacement of the statutory auditor.

1.8 Advantages and Disadvantages of Voluntary Compliance

With Corporate Governance Practices and Rules

If rules remain voluntary, they maintain their adaptability and flexibility to adapt to the different environ-
ments and situations in which organizations operate. In addition, some corporate governance requirements
do not appear to be relevant to all organizations, especially with regard to small or those in which the
owner is also the manager. This saves organizations from significant costs that are unnecessary.
However, if the basis for applying these rules remains voluntary, there is always the risk that organi-
zations - due to structure or size - should apply them, not do so, and that their shareholders may be at a
disadvantage. It also contributes to such a situation, limiting the comparability of agencies and capital
markets if not all organizations are subject to the same requirements, and makes it more difficult for
shareholders to make decisions.
At the state level, in order to make the most positive of these rules and to avoid other rules that are
not particularly practical and useful to follow, States may adopt an approach in which compliance with
some of the rules is mandatory, while keeping some others voluntary.

1.8.1 Principles

In corporate governance we should:

1. Protect the rights of shareholders,

2. Ensure equal treatment of all shareholders, including minority shareholders or shareholders living
in another country. All shareholders should be able to have legal protection in the event of a viola-
tion of their rights,
3. Recognize the rights of stakeholders other than shareholders as defined by national law and encour-
age active cooperation between organizations and other stakeholders in the creation of wealth, jobs
and the maintenance of financially viable businesses;
4. Ensure that timely and accurate information is provided on all important matters relating to the
organization, including its financial position, financial performance, ownership and governance;
5. Ensure the implementation of the strategy that the organization has established, the effective over-
sight of management by the Board of Directors, as well as the Board of Directors being accountable
for its operations at the General Assembly.

41

Corporate Governance

The same authorities report that an annual audit of the financial statements should be carried out by
independent auditors.
There are three important parameters that these authorities refer to external auditors:

1. Audit on an annual basis: The authorities strongly recommend that all entities audit their financial
statements by an independent auditor annually. In many countries, this is now a legal requirement
for organizations.
2. High quality standards: It is stated in the principles that relevant information should be compiled
and verified on the basis of high quality standards. This is intended to increase the reliability and
comparability of financial statements by allowing investors to make better investment decisions.
3. Other information available: The authorities also state that other stakeholders will also benefit if
any other information about the organization is subject to audit by auditors. This other information
reported to the authorities includes disclosures about:
a. The financial and operating results of the organization,
b. Its objectives,
c. The major shareholders and voting rights among them,
d. Management and other senior executives and their remuneration,
e. Significant predictable risk factors for the organization,
f. Important issues for employees and other stakeholders,
g. Corporate Governance Structure and Policies.

For Corporate Governance purposes, Management should determine the corporate policy, including
the policy to deal with any business risks, while also being responsible for the organization’s Internal
Audit system.

1. Policies: Management is responsible for managing the organization, including defining strategy,
budgets, employee management, asset retention, and ensuring that corporate governance rules are
implemented. An important element in defining strategies is identifying and managing business
risks. The Internal Audit department has a role in this.
2. Systems, networks and their monitoring: Management is responsible for establishing Internal Control
systems to apply the organization’s and network policies to these systems to reduce exposure to
risks recognized by the organization.

The administration is also responsible for monitoring the effectiveness of these systems and safety
nets. Internal Auditors play an important role in this regard, however, it is the management that decides
whether or not the organization will have an Internal Audit service to assist it in its role or not.

1.8.2 Recommendations

At a recommendation level, the following may be proposed:

• There is a well-documented and well-defined procedure for evaluating the effectiveness of secu-
rity clearances in the general system of Internal Control,

42

Corporate Governance

• The Internal Audit Service should issue reports on the effectiveness of security clearances while
on the other hand, management should review reports on security clearances on a regular basis;
• Assessing business risks and determining how their organizational manages them;
• Assessment of the appropriateness and effectiveness of the action taken after identifying any
weaknesses or specific disturbing events that may affect the organization’s own course;
• Assessment of the suitability of the security clearance monitoring process,
• Evaluation and review of risks at least annually, as well as the effectiveness of safety valves with
corresponding renewal of systems valves where necessary,
• Management’s statement to shareholders on the process and system of Internal Audit in its annual
report.

1.8.3 Non-executive Members of the Board

The Board of Directors should also include non-executive members whose role will be to ensure that
the Board makes objective decisions.
Non-executive members of the Board are those who have no authority to make decisions about stra-
tegic choices or the day-to-day running of the organization.
Non-executive members can play important roles in sensitive areas of business, such as preparing
the financial statements, appointing or hiring directors, drawing up the remuneration of members of
management and directors, etc. The Boards establish committees that assume the aforementioned roles.
One of these committees is the “audit committee”.

1.9 Audit Committee

The main concern of the Audit Committees is to ensure that internal and external audits are carried out
legally and unaffected by the organizations and to ensure effective communication between the Audit
Institutions and the Board of Directors.
The Audit Committee should be elected by the Board of Directors of the organization, which deter-
mines its responsibilities and how it operates.
The main responsibilities of the Audit Committee are to confirm reliable financial analysis and to
ensure the proper functioning of the organization’s Internal Control system.
Although the committee reports to the Board of Directors, it should always operate in the interest
of all shareholders and other stakeholders in the organization, with whom it has ultimate responsibility.
The responsibilities of the Audit Committee for Corporate Governance are to ensure that the organi-
zation complies with relevant laws and regulations, to operate in a manner that promotes its ethical and
social role and to maintain an effective Internal Control system.
In addition, the Audit Committee should require the Head of Internal Audit of the organization to
report at least annually in writing, for the extent and scope of the Internal Audit Department’s audit
work on Corporate Governance.
The setting up of Audit Committees allows for a “clear” relationship with the board to which they
are accountable and should report frequently. Such a committee helps independent members to judge
independently, objectively and positively, as well as being a direct link to external auditors.

43

Corporate Governance

It could be said that the quality of the committee depends on the quality of its members. They need
to be competitive and have time not only to attend meetings but also to meet with the staff of the orga-
nization, to visit various parts of the organization and to study important reports.
It should not be forgotten that the Audit Committee is an independent communication channel in the
Board of Directors that monitors the control systems of the organization, and should therefore have the
power to influence the Board.
The Audit Committee can help the organization maintain its impartiality in preparing and auditing
the financial statements.
The Audit Committee is a subcommittee of the Board of Directors which as best practice should
include independent non-executive members of the Board.
The effective functioning of the audit committee gives the organization significant benefits such as:

• Specifies the scope of the Internal Audit service’s activities.

• Provides guidance to the Internal Audit service on the performance of its work.
• Examines the activities of the Internal Audit service in order to evaluate its effectiveness.
• Informs on a regular basis about the progress of the Internal Audit Department’s work and con-
firms that significant problems and weaknesses identified, as well as related recommendations,
have been communicated and discussed in good time with the Administration, which has taken
the necessary corrective action.
• Oversees the system of providing financial and administrative information to the Management of
the organization.
• Improves the quality of the financial statements by reviewing the financial statements and their
preparation process on behalf of the Board of Directors,
• Creates a climate of discipline and control that may reduce the likelihood of fraud,
• Assess various corporate issues objectively,
• Supports the Financial Department as a group of concerns that can be used to implement issues
that are otherwise difficult or impossible to implement;
• Enhances the external auditor’s position as a communication and discussion channel for issues
that concern them,
• Provides the framework in which the external auditor maintains his / her independence and at the
same time can discuss issues that he or she disagrees with Management;
• Strengthens the functioning of the Internal Audit Service by providing a high degree of indepen-
dence from Management;
• Increases the confidence that the general public shows in the reliability and objectivity of the
financial statements.

Perhaps the most important advantage of having an audit committee is that it consists of independent
members, providing the internal and external auditor with an independent benchmark different from that
of the executive members of management, which is particularly useful in cases of disagreement with
management administration.
Other advantages of having an audit committee are the following:

• Increased confidence in the reliability and objectivity of financial statements, especially useful in
the case of listed companies.

44

Corporate Governance

• With the expertise gained by Internal Audit staff in the preparation of financial statements, they
help Management to be more effective in dealing with them and to spend less time on these
problems.
• In cases where the interests of the organization, members of Management and its employees con-
flict, the audit committee may provide an independent opinion, useful to external auditors as well.
It can also provide a channel of communication between internal and external auditors.
• The Internal Audit of the organization will be able to report its findings to the Audit Committee
rather than Management itself, which enhances its ability to be objective.
• The Audit Committee may be the Management’s advisor in ensuring that it complies with corpo-
rate governance requirements.

On the other hand, the following disadvantages of audit committees can be mentioned:

• The executive members of the Board may not understand the role of the audit committee and may
believe that it is intended to remove power from themselves;
• Difficult to select non-executive members, with the necessary qualifications and knowledge of
audit matters to make these committees truly effective;
• The establishment of such a committee and such a formal process of preparing the financial state-
ments may discourage auditors from raising issues based on their judgment and limiting them only
to matters of proper application of accounting policies;
• Increased costs.

It is important to comment that it is really difficult to find sufficiently qualified individuals ready to
take on non-executive positions on the Boards. If such individuals are again tempted to pay significant
fees, then they may lose some of their objectivity.
However, difficulties should not deter organizations from applying corporate governance rules. If the
audit committees were mandatory, corporate culture would have to change, and we might see executive
members of one organization much more often, becoming non-executive members of another who is
not competitive with their main employer.

1.10 The Role of Internal Audit

Audit is primarily aimed at achieving the objectives and objectives of the organizations as set out at the
planning / planning stage. Each organization has its own Internal Control system, which aims to eliminate
the risks associated with doing business through relevant policies, procedures, instructions and regulations.
In accordance with sound Corporate Governance principles, the evaluation of the Internal Control
system is defined as a responsible, relevant independent service within the organization. In order to
exercise its role independently and effectively, the latter should be able to communicate directly with
either the Board of Directors or a sub-committee thereof (Audit Committee).
The Internal Audit service reviews, evaluates and advises the management of the organization on issues
related to the existing Internal Control system. It is also the one that will identify any risks that threaten
the good functioning of the organization and the one that will advise on how the identified risks can be
addressed. It does not take the same risk management measures, nor do any of its executives engage in
controlled activities and functions of the organization to ensure its impartiality.

45

Corporate Governance

Internal Audit, as opposed to External Audit limited to the Audit and Certification of the accuracy
of the Financial Statements, performs both Financial and Operational and Administrative audits. The
above audits are carried out in the form of special projects, based on the relevant planning and budget-
ing. Specific audit programs may be used for their effective implementation on a case-by-case basis
developed by the service itself.
In order to succeed in its work, the Internal Auditor must have the full support of the management of
the organization, which will provide him with free access to all kinds of files and any auxiliary material
which may be useful in the evaluation of the Internal Control system. The Internal Audit department’s
proposals should be directed to the Management of the organization, mainly in the form of written reports
and having previously been discussed and agreed with the auditors. Management in turn undertakes the
implementation of the Internal Audit’s proposals and sets time limits for their implementation.
Regarding the importance of the issues that Internal Audit incorporates, the latter are particularly
important for Management as they help to:

• Safeguard the assets of the organization,

• Avoid but also detect fraud;
• Consequently, they help to safeguard the shareholder investment.

Effective locks help the organization handle its cases effectively. A sound Internal Control system
reduces the risks of the body already identified. It also helps to ensure the reliability of financial state-
ments and compliance with laws and regulations.
The ultimate responsibility for the Internal Control system lies with the management. She must es-
tablish Internal Control procedures and regularly monitor that these procedures are followed.
Part of the process of setting up Internal Control systems is to identify the risks that the organization
faces, in order to design systems to ensure that these risks are precisely addressed or avoided.
Internal Control systems always face inherent weaknesses and limitations, with the most common
in all systems being that none of them can eliminate the possibility of human error, or the ability of
employees to engage in fraud.
Once management has put in place an Internal Control system, they are responsible for overseeing
its effective operation at regular intervals.
Management may decide that in order to do this job more effectively, it must hire a team of people
to staff an Internal Audit department. In order for management to decide whether a dedicated Internal
Audit department is needed, it should evaluate the extent and complexity of the systems, as well as the
alternative costs of outsourcing this function.
If management is not convinced on the need to have an Internal Audit department, then organizations
are required to evaluate the need for an annual review of the processes and processes they incorporate,
in order to reassess the need for establishing an Internal Audit department. In the same context, it is also
recommended that management prepare and publish a report, together with the financial statements,
on the Internal Audit review. The related report includes a statement based on the annual review of the
Internal Control system, which should state that the management has evaluated all important aspects of
the Internal Control system. In particular, the relevant statement should state:

• Changes in relation to the previous similar statement regarding the risks the organization faces and
its ability to respond to changes occurring in the financial environment and industry,

46

Corporate Governance

• The extent and quality of the process of monitoring the effective functioning of the management
network, as well as the work of the Internal Audit Department, or, if this does not exist, the evalu-
ation of whether or not to establish such a department,
• The extent and frequency of Internal Audit reports prepared and considered by management,
• Significant faults, whose failure or failure would have a significant impact on the body,
• The effectiveness of the financial statements process.

1.11 Responsibilities of External Auditors

Auditors should focus on the overview of the Internal Control system that management does. The purpose
of external auditors is to determine whether there is sufficient evidence of the work that the manage-
ment claims in its statement to shareholders that it has done. Specifically, whether the summary of the
procedure that the management claims to have followed in assessing the effectiveness of Internal Control
systems and which this summary appears in the statement is sufficiently substantiated.
Auditors should ask appropriate investigative questions and review the statement that Management
has made by crossing it with the supporting evidence.
The external auditors will have an understanding of the faults that the processes incorporate as they
evaluate the effectiveness of these processes in the context of their audit, however, what international
auditing standards require them to do is significantly more limited than the overview of internal control
systems. the management is called upon to do. So auditors are not expected to evaluate e.g. whether
in its statement the management mentions all the risks that the organization faces or the significant
faults it has established, or whether the risks involved are successfully addressed by those faults or not.
However, it is particularly important for external auditors to communicate promptly to Management any
significant weaknesses that they identify due to management’s requirement to make the statement cited
in the organisation’s annual report.
Management is required to evaluate any significant extensions to the Internal Control system that the
auditors’ findings have identified regarding the financial statements. Auditors may report to manage-
ment, exceptionally, and specifically on the specific issues which they have come to realize, although it
was not their primary purpose to evaluate their procedures and faults, such as:

• An overview of the summary of the process that management has drawn up and claims to have
followed regarding the review of Internal Audit systems and their effectiveness as to whether they
are consistent with the auditors’ perception of the effectiveness of this process;
• Overview of the procedures related to important aspects of the Internal Control system as to
whether it is in line with the auditors’ perceptions of this process;
• If management has not sufficiently disclosed whether it has failed to conduct an annual review or
this disclosure is inconsistent with the view that auditors hold.

SUMMARY

• Corporate Governance is the system through which organizations are controlled, monitored and
managed.
• The day-to-day management of the organization is in the hands of senior management.

47

Corporate Governance

• It is important to have structures and procedures in place, to ensure that the interests of stakehold-
ers within and outside the organization are safeguarded.
• There is no common way of governance for all organizations.
• The Audit Committees should be composed of non – executive and independent non – executive
members to ensure the objectivity of their work.
• The responsibility for the effectiveness of the Internal Control system lies with the management.
The Internal Audit Service should issue reports on the effectiveness of controls.
• The appropriateness and effectiveness of the action taken after identifying weaknesses should be
evaluated.
• Risks should be evaluated and reviewed annually.
• Effective locks help the organization handle its cases effectively.
• An adequate Internal Control system reduces the risks already identified by the organization and
helps to ensure the reliability of the financial statements preparation.

ADDITIONAL READING

AICPA. (2009). Guidance on monitoring Internal Control systems. AICPA.

Anderson, U. (2006). Implementing the professional practices framework (2nd ed.). The IIA Research
Foundation.
Biegelman, M. (2008). Building a World – Class Compliance Program: Best practices and strategies
for success. John Wiley & Sons, Inc.
Braiotta, L. (2004). Audit Committee handbook (4th ed.). John Wiley & Sons Inc.
Green, S. (2004). Manager’s guide to the Sarbanes-Oxley Act: Improving internal controls to prevent
fraud. Wiley.
Hargraves, K. (2003). Privacy: Assessing the risk. The IIA Research Foundation.
IIA. (2007). Common body of Knowledge 2006, A global summary. IIA Research Foundation.
Mclellan, J. (2005). All Above Board: Great governance for the government sector. Paperback, Australian
Institute of Company Directors.
Pickett, S. (2006). Enterprise Risk Management: A Manager’s Journey. John Wiley & Sons Inc.
Roth, J. (2003). Internal Audit’s Role in Corporate Governance: Sarbanes-Oxley Compliance. The IIA
Research Foundation.
Sobel, P. (2005). Auditor’s Risk Management Guide: Integrating Auditing and ERM. CCH Incorporated.
Vassiliou, D., Heriotis, N., Menexiadis, M., & Balios, D. (2017). Internal Audit. Rosili.
Verschoor, C. (2008). Audit Committee Essentials. Wiley & Sons Inc.

48
49

Chapter 4
Fraud Governance and Good
Practices Against Fraud
Antonios Zairis
Neapolis University Paphos, Greece

ABSTRACT
Corporate governance standards allow corporate actions to be in accordance with law. In recent years,
allegations of corporate misconduct have raised questions about the prevailing norm of conformity.
This chapter discusses the effect of law on corporate activity by comparing the provisions of law with
the actual conduct of business in the market. In particular, it explores how such legislation causes a
greater commitment of corporate entities to legal enforcement than others. The inference drawn is that
the existing rule—an ambiguous common law or statutory requirement—usually has to do with corporate
conduct that evades the requirement or underlying intent of the law or ignores it. In its fraud policy and
fraud response plan, the strategy of a company to deal with fraud should be explicitly defined.

INTRODUCTION

Corporate governance standards allow corporate actions to be in accordance with law. In recent years,
allegations of corporate misconduct have raised questions about the prevailing norm of conformity. This
article discusses the effect of law on corporate activity by comparing the provisions of law with the actual
conduct of business in the market. In particular, it explores how such legislation causes a greater com-
mitment of corporate entities to legal enforcement than others. The inference drawn is that the existing
rule – a ambiguous common law or statutory requirement – usually has to do with corporate conduct
that evades the requirement or underlying intent of the law or ignores it. In its fraud policy and fraud
response plan, the strategy of an company to deal with fraud should be explicitly defined. However, in
order to identify the practices against fraud, it is necessary to understand and highlight the definition
of fraud. Fraud according to Baukus and Near (1991) involves criminal offenses involving frustration
and dishonesty that favours a certain individual or entity or are harmful. Fraud and ethics are entangled
in this way. The risk of fraud rises exponentially, without a solid ethical culture. This paper stands to

DOI: 10.4018/978-1-7998-4805-9.ch004

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Fraud Governance and Good Practices Against Fraud

investigate the role of good practices against fraud in corporate governance and critically discuss mitiga-
tion measures of fraud in a corporate level.

CORPORATE GOVERNANCE

Corporate governance has not been awarded a univocal meaning. In fact, Brickley and Zimmerman (2010)
state that Corporate governance is not specifically defined. Bebchuk and Weisbach (2009) claim that
corporate governance will lead to problems in reward rights, so governance becomes stakeholders and
ownership split. Bushman et al. (2004) say that corporate governance relies on the community, manage-
ment and leadership of an organization. Fombrun (1983) describes corporate governance as a system
organization and social security aimed at safeguarding shareholder interests. Stein (2008) defined corpo-
rate governance as the acts of managers and the responsibility of trusteeship. Fombrun (1983) suggests
that an organization’s community has long-term governance goals through organizational cooperation.
Corporate responsibility can be calculated exhaustively, and corporate responsibility can be maintained.
The main principles of corporate governance include the following:
Strategy, mission and core principles-assess and encourage an ethical working atmosphere and en-
dorse corporate goals.
Code of Ethics and Related Party / Conflict of Interest Policies – continuously strengthen the Inde-
pendent Committee – track and analyse executive management conduct – Internal monitoring and control
practices to achieve financial supervision and monitoring.

FRAUDULENT ACTIVITIES IN A CORPORATE LEVEL

Corruption is now being viewed as one economic obstacle and not just a subversive act i. There are
some warning signs of fraud, according to Heiman-Hoffman et al. (1996). For example, when managers
ignore internal auditors or if the administration indicates that the organizations show grave disrespect.
The triangle of fraud and diamond of fraud are the two most common models used in the literature of
fraud. The criminologist Cressey Donald created a fraud theory that involves three fraud elements (Wells,
2000). Initially, there is a business-related stimulus (e.g., accomplishment of high targets or funding
need). Nonetheless, it typically comes for personal purposes, such as greed, revenge, and delinquency.
Instead, if circumstances allow, the chance. for eg, weak or unusual control or the management’s ability
to bypass controls and laws. Finally, moral justification is the requisite excuse that the fraud person uses
to overcome any moral barriers that differentiate him. A new model was used by Wolfe & Hermanson
(2004) to complete the triangle of fraud and add the element of indivual portion in the equation of com-
mitting a fraud.
Forging financial statements is the third row type of financial fraud, according to a study carried out
by the Association of Accredited Fraud Examiners (2016). First of all, the misappropriation of funds
and secondly, corruption. Corruption is the number one hurdle for economic growth and development
(Healy & Serafeim, 2012) according to a World Bank survey of more than 150 government officials and
citizens of 60 nationalities. This research explores the attempts they make to combat corruption in 480
of the world’s largest corporations.

50

Fraud Governance and Good Practices Against Fraud

Growing organization is confronted with several types of risk of fraud. And fraud costs go way
beyond direct economic damages. The initial spike of crime itself will exacerbate investigation costs
and indirect costs linked to productivity loss, morality, and credibility. The problem is that fraud threats
are continuously in circulation – more than can be understood by the Board. Continuing fraud debates,
often in conjunction with other talks, are important for successful risk governance in today’s changing
risk climate. However, there are often two main elements absent from these debates – the knowledge
of drivers and the awareness of the cross-functionality of the possibility of fraud – contributing to a
retrospective and inadequate evaluation of fraud. Members of the Board should act in order to take a
more constructive approach to risk management of fraud.
Factors connected with such efforts should be investigated in order to identify if these efforts are
successful and if there is a direct link between corruption efforts and their financial results and if reports
of corruption are actually effective in combating the phenomenon.
Conditions that favour fraud in a corporate level include the following (Coso, 2011):

• The system of internal control works incorrectly.

• Human resources are recruited without clarity.
• Employees are under pressure to meet their financial goals.
• Management techniques are unsuccessful or sometimes unethical.
• An employee faces severe financial difficulties because of a crisis.
• Corruption is characteristic of the industry.
• The business is facing a financial crisis.

In strictly business terms, in order for a fraud to be possible, one is needed motivation, an opportunity
and the application of a behaviour. The motivation may be even putting pressure on a manager to show
improved profits and / or gambling problems. In terms of opportunity, an example is the decentralized
administration, a weak internal control system, the complex transactions. The behaviour of one or more
people to lead to fraud is accompanied by fraudulent behaviour.
In addition, corporate governance structure per se, can sometimes nurture and enhance fraud chances;
this has to do mainly with the cross-functional nature of frauds. In fact many organizations categorize
their risks into specific categories, such as strategic categories, enforcement, operations or financing.
Some of the threats are present and are handled efficiently in one region or department through a typic
ERM classification structure, with minimal feedback from other categories. There may be differences
between risk in one sector and risk in another, however, most assessment and mitigation in a single field
can be established. However this is not the case with the risk of fraud. The risk of fraud is also caused by
problems that intersect and link different departments or functions. Input from individuals in account-
ing, procurement, information management, human resources, distribution, and various other roles, for
example, may be collected in order to better determine one particular category of delivery fraud. Based
on the need for knowledge from many fields, fraud risk management can be the weak link in a company
risk management system, if conducted in isolation.

51

Fraud Governance and Good Practices Against Fraud

GOOD PRACTICES AGAINST FRAUD

On a ‘better save than regret ‘basis, corporate governance has to be proactive against risks that are related
to fraud. In the same context, management should be ready to identify the risks that are related with a
high possibility of fraud, by taking actions like the following (COSO, 2011):

• Identify the intrinsic risk of fraud — collect data that may relate to an organisation for the popula-
tion of fraud risks
• Assess the likelihood and the importance of an intrinsic fraud risk — the evaluation on historical
records, documented fraud processes and interviews with staff and business process owners. The
evaluation of the relative likelihood and the potentiality of identified fraud risks.
• Respond to substantial inherent and latent fraud threats
• Carry out an examination of the cost-benefit to assess the answer to the defined threats.

The management of fraud risk follows a similar direction to the wider organization risk manage-
ment process: firstly, management needs to establish a comprehensive structure for assessing individual
risk of fraud, monitoring and Board approval. This assessment also starts with the creation of a list of
potential fraud schemes based on different sources – past experience, regularly recorded or public fraud
operations, surveys, interviews, etc. While this approach itself can provide a fair representation of the
probability of organizational fraud, it does not take into account the fact that fraud does not occur in
a vacuum. Fraud is not a natural phenomenon. A variety of conditions or occurrences are a cause for
fraud. The same influences also can alter the current risk of fraud by altering how fraud is carried out or
by raising or diminishing its probability or effect. The additional analysis of the driving factors of fraud
risk is therefore far more likely to put the organization, instead of merely responding to fraud, ahead of
the curve. Therefore, drivers of fraud are identified:

• Strategy
• People (attitudes, morale, etc.)-Technology
• Internal environment (corporate culture, change in management, etc.)

Economic conditions

• Competition
• Regulation and enforcement Climate Compliance:
• Ability of companies to overcome frauds ·

The answer to the question what are the factors that enhance the possibility of a corporate fraud can
vary from organization to organization. Thinking about the drivers of risks of fraud is much more likely
than confined to the list of risks of fraud, to involve the board of directors thoroughly and build a valu-
able conversation. Members of the Board of Directors and other interested parties and shareholders shall
raise questions. It is also critical to decide how have emerging innovations been used by the company
in the activities related to tackling emerging fraud threats or improvements in existing risk of fraud.
Another question in relation to changes that are likely to result from a new strategic plan, identify
what new fraud threats have been identified. These are the kind of problems that the Board is, ideally,

52

Fraud Governance and Good Practices Against Fraud

already facing reasonable extensions of discussions. They provide the framework required to recognise
potential ways for fraud to occur (Kummer et al, 2015). Taking this into account, which in an enterprise
leads to fraud risk assessment and the subsequent creation of risk reduction strategies eventually leads
to a considerably better risk assessment.
In their findings (Tazilah & Hussain,2015) assert that small and medium-sized enterprises should
be able to maintain a core internal control system in order to monitor risk of fraud, especially for moni-
toring and maintaining their activities, through an independent department, such as the department of
internal affairs control. Finally, they suggest that small and medium-sized enterprises should outsource
partners the responsibilities of the internal control department, as this option (outsourcing) may have
lower costs and greater reliability, since the External assignment companies have more experience in
design of internal control systems for small and medium-sized enterprises with particular characteristics.
Among the activities of internal auditors is the prevention of fraud(Flesher, 1996). The internal control
system has appropriate controllers and Mechanisms and internal safety valves to be treated in a timely
manner any risks that may arise. The security valves of internal control work in the following ways:
Organizational: related to the basic organization of activities and related to the company’s regula-
tions and objectives.

• Preventive: related to highlighting errors in procedures.

• Depressants: related to the intervention for cases of deviations from the normal operation of the
business.

Internal audit is one of the two main instruments of the internal system of control in order to prevent
fraud, and internal auditing is the other instrument (Mustafa and Meier, 2006). However, in 1992, the
Cadbury Committee acknowledged an efficient system of internal control in ensuring effective corporate
governance. In its report CFACG (1992) notes that an efficient system of internal control is an integral
part of an efficient company management. “However, it recommended that the managers’ report on the
efficacy of their company’s own internal control scheme in the annual report of their business, while the
auditors will report on the statements of the managers (Harrast and Mason, 2007).
Tunji (2013) researched the role of the internal control system’s existence and effectiveness on fraud
removal and the accuracy and trustworthiness of bank accounts. The study found that the only benefi-
cial effect on fraud reduction is the presence of an efficient internal network. An important relationship
between screening for fraud and auditing of financial reports is found by Josiah, Adediran, and Akpeti
(2012). There has been a shortage of supervision, an ineffective internal auditors, and an inadequate
monitoring structure in the organizations studied. The Wan, Wan, & Roshayani (2014) research indicates
a major adverse repercussion on the probability of fraudulent financial statements on the internal audit
effectiveness. These results show that the internal audit function has strengthened the roles of the internal
audit system to strengthen their position and responsibility for the efficiency of governance
One primary regulation that is effective in deterring fraud and corruption is a transparent and reliable
disciplinary framework. Management will send both internal and external stakeholders a message by
implementing concrete penalties that fraud prevention and malpractice risk management are a priority for
the company. Suitable training under leading regulatory and assessment systems will also be a prerequisite.
Organizations should do their utmost to build a well-conceived disciplinary structure and communi-
cate to staff, through corporate standards that promote (Ebaid, 2011):

53

Fraud Governance and Good Practices Against Fraud

• gradually punish the severity and seriousness of an offense (e.g. verbal warning, written alarm,
dismissal, pay reduction, relocation, deterioration or termination), and
• regularly and reliably apply.

Another significant factor is the keeping managers accountable for their subordinates’ abuse. In those
situations where managers knew or should have known about fraud and corruption, or where:

• guided or coerced others to violate expectations of organizations to achieve business objectives or

set unrealistic goals which had the same impact
• ensure adequate training or resources for employees.

Another practice that can be used in order to mitigate fraud is delegation of authority. A ‘Delegation
of Authority’ policy is defined, specifying the limitations for the authority that are assigned for certain
positions of responsibility within the company and identifying types and maximum amounts of liability
which can be accepted by individuals and the title.
The realistic and seamless communication and training of the staff of their responsibilities to mini-
mize the risks of fraud and abuse (Ebaid, 2011). Although other organizations, using a one-size-fit-all
approach or engaging on these topics, these attempts do not inform the workers or give them a strong
message to the effect that their controls must be taken seriously.
Management should consider designing, in drawing up a detailed training and communications
program, fraud and misunderstanding initiatives based on the results of the evaluation of fraud and
misconduct risk in order to deal with (Wells, 2011):

• customized to the needs of individual tasks

• incorporated in other training initiatives, as far as possible
• Successful, in various settings, with multiple applications.

A very important factor in eliminating risk of fraud, is culture within the organizations. Corporate
culture has undoubtedly a significant role to play in defining and directing the actions of organizational
shareholders The Center for Audit Control (2010) affirms that market culture impacts all three sides of
the fraud triangle in their study on fraud prevention and detection. A strong ethical culture generates an
understanding of doing what is right, thereby growing the tendency to rationalize fraud. It also facilitates
efficient monitoring and decreases fraud opportunities, improving the likelihood that fraud is detected
quickly and decreases motivation and incentives to fraud. Culture involves the convictions and values,
behaviours and comportments expressed in and through the operations of an organization. This reveals
what an organization stands for and how it is perceived both internally and externally. Corporate culture
is the individual and common beliefs of an organization, principles, actions, the way things are done, and
formal and informal rules (Bouwman, 2013). Visible and unseen, official and informal corporate cultures
are evident (Weiss, 2009). Culture also expresses itself informally through remarks, actions and behaviour
of the top management in particular. KPMG International (2017) also states that organizational culture is
not a norm ... but an undeclared law guiding thousands of decision taking in the organization every day
(p.4). Culture can serve as an solution to many organizational problems and have a significant effect on
how an company works (Warrick 2017). That is to say, the development of a good corporate culture will
achieve sustainable culture. The strong cultures are based, according to Chatman and Cha (2003, on the

54

Fraud Governance and Good Practices Against Fraud

following two characteristics, a high employee awareness of the principles and high strength. When both
are high, there is a strong culture; when both are weak, there is no strong culture at all. Graham, Haven,
Popadak, and Rajgopal (2015) have revealed that a good organizational culture has a greater effect than
policy on the effects of improved efficiency, minimizing the costs of the business, encouraging workers
to take clear decisions in times of difficulty. They added that innovation, efficiency, valuation of the
business and profitability are affected. A good corporate culture has been the cause of the achievement
of Google (Schmidt & Rosenberg, 2014; Edwards, 2012). Furthermore, business culture in several re-
spects has been conceptualised. Graham et al. (2015) categorized corporate culture into seven key types:
complex and violent, entrepreneurial (down and centralized), hierarchical, collaborative (corporate and
participatory), results focused (performance-led, customer oriented), integrity high (consistency-driven
and reliable), transformative (strongly-growing) and dysfunctional (non-functional) Through their or-
ganizational strategies, managers can build and maintain a healthy company culture. Corporate culture
may thus serve as mighty domestic codes of behaviour and identification (Wells,2011).
In cases where management doesn’t seem to care about or reward appropriate behaviour, and there
is a lack of appreciation of proper jobs and perceived disparities and prejudice as favouritism, nepotism,
sexism and so forth, the amount of moral or loyal workers decreases and the business is harmed by the
use of skilled fraud. Moreover, autocratic management, concern that subordinates would report incor-
rect news, poor performance evaluation, poor education and incentives for advancement, unequal and
ambiguous organizational roles and poor internal communication practices may promote a poor and
weak corporate culture (Association of Accredited Fraud Examiners, 2011; Jennings, 2006).
The Association of Certified Fraud Examinators (2011) reports that employees are likely to commit
fraud if senior management fails to follow and maintain high ethical standards. Employees track their
leaders’ actions closely and notify their behaviour. The Association of Accredited Fraud Examiners
(2016) also recommends four crucial steps to be taken by top management: communicating employee
expectations and instances, establishing secure reporting channels for culprits and recompensing cred-
ibility. In other words, a high ethics culture developed within an organization by management practices
and principles will discourage workers from unethical behaviour. Stein (201) states that “the best strate-
gies to incorporate and improve culture are (1) those that leaders are concentrating their attention on,
interventions and controls; (2) leaders respond on critical incidents and organizational crises; active
leadership role modelling, teaching and coaching; However, in order to achieve genuineness and hit
the “heart” of workers, these techniques have to go beyond verbal instructions. The saying “lead by
example “applies here and management decisions and actions are continuously measured by workers
as key examples of what is technically acceptable and inappropriate in the company. We are watching
how leaders are committed to what we say in their speech and everyday actions. There is also no moral
strength to discourage corporate fraud when top management do not set worthy examples.

CONCLUSION

To sum up in order to eliminate the risk of a fraud, several actions have to be taken into account. A
fraud risk management strategy should be developed as part of an organisation’s governance process,
including written policy to communicate the Board of Directors and senior management priorities with
regard to the management of fraud risk.

55

Fraud Governance and Good Practices Against Fraud

The potential perception of fraud will be measured periodically by the company to identify these pos-
sible approaches and events that can be mitigated by the enterprise. To order to reduce possible impacts
on the organization, plans should also be built to prevent future key fraud risk events. In the event of
failure or risk-free avoidance, detection techniques should be structured to disclosure fraud. To order to
gain possible input on fraud and to ensure that a comprehensive investigation and response plan ensures
that suspected fraud is dealt with correctly and promptly, there should be a notification process developed.
In order to recognise these future strategies and incidents to be mitigated by the company. Fraud
risk exposure should be assessed annually by the organisation. In addition Strategies will be developed
for the avoidance of future core fraud risk incidents to minimize potential impacts on the organization,
as feasible. Further, Identification strategies should be built to expose fraud in the event of a malfunc-
tion or risk-free prevention. To end up with a notification mechanism should be developed in order for
potential fraud feedback to be obtained and a systematic investigation and response strategy should be
used to ensure that potential fraud is properly and promptly handled.
Effective frameworks for the prevention of fraud will greatly assist in organisation, in which regard
regulatory agencies and policymakers in the various economic sectors should think as a priority of creating
robust new corporate governance codes, and productive frameworks for the prevention of fraud (Board
of directors, Audit Committee and External Auditor). This process should be supported by through the
reporting and tracking activities of the entity’s overall risk (Dittenhofer, 2001). Policy formulation to
improve transparency should be focused also in the processes. Furthermore, the new codes of corporate
governance must also have legal protection in country law so that any form of violation of the law can
be properly dealt with by the prosecution of fraud offenders in organizations and by the penalty of act-
ing as a deterrent auditing duties under the corporate governance code, which has to be standard for all
the organizations.
In order to highlight the significance of successful corporate governance processes in the prevention
of the impact of fraud, internal audit, seems to have a significant role since external audits can be con-
sidered vital governance structures of considerable advantages which, if there is a strong desire to deter
fraud, should be strengthened in an organization. The conclusion of the paper is not cast iron as some
recorded cases of fraud in organizations, while others include members of the audit committee, internal
and external auditors are committed by directors. The paper highlights that these corporate governance
elements analysed in an optimal situation would potentially lead to reducing the scam.

REFERENCES

Association of Certified Fraud Examiners. (2016). Report to the nations on occupational fraud and
abuse. Global Fraud Study. https://www.acfe.com/rttn2016/docs/2016-report-to-the-nations.pdf
Baucus, M. S., & Near, J.P. (1991). Can Illegal Corporate Behavior be Predicted? An Event History
Analysis. Academy of Management Journal, 34, 9–36.
Bebchuk, L., & Weisbach, M. (2009). The state of corporate governance research. Review of Financial
Studies, 23(3), 939–961. doi:10.1093/rfs/hhp121
Brickley, J. A., & Zimmerman, J. L. (2010). Corporate governance myths: Comments on Armstrong, Guay,
and Weber. Journal of Accounting and Economics, 50(2–3), 235–245. doi:10.1016/j.jacceco.2010.10.002

56

Fraud Governance and Good Practices Against Fraud

Committee of Sponsoring Organizations of the Treadway Commission (COSO). (2011). Internal control-
integrated framework. Coopers and Lybrand.
Dittenhofer, M. (2001). Internal Auditing Effectiveness: An Expansion of Present Methods. Managerial
Auditing Journal, 16(8), 443-445.
Ebaid, I. E. (2011). Internal audit function: An exploratory study from Egyptian listed firms. International
Journal of Law and Management, 53(2), 108–128. doi:10.1108/17542431111119397
Edwards, D. (2012). I’m feeling lucky: The confessions of Google’s employee number 59. Mariner Books.
Fombrun, C. J. (1983). Corporate culture, environment, and strategy. Human Resource Management,
22(1–2), 139–152. doi:10.1002/hrm.3930220118
Graham, J. R., Harvey, C. R., Popadak, J., & Rajgopal, S. (2015). Corporate culture: Evidence from the
field. Available at Retrieved from www.newyorkfed.org
Harrast, S. A., & Mason, O. (2007). Can Audit Committee Prevent Management Fraud? The Accounting
Journal., 77(1), 24–28.
Healy, P., & Serafeim, G. (2012). Causes and Consequences of firms’ self-reported anticorruption ef-
forts. Harvard Business School. doi:10.2139srn.2229039
Jennings, M. M. (2006). The Seven Signs of Ethical Collapse: How to Spot Moral Meltdowns in Com-
panies... Before It’s Too Late. St. Martin’s Press.
Kummer, T., Singh, K., & Best, P. (2015). The effectiveness of fraud detection instruments in not-for-
profit organizations. Managerial Auditing Journal, 30(4/5), 435–455. doi:10.1108/MAJ-08-2014-1083
Mustafa, S. T., & Meier, H.H. (2006). Audit Committees and Misappropriation of Assets: Publicly Held
Companies in the United States. Canadian Accounting Perspectives, 5(2), 307-333.
Stein, M. J. (2008). Beyond the boardroom: Governmental perspectives on corporate governance. Ac-
counting, Auditing & Accountability Journal, 21(7), 1001–1025. doi:10.1108/09513570810907456
Tunji, S. T. (2013). Effective internal controls system as antidote for distress in the banking industry in
Nigeria. Journal of Economics and International BusinessResearch, 1(5), 106–121.
Wan, A. A., Wan, M. R., & Roshayani, A. (2014). Disclosure of corporate governance structure and the
likelihood of fraudulent financial reporting. Procedia: Social and Behavioral Sciences, 145, 243–253.
doi:10.1016/j.sbspro.2014.06.032
Warrick, D. D. (2017). What leaders need to know about organizational culture. Business Horizons,
60(3), 395–404. doi:10.1016/j.bushor.2017.01.011

57
58

Chapter 5
Theoretical Analysis of
Creative Accounting:
Fraud in Financial Statements

Christianna Chimonaki
University of Portsmouth, UK

ABSTRACT
This chapter begins with the definitions of creative accounting, fraud and financial statement fraud and
explains the relationship between them. Next, it presents the classical theories on the determinants of
financial statement fraud. Section 1.4 presents the profile of accounting scandals. Section 1.5 presents the
components of financial report fraud as well as the parties involved in in creative accounting. Section 1.6
presents the reasons and motivations for creative accounting. Specifically, the authors analyse manipu-
lation practices, the methods and the opportunities for creative accounting and address why financial
frauds occur. Finally, they offer conclusions in Section 1.7.

1.2 EXPLORING THE TERMS

1.2.1 Definition of Creative Accounting

While creative accounting is the widely used terminology, no agreement has been reached on its exact
definition. There is a widely used definition that was used by Mulfors and Comiskey, (2002) in the U.S.A.
with a quit smaller definition that was practiced in U.K. In the following table, the two representative
definitions of creative accounting have been presented.
United States meaning of creative accounting includes fraud which is omitted in U.K as it takes for
granted the use of accounting flexibility. This thesis adopts the definition of creative accounting of Jones
(2011). As Jones (2011) argued, “the flexibility in accounting opens the door for many different methods
of creative accounting”. Thus, it is perceived as legitimate accounting flexibility use in accordance with
the interests of the preparers, hence not illegal. Creative accounting utilizing firms are not violating the
law, as they use accounting flexibility to promote its interests.

DOI: 10.4018/978-1-7998-4805-9.ch005

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Theoretical Analysis of Creative Accounting

Table 1. Definitions of Creative Accounting

Year Definition Authors

Narrow Definitions of Creative Accounting
‘The exploitation of loopholes in financial regulation in order to gain advantage or
2005 Oxford Dictionary of English
present figures in a misleadingly favourable light.’
Wide Definition of Creative Accounting
‘Any and all steps used to play the financial numbers game, including the
aggressive choice and application of accounting principles, both within and
2002 beyond the boundaries of generally accepted accounting principles, and fraudulent Mulford andComiskey (2002)
financial reporting. Also included are steps taken toward earnings management
and income smoothing.’
Preferred Definition of Creative Accounting
‘Using the flexibility in accounting within the regulatory framework to manage
2011 the measurement and presentation of the accounts so that they give primacy to the Jones (2011)
interests of the preparers not the users.’

Creative accounting is formed by taking advantage of the ambiguities in the present regulatory system
to work towards the interest of the “preparers” and not that of the “users”. Economic reports of listed
firms in Europe are demanded to put forward account report fair and just. In many countries there is a
dominant belief that accounts must truly depict economic reality. The users are assumed to be provided
with a series of economic accounts that depict financial reality. On the contrary, creative accounting
favours the interests of the preparers (for instance, those of the managers). This is likely to happen be-
cause of the economic reports’ basic need to be adaptable so as to give a precise image of the accounts.
No creative accounting occurs with inflexibility, as one of the ultimate purposes of accounting is
to offer shareholders vital facts that ensure shareholders create economics related decisions regarding
shares. While regulatory structure varies in different countries, the framework sets is aimed at provid-
ing a true and fair view to shareholders. More so, elasticity offers managers with creative accounting.
While managers may not be breaking laws, they are deviating from basic ethics of accounting and may
be participating in fraud.

1.2.2 Definition of Fraud

The boundary between fraud and creative accounting is not always clear. Fraud is normally decided by
the courts or regulatory authorities. However, as previously stated, companies, uses creative accounting
whilst ending up getting involved in committing fraud. Thus, it is essential to define fraud and analyse
the difference between creative accounting and fraud. No definite definition of financial fraud exist,
therefore, the table presents some definitions of fraud.

1.2.3 Types of Fraud

While creative accounting was used within regulatory structure, fraud works outside regulatory framework.
In every country, fraud’s definition differs. However, it essentially comprises violation of the regula-
tory framework and/or breaking the law. Individuals or a management can be involved in committing
the act of fraud. In case of individuals, the accounting fraud would, in general, involve theft of’ assets,

59

Theoretical Analysis of Creative Accounting

Table 2. Definitions of Fraud

Year Definition Authors

“A false representation or concealment of material fact to induce
someone to part with something of value”.
Sawyer (1988).
1988 “A knowing misrepresentation of the truth or concealment of a
Black’s Law Dictionary, 7th edition
1999 material fact to induce another to act to his or her detriment.”
(1999)
2005 “Leading to the abuse of a profit organization’s system without
Phua, Lee, Smith andGayler (2005).
2006 necessarily leading to direct legal consequences”.
Wang, Liao, Tsai and Hung (2006).
“A deliberate act that is contrary to law, rule, or policy with intent
to obtain unauthorized financial benefit”.
Fraudulent Financial Reporting
“Fraud comprises both the use of deception to obtain an unjust
or illegal financial advantage and intentional misrepresentations
affecting the financial statements by one or more individuals among
management, employees, or third parties. Fraud may involve:
• Falsification or alteration of accounting records or other
documents
Auditing Standards Board, Statement
1995 • Misappropriation of assets or theft
of Auditing Standard, SAS 110 (1995)
• Suppression or omission of the effects of transactions from
records or documents
• Recording of transactions without substance
• Intentional misapplication of accounting policies
• Wilful misrepresentation of transactions or of an entity’s state of
affairs”
Preferred Definition of Fraudulent Financial Reporting
“The use of fictitious accounting transactions or those prohibited
by generally accepted accounting principles gives the presumption
2011 Jones (2011).
for fraud which becomes proved after an administrative or court
proceeding.”

such as, cash or inventory. On the other hand, in the case of management, it also includes the crime of
the preparation of financial statements that are intended to practise deception occurs. When suspicions
that fraud has occurred arise, we can name it as alleged fraud. However, we have a demonstrable instance
of fraud only when a court case is proven.
As a subset of fraud Jones (2011), two major types of financial report fraud exists; First, financial
report fraud when company utilizes accounting does without the permission regulatory framework’s,
hence fraud in a law court.
The second type of fraud that is major is the cases when transactions are invented. Therefore, existing
businesses are recorded in the form of fictitious sales or fictitious inventory. Fraud is material-based.
The average financial report fraud reported by the survey’s respondents was over U.S. $1 million
(ACFE, 2014). Financial statement fraud, such as the WorldCom and Enron frauds, can overstate income
by billions of U.S. dollars.
Several occupational frauds have been identified by the ACFE survey. The three primary occupational
frauds forms accounts for approximately 30% of the 1,483 cases analysed in the report.

• In 40.7% of the cases of check tampering and in 53.2% of the cases that involve expense reim-
bursements, the perpetrator’s engagement in a billing scheme was also noticed.

60

Theoretical Analysis of Creative Accounting

• In 75.9% of the cases of financial statement frauds, 80.2% of the cases related to cash-on-hand
misappropriations and 75.6% of cases associated with expense reimbursement schemes, at least
another occupational fraud was undertaken by the perpetrator.
• It appears that corruption is the most compatible with the other types of schemes, as it occurs
contemporaneously with 51.1% of the cases of financial statement fraud schemes occurring on
the high end and with 23.5% cases related to check tampering schemes occurring on the low end.

According to the Fraud Tree (occupational fraud and abuse classification system), the 3 classes of oc-
cupational fraud are; asset embezzlement, corruption and financial report fraud, each with subcategories.
Amongst the occupational fraud, misappropriation which is least costly with a median loss of U.S.
$130,000, is the most common, and accounts for over 85% of the cases analysed in the ACFE report.
However, financial statement fraud which causes the greatest financial effect with a median loss of U.S.
$1 million occurs much often and account for 9% of these cases. In both frequency and median loss,
corruption falls in the middle.

1.3 CLASSICAL THEORIES ON THE DETERMINANTS

OF FINANCIAL STATEMENT FRAUD

1.3.1 Fraud Triangle Theory

The three elements of FFS, is summarised in Figure 2 (Cressey, 1952). In the last few years, Donald R.
Cressey’s hypothesis (1919–1987), which tries to elucidate the conditions that generally occur when
a fraudulent activity takes place, has come to be popularly referred to fraud triangle (Figure 2), which
represent perceived pressure, opportunity and rationalization respectively. The element at the top of the
diagram refers to the motive or pressure of or on an individual to engage in the fraudulent act, whereas
the two elements present at the bottom of the triangle comprise supposed opportunity and rationalisation
(Wells, 2011,as cited in Rasha &Andrew, 2012). In the triangle of fraud, as shown in Figure 2, the two
factors interact with one another.
Rezaee (2002, pp 70–72) used a “3Cs” model comprising conditions, corporate structure and choices
to explain incentives, opportunities and rationalisations for FFS. In order to explain the conditions he
suggested FFS will take place if and when the profits to the person who commits the fraud offset the
associated costs estimated by means of possibility and the effects of detection and, from this point of
view, financial statement fraud will take place particularly in conditions of financial pressure that results
from an incessant worsening of earnings, a recession in organizational operation, a non-stop turn down
in industry function or a general financial recession.
In terms of opportunity, he considers the follow in “because financial statement fraud is typically
committed by the top management team level rather than lower management or employees, one would
expect incidences to occur most often in an environment characterized by irresponsible and ineffective
corporate governance. Management would be more reluctant to engage in financial statement fraud when
an effective corporate governance mechanism increases the probability of prevention and detection”.
According to the model Choice respected, the model demonstrates that when both environmental
pressure and corporate structure do not have a serious effect. Financial report fraud may be enhanced

61

Theoretical Analysis of Creative Accounting

Figure 1. Occupational fraud and abuse classification system (fraud tree)

Source: Wells (2005)

62

Theoretical Analysis of Creative Accounting

Figure 2. Fraud triangle

by cautions prompted by hostility, ethical code deficit or ill-advised inventiveness or originality by

management.

1.3.2 GONE Theory

GONE theory, is a classification method for fraud risk factors and is formed by four letters: ‘G’for
greed, ‘O’for opportunity, ‘N’for need and ‘E’for exposure (Bologna et al., 1993). The GONE theory is
primarily applied in studying asset misappropriation; however, the four risk factors are also applicable
in interpreting financial statement fraud, as indicated in Figure 3.

Figure 3. GONE theory

The main party in financial statement fraud is corporate management, whose ‘greed’ is directed
towards receiving high dividends or compensation or having opportunities to gain rationed shares and
additional shares, thereby indirectly achieving personal economic benefits. This greed transforms to a
‘need’ for financial statement fraud. Based on the advantages of daily management activities and internal

63

Theoretical Analysis of Creative Accounting

information, corporate management has the ‘opportunity’ to produce fraudulent financial reports. ‘Ex-
posure’ depends on the possibility of financial fraud being disclosed by external auditors and regulators.

1.3.3 Risk Factors of Corporate Governance

Jennings et al. (2006) and Duncan (2009) emphasised that corporate governance as the greatest cause
that affects occurrence of financial report fraud. Corporate governance is responsible for developing and
overseeing the ongoing mechanisms in a company. In addition, corporate governance is responsible for
eliminating the foundations of financial report fraud through palliating effects of incentive, prospect and
rationalisation. As a multi-faceted concept which includes narrow and broad definitions, a narrow defini-
tion of corporate governance was provided by Williamson (1975). Williamson (1975) emphasised on the
need for setting up a governance structure, which includes general meetings of stockholders, executives,
regulatory boards and top management to govern corporations. In addition, Jensen and Meckling (1976)
stated that corporate governance should focus on the link between owners and managers of companies
to make their benefits consistent. Fama and Jensen (1983) observed that corporate governance should
resolve the primary agent challenge caused by separation of ownership and management aimed at re-
ducing agency cost.
Abroad definition of corporate governance was put forward by Brenner and Cochran (1990),which
incorporates stakeholder theory, that is, the idea that corporate governance should bear the shareholders
interest in mind, including that of stockholders, creditors, suppliers, employees, the government and the
society. Moreover, Qian (1995) argued corporate governance is a structure of arrangement that used to
manage relationship among investors, the management and employees. Finally, Li (2001) argued that broad
corporate governance is a system that includes formal and informal and internal and external governance
and comprises a relationship to balance the benefits between the companies and their related parties.

1.3.4 Principal–agent Theory

Agency relationship which is formed when one or more persons employs another authority to the agent,
encompasses a contract existing between manager and owner (Jensen and Meckling, 1976). While the
agent is held accountable for the owners’ benefits; the managers also have interests in exploiting their
own welfare (Ujiyanto and Pramuka, 2007). Therefore, clash of interest often occurs between owner and
agent which can affect quality of reported earnings. Asymmetric sharing of information with the owner
as a means of earnings management is financial report fraud, which agrees with the findings of Rezaee
(2002), who stated that management of earnings are closely associated with financial report fraud. There-
fore, unnoticed by the owner, they may develop into FFS that are misleading. Hence, misleading and
detrimental as it is, agency challenges associated with owner and agent can lead to financial report fraud.

1.4 ACCOUNTING SCANDALS

1.4.1 Profile of Creative Accounting in Greece

In the light of the classical theories of financial report fraud determinants, it is observed that Greece
and many other countries have suffered due to many accounting scandals. As a consequence of such

64

Theoretical Analysis of Creative Accounting

economic scandals, many firms have gone bankrupt. The history of Greek accounting scandals started
when Greece joined the EU in 1981. Greece in the last two decades have accounted for the most ac-
counting and fraud scandals. EU membership ensures lower limit control with unlawful importation of
products such as cigarettes, food, alcohol and petrol (Kourakis, 2001). These cases involved a financial
company (ETBA Bank), an accounting software company (Ipirotiki Software & Publications SA), an
underwear clothing company (Sex Form SA), health club chain (Dynamic Life) and Bank of Crete related
scandal; verdict has already been reached by the Capital Market Commission. Spathis (2002,p. 179)
stated the following: “in Greece, the issue of false financial statements has lately been brought more
into the limelight in connection primarily with: a) the increase in the number of companies listed on the
Athens Stock Exchange and b) the raising of capital through public offering and attempts to reduce the
level of taxation on profits”.

1.4.2 Profile of Creative Accounting in International Scandals

The Austrian economist Joseph Schumpeter argued that economic activity occurs in the following four
stages: expansion, crisis, recession and recovery. According to Schumpeter, the stage of the crisis may
continue for two to eleven years. When we say that the economy is at a stage of crisis, this means that
the public and private investments are reduced, which implies a dramatic increase in unemployment,
decline in purchasing power, drop in market value of many businesses and an increase in mergers and
acquisitions. The level of public and private investments mainly influences the macroeconomic data.
The recent global financial crisis began in the U.S. banks that issued subordinated loans. These
loans impacted large financial groups and created risks that reduced the confidence of both investors
and depositors. Furthermore, this crisis affected the profitability and the liquidity of many companies,
leading many to bankruptcy. Several of these companies, in their effort to survive, used legal or illegal
accounting methods to smooth their earnings. The result comprised a falsification of their financial
statements by using creative or fraudulent accounting.
Although it is an old fact, the quantity of corporate earnings restatement which are connected to ac-
counting fraud, accounting abnormalities or violent accounting methods has greatly augmented during
the last few years. Furthermore, analysts, investors and regulators have paid much attention to it.
In the last few years, the amount of corporate earnings recurrences associated with accounting fraud,
irregularities or practices has significantly increased and has drawn more attention from investors, ana-
lysts and managers.
Arthur Levitt advocated for the improvement of the quality of reported earnings in 1999 that extreme
management of earnings concealed the basic firm’s performance. Government increased strict interven-
tions and regulations after the occurrence of numerous notorious accounting frauds and scandals. To
ensure precision and consistency of corporate financial reporting, U.S Congress in 2002 enacted the
Sarbanes-Oxley Act. Although most of these scandal varied form those observed in the U.S. Financial
scandals has also being experienced in Europe, with the most notorious being the Parmalat scandal dur-
ing the same period. The two characteristics frauds; High leverage and management fraud were more
common in many of the cases that had been investigated in Europe over the past 25 years.
While accounting issues shows significance in many Europe business disasters which is however sig-
nificantly less compared to that in the U.S. following increased accounting fraud (e.g. Enron, WorldCom
and Adelphia), what Levitt has stated sounds prophetic. Great government interference and regulations
came after these cases of fraud. U.S Congress in 2002 enacted the Sarbanes-Oxley Act to ameliorate

65

Theoretical Analysis of Creative Accounting

precision & consistency of business economic reporting and leaks. Several economic scandals also took
place in Europe at that same time (e.g. the Parmalat, which was the most infamous of all), although the
majority of them were varied in a great deal from the ones in the U.S. In trying to find out the causes
that shows significance led to Europe’s greatest business breakdowns that took place in the last 25 years,
researchers found out that excessive control and fraud in administration were the two features common
in many of these incidents that had been examined. Nevertheless, the writers drew the conclusion that
even though accounting matters were discovered to be vital in a lot of business failures in their research,
the number was less important when compared to the great U.S. business breakdowns.
During the years there are many e accounting scandals in Germany, Italy, Spain, U.S., UK, Neth-
erlands, Sweden, Greece, Australia, China, Japan and India. Most of these accounting scandals were
presented in the study conducted by Jones (2011). In most of these cases, these accounting scandals led
to wider corporate failure outcomes.

1.5 COMPONENTS OF FINANCIAL STATEMENT FRAUD

1.5.1 Parties Related to Creative Accounting

There are many parties that are interested in the subject of financial statement fraud. These parties
comprise managers, shareholders, auditors, merchant banks e.t.c. These parties have an important role
in fraud and creative accounting. The legal authorities are interested when creative accounting turns
into fraud. The corporate environment and the economic conditions of a firm play a vital role in fraud
associated with creative accounting. For instance, Crutchley, Jensen and Marshall (2007) found rapid
growth, high earnings, reduced outsider in the audit committee & outsider director smoothing can lead
to an accounting scandal. In addition, the economic conditions and the personal ambitions of the man-
agers are important contributory aspects of FFS. Accounting flexibility permits managers utilization of
creative accounting. Jones (2011) described exactly how creative accounting operates in an economic
environment as follows: Although complying with the law and transgressing its spirit, the idea for the
use of creative accounting by managers may be from merchant banks. Regulators seek out regulate and
limit creative accounting by setting rules and regulations. Using supervisory structure as reference point,
auditors drive to ensure true and fair accounts. While managers are the causes, shareholders experienced
the consequences of creative accounting. Share analysts seek to adjust the accounts for creative account-
ing by efficiently pricing stock. Shareholders are the major losses if the firm goes bankrupt. Creative
accounting has also caused bankers and creditors to worry, because it conceals poor results.
Thus, to minimise fraud from creative accounting, efficient internal control, good corporate gover-
nance and creation of autonomous audit committee are required.

1.5.2 Managers

In theory, managers carry out the administration of the firms that are owned by shareholders. Thus, it
should be the interest of managers to satisfy shareholders. However, in practice, managerial self-interest
may dictate the use of the flexibility within the accounting system to carry out fraud and creative ac-
counting. Managers could use fraud and creative accounting either to raise or reduce profit or liability.
Their motivations vary. For instance, a manager’s salary maybe dependent on an increase in profit. In

66

Theoretical Analysis of Creative Accounting

addition, if managers want to meet market hope of profit, there are many possibilities to manipulate
profits by using creative accounting and fraud. One more reason for the managers to use the accounting
techniques to manipulate accounts is when they want to avail a bank loan.
Generally, it is difficult for outsiders to detect creative accounting and fraud. Jones (2011) included
an example that explains in detail the manipulation in accounts as follows: “A company is operating a
fleet of lorries and each lorry will do 100 000 miles in its working life. Currently, each lorry’s estimated
annual mileage is 20 000 miles. Each lorry costs £50 000 and, therefore, £10 000 is written off each
lorry each year in depreciation. If the managers think that next year the lorry will do 10 000 miles, then
depreciation will fall to £5000 per year. Profit will increase by £5000. This is true and fair and reflects
economic reality. It is not creative accounting. However, there may be pressures on managers to interpret
the amount of miles the Lorries will do generously, so as to reduce profit. So, this is creative account-
ing”.In this example, it is not possible for outsiders to know the truth.

1.5.3 Investment Analysts

Investment analysts investigate the accounts of firms to suggest investors whether stocks and shares are
priced efficiently. Thus, investment analysts should have the ability to detect creative accounting. The
literature includes some examples in which the investment analysts failed to perceive fraud and creative
accounting. For instance: “Gwilliam and Russell (1991) showed that in 1989 analysts failed to spot that
Polly Peck’s earnings were overstated or that the company was losing huge amounts on its overseas
borrowings. Indeed, only days before one of the most spectacular collapses in British corporate history,
analysts were predicting a substantial increase in profits. In another example, Breton and Taffler (2001)
presented analysts with a set of doctored accounts. They used nine creative accounting techniques
across different accounting areas, for example, deferred taxation, pensions, off-balance sheet financing
and hidden interest charges. Very few analysts actually adjusted, or even detected, any of the creative
accounting practices that were used”.
In general, investment experts must be autonomous observers of the firms. However, in real time,
this is not the case. The main reason is that investment analysts work for merchant banks that have the
firms as their clients, making it difficult for them to accuse their clients.

1.5.4 Regulators

Regulators control creative accounting and fraud by designing counting rules and regulations that ensures
flexibility for fair and true view in order not to demean the currency of accounting. With the national and
international regulatory frameworks developed over the years, new rules and regulations are introduced
to cob accounting scandals.
Regulators work against creative accounting. In most countries, accounting regulations often com-
prises of companies’ acts, government regulations, accounting standards and SEC regulations, while
the IASB sets the international accounting standards (IAS) at the international level. Therefore, to allow
for expression of fair and true view, the essential principles for financial report should conform to the
economy. Observed main difficulty for regulators is that, flexibility in the accounts for delivering a fair
and true view is same features employed by creative accountants.

67

Theoretical Analysis of Creative Accounting

1.5.5 Auditors

Watts and Zimmerman (1990) argued that inspecting financial report assists in reducing irregularity
in sharing of information and protects shareholders’ interests by facilitating rational assurance that the
financial report are devoid of misstatement. Nevertheless, in reality, detection of fraud by management
is challenging using normal audit procedures due to dearth of knowledge associated with management
fraud’s features and lack of experience by most auditors required to detect it, while managers at one end
deliberately tries to deceive examiners.
Fraud and creative accounting are the major challenge for auditors when checking accounts presenta-
tion for fair result. One challenging issue is the dependence of auditors on their clients. This situation
is complicated, as most audit firms are private. Thus, they are concerned with their reputation and their
profits. Auditors fear both creative accounting and fraud, both of which are difficult to detect. Auditors
have a great responsibility towards what they can determine about the state of the financial statements.
Jones (2011) included some examples in which the auditors could not see that the results were manipulated
as follows: A British auditor (Stoy Hayward) was asked to pay a £75,000 fine and £25,000 in cost when
Poly Peck collapse (Perry, 2002).In extreme conditions, collapse of firm being audited can occur. Arthur
Andersen experienced similar in USA, when one of the auditors was destroying implicating evidence.

1.5.6 Shareholders

External shareholders are probably the victims of creative accounting and fraud. Shareholders cannot
trust anybody, as nobody protects them. If managers manipulate the accounts and the investment ana-
lysts and the auditors do not detect the manipulation, shareholder can loss their investments or engage
in investing in a sub-optimal way.
Jones (2011) included some cases such as those observed in Enron, City of Glasgow Bank in which
the shareholders lost their money. These lead inverters to go bankrupt which was also contributed by
lack of information by outside shareholders on the state of the company.

1.5.7 Merchant Banks

The role of merchant banks is complicated. Several times managers and accountants ask merchant banks
to consult them about creative accounting and fraud. What follows is a typical example of the role of
merchant banks: as far as the Enron scandal is concerned, for instance, there has been a lot of thought on
the role of banks in settling complex deals in order to establish balance sheet financing systems Merchant
banks perform complex roles amidst providing advice on creative accounting and fraud to managers and
accountants. Using the Enron scandal as a case study, questions concerning bank involvement in making
complex deals to balance their sheet were raised, which was especially strong in the U.S senate. The
U.S. Senate Permanent Subcommittee on Investigations provided ‘document showing banks and foreign
firms syphoned billions of dollars setting up and running secrete off shore shell companies (Iwata, 2002).
In return for consideration for many other transactions, these financial institutions which where aware
of Enron questionable accounting actively aided Enron. In their defence, however, the banks representa-
tives stated that their accounting transactions were perfectly appropriate as they had followed GAAP
but deceived by Enron. In effect, corporate advisors compromised ethics for fees and other business

68

Theoretical Analysis of Creative Accounting

considerations. More so, merchant bankers are a major beneficiaries of creative accounting, as they are
can plan and market creative accounting schemes.

1.5.8 Other Users

The examples of other users are bankers, suppliers, employees and other stakeholders, such as trade
unions and the government tax authorities. These users depend on a firm’s economic performance. Bank-
ers prefer consulting a healthy balance sheet to judge whether they should give a loan to a firm or not.
Therefore, the suppliers want to know these loans will be repaid, and the employees require job security.

1.6 REASONS: MOTIVATIONS FOR CREATIVE ACCOUNTING

1.6.1 Manipulation Practices

Stolowy and Breton (2003) attempted to identify a hypothetical structure for the accounting manipulations
as follows: “The fundamental principle which their theoretical framework is based on is the following:
the aim of publishing financial information is to reduce the costs of the enterprise projects financing.
But this reduction depends on the risks to transfer the riches as they are perceived by the agents on the
market. The practical means to operate these transfers are based on the results and the balance between
the debts and share capital”.
Changes in two ratios are the purpose of accounting data management. Deviation of per share result
(first ratio) and connection between the assets and liabilities (second ratio). The first ratio could be
altered by subtracting or adding some specific expenses or result profits used as computational base
for per share results. The second ratio could be altered by raising benefits or concealing some financial
deals from the balance sheet.

1.6.2 Methods: Opportunities for Creative Accounting

Jones (2011) stated that fraud and creative accounting results from account flexibility that allows for
accounting policies to be altered in order to change the reported accounting figures.
There are four main financial reports companies is obligated to file: account of profit and loss, fi-
nancial situation of a firm, report of equity change and report of cash flow; which can be used for fraud
and creative accounting.
The purpose of income report is to inflate profit by increasing income and reducing expenses and
vice versa. The purpose of balance sheet report is to increase a firm’s net income while cash flow report
aim to increase functional money flow at the detriment of other money flow.
The boundary between fraud and creative accounting is unclear.
In addition, Jones (2011) stated that the purpose of the first two approaches increases the profit in the
income report via increasing sales or decreasing expenses. The third and fourth approach boosts assets
and reducing liability. The fifth approach aims to increase the flow of money via increasing functional
flow of money.

69

Theoretical Analysis of Creative Accounting

1.6.3 Why Does Financial Statement Fraud Occur?

Motivations for Creative Accounting

In a perfect world where enterprises have maximum profit, minimum expenses, high share prices and
high bonuses, there is no motivation for creative accounting. However, in the real world, there are many
motivations for fraud and creative accounting. In general, main methods fraud and creative accounting
are maximising reported sales and reported profits, increasing assets and decreasing the liabilities that
not necessary simultaneously. The levelling of income effects is prominent due to increased level of
requirements that accumulates in countries with highly conservative accounting systems (Amat et al.,
2003). A firm making a loss will minimizes its reported loss in the present year for subsequent years to
appear better, a phenomenon called “big bath” accounting.
Jones (2011) stated that the incentives for fraud are the same as that for creative accounting. The
difference between fraud and creative accounting is that the enticements for fraud are greed, gambling
and lifestyle. Studies such as those conducted by DeAngelo (1988), Healy and Whalen (1999), Beneish
(2001) and Brennan & McGrath (2007) and many others analyse the incentives for fraud and creative
accounting and summarise the following factors as being major motivations:

• To meet internal targets or personal incentives

To meet targets by senior executives regarding share prices, sales and profits, managers dishonestly
want to alter figures or facts thus protecting and increasing their salaries, job security and personal
satisfaction from which they benefit directly. New U.S. bank managers show off the quality of their
proficiency by emphasising the poor management conducted by the previous managers (Dahi (1996).

• To meet external expectations or market incentives.

The motivations for this include three categories; Firs, company meeting various expectations from
its stakeholders; and for personal interests, employees and customers requires a firms long term survival
while suppliers requires guarantee respecting long term connection with the company and payment.
Second, to impress shareholders to retain stable stock prices, enterprises want to provide income
smoothing. This approach favour remedial features against short term means of assessing an investment
on instant yields. It also avoids increase in the expectations to be met by the management.
Third, society expects managers to use creative accounting, as everybody is using creative accounting.
Thus, managers may feel that it is perfectly legitimate for them to do the same. Managers are expected
by the market to manipulate figures by recording outrageously increased earnings rather than taking
measures to increase earning following increase firm worth (Watts and Zimmerman, 1986). Thus, in
accordance with this argument, the society develops the idea of creative accounting.

• Special circumstances. This category has many different motivations, some of which include the
management of gearing and borrowing, taxation and an initial public offering (IPO).

This category has many different motivations, some of which include the management of gearing
and borrowing, taxation and an initial public offering (IPO).

70

Theoretical Analysis of Creative Accounting

An IPO window dressing or a loan is necessary as it can be done before corporate events. The ten-
dency of a firm to be near violation of debt agreements prompts them to formulate income-increasing
changes in their accounting policies (Sweeney, 1994). In addition, with many loans made available by
firms, it is difficult for them to borrow more and more as debt providers are concerned with their funds
recovering. Thus, a firm faces penalty if they do not abide by the debt covenants. This encourages the
use of balance-sheet-based financial techniques to remove selected debt from the balance sheet, in order
not to breach any loan covenants. In addition, creative accounting could help boost the price of shares
by decreasing obvious level or borrowing with good profit trend appearance.
Desire for tax benefits can cause creative accounting and fraud (Niskanen and Keloharju, 2000;
Herrmann and Inoue, 1996).
Another motivation for creative accounting and fraud exists when firms decide to enter the stock
market. Stock markets have rules for firms that wish to register. Thus, this may provide firms to use
creative accounting to maximise the reported sales and profits statement them to issue an ideal number
of shares. We summarise the most important benefits for firms by using creative accounting and fraud,
as demonstrated in Table 3.

Table 3. Rewards for managing profits and financial position

Category Objectives and Benefits That Companies Are Trying to Achieve

Higher share price
Reduce share price volatility
Share-price effect Increase firm value
Lower cost of equity capital
Increased value of stock options
Improve credit rating
Borrowing cost effects Lower borrowing costs
Relaxed or less stringent financial covenants
Management performance evaluation effects Increased bonuses based on profits/ share price
Decreased regulations
Political cost effects
Avoidance of higher taxes
Source: Mulford and Comiskey, 2002

1.7 CONCLUSION

This chapter has provided a comprehensive literature review of the prior research conducted on fraud,
creative accounting and financial report fraud. We concluded that despite extensive research that has
been conducted in this field, the most important gap in the literature focusses on new ideas to interpret
the incidence of financial report fraud. This chapter considered the causes of financial report fraud
from subjective, objective and conditional aspects. With respect to the subjective aspect, we argued that
bounded rationality of senior management creates subjective motivations, limited perception and knowl-
edge and an environment, which may result in them committing financial fraud. Accounting information,
as the objective cause of financial statement fraud, has economic characteristics. It provides no direct
utility to the production of a firm, where assets value only increases through its ability to influence the
decision-making process of related parties with respect to resource allocation. The positive and negative

71

Theoretical Analysis of Creative Accounting

externalities of accounting information may affect the potential of whether financial statement fraud is
undertaken or not. Empirical analysis is presented in the next chapter.

REFERENCES

Amat, O., Perramon, J., & Oliveras, E. (2003). Earnings management in Spain. Some evidence from
companies quoted on the Spanish Stock Exchange. University Pompeu Fabra, Economics and Business
working paper No 677.
Auditing Standards Board. (1995). Statement of Auditing Standard, SAS 110 fraud and error. Author.
Beneish, M. D. (2001). The detection of earnings manipulation. Financ. Anal. J., 24–36.
Black’s Law Dictionary. (1999). (7th ed.). Academic Press.
Bologna, J., Lindquist, R. J., & Wells, J. T. (1993). The Accountant’s Handbook of Fraud and Com-
mercial Crime. Wiley.
Brennan, N. M., & McGrath, M. (2007). Financial statement fraud: Some lessons from US and European
case studies. Australian Accounting Review, 17(42), 49–61. doi:10.1111/j.1835-2561.2007.tb00443.x
Brenner, S. N., & Cochran, P. (1991, July). The stakeholder theory of the firm: Implications for business
and society theory and research. In Proceedings of the international association for business and society
(Vol. 2, pp. 897-933). 10.5840/iabsproc1991235
Breton, G., & Taffler, R. J. (2001). Accounting information and analyst stock recommendation deci-
sions: A content analysis approach. Accounting and Business Research, 31(2), 91–101. doi:10.1080/0
0014788.2001.9729604
Cressey, D. R. (1953). Other People’s Money. Montcl air. Patterson Smith.
Crutchley, C. E., Jensen, M. R., & Marshall, B. B. (2007). Climate for scandal: Corporate environments
that contribute to accounting fraud. Financial Review, 42(1), 53–73. doi:10.1111/j.1540-6288.2007.00161.x
Dahi, D. (1996). Management turnover and successor accounting discretion, bank loan loss provision
after resignation, retirement or death. Research in Accounting Regulation, 10(95), 110.
DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: The use
of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10(1),
3–36. doi:10.1016/0165-4101(88)90021-3
Duncan, S. M. (2009). The Empirics of Governance and Fraud. University of Pittsburgh Law Review.
University of Pittsburgh. School of Law, 70(3), 465–486.
Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. The Journal of Law & Eco-
nomics, 26(2), 301–325. doi:10.1086/467037
Gwilliam, D., & Russell, T. (1991, January). Polly Peck: Where were the analysts? Accountancy (Lon-
don), ▪▪▪, 25–26.

72

Theoretical Analysis of Creative Accounting

Healy, P. M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and
Economics, 7(1-3), 85–107. doi:10.1016/0165-4101(85)90029-1
Iwata, E. (2002, July 24). Banks face accusations in Enron case. USA Today.
Jennings, M. M., Pany, K. J., & Reckers, P. M. (2006). Strong corporate governance and audit firm
rotation: Effects on judges’ independence perceptions and litigation judgments. Accounting Horizons,
20(3), 253–270. doi:10.2308/acch.2006.20.3.253
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and
ownership structure. Journal of Financial Economics, 3(4), 305–360. doi:10.1016/0304-405X(76)90026-X
Jones, M. (2011). Introduction—Setting the Scene. Creative accounting, fraud and international ac-
counting scandals, 1-19.
Kourakis, N. (2001). Economic crime in Greece today. In Economic Crimes in Cyprus: A Multi disci-
plinary Approach (pp. 323–353). Sakkoulas Publishers. (in Greek)
Li, W. (2001). Corporate Governance. Nankai University Press Inc. (in Chinese)
Mulford, C. W., & Comiskey, E. E. (2011). The financial numbers game: detecting creative accounting
practices. John Wiley and Sons.
Niskanen, J., & Keloharju, M. (2000). Earnings cosmetics in a tax-driven accounting environment: Evidence
from Finnish public firms. European Accounting Review, 9(3), 443–452. doi:10.1080/09638180020017159
Oxford Concise English Dictionary. (1999). (10th ed.). OUP.
Phua, C., Lee, V., Smith, K., & Gayler, R. (2010). A comprehensive survey of data mining-based fraud
detection research. arXiv preprint arXiv:1009.6119
Qian, Y. (1995). Reform on the Chinese Corporate Governance Structure and Financing Structure. [in
Chinese]. Economic Research Journal, (1), 20–29.
Rasha, K., & Andrew, H. (2012). The New Fraud Triangle. Journal of Emerging Trends in Economics
and Management Science, 3(3).
Rezaee, Z. (2002). Financial statement fraud: prevention and detection. John Wiley and Sons.
Sawyer, L. (1988). Sawyer’s Internal Auditing. The Institute of Internal Auditors.
Spathis, C. T. (2002). Detecting false financial statements using published data: Some evidence from
Greece. Managerial Auditing Journal, 17(4), 179–191. doi:10.1108/02686900210424321
Stolowy, H., & Breton, G. (2003). Accounts Manipulation: A Literature Review and Proposed Concep-
tual Framework. Academic Press.
Sweeney, A. P. (1994). Debt-covenant violations and managers’ accounting responses. Journal of Ac-
counting and Economics, 17(3), 281–308. doi:10.1016/0165-4101(94)90030-2
Ujiyantho & Pramuka. (2007). Mekanisme Corporate Governance, Manajemen Laba dan Kinerja
Keuangan. Simposium Nasional Akuntansi X.

73

Theoretical Analysis of Creative Accounting

Wang, J. H., Liao, Y. L., Tsai, T. M., & Hung, G. (2006, October). Technology-based financial frauds in
Taiwan: issues and approaches. In Systems, Man and Cybernetics, 2006. SMC’06. IEEE International
Conference on (Vol. 2, pp. 1120-1124). IEEE. 10.1109/ICSMC.2006.384550
Watts, R. L., & Zimmerman, J. L. (1990). Positive accounting theory: A ten year perspective. The Ac-
counting Review, 131–156.
Wells, J. T. (2005). Principles of Fraud Examination. Wiley.

74
75

Chapter 6
Operational Risk Framework
and Fraud Management:
A Contemporary Approach

Elpida Tsitsiridi
Technical University of Crete, Greece

Christos Lemonakis
Hellenic Mediterranean University, Greece

Constantin Zopounidis
School of Production Engineering and Management, Technical University of Crete, Greece &
Audencia Business School, France

ABSTRACT
The universal financial shake of 2008 altered business and occupational circumstances and will inevita-
bly trigger the outbreak of new forms of operational risk. Under normal conditions, OR does not cause
significant losses; thus, severe damage is likely to occur when an operational miscarriage or an unex-
pected event takes place. Under the Basel III context, the banking sector is trying to increase safety and
stability, by focusing on the quality of historical loss data, while cultivating an inside operational risk
awareness culture. One of the most perilous types of OR is fraud, and its effects are often dangerous and
may have long-term spillovers. In this chapter, an analysis of the meaning and the main characteristics
of fraud is provided, focusing on contemporary trends of the issue. Going further, the business anti-fraud
strategic plan is described along with how it maximizes its efficiency, while the chapter aims to analyze
the demands for an organization to pass through fraud-fragile to fraud-resistant.

DOI: 10.4018/978-1-7998-4805-9.ch006

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Operational Risk Framework and Fraud Management

INTRODUCTION

Over the last decades, the global financial market has witnessed major changes, concerning both the
products and services provided and the way financial institutions do operate. Going along with the digita-
lization of our times, operations continuously alter in such extend, that new risks - or even differentiated
already known risks - unstoppably menace the entities and the market as a whole. As Marshall (2001)
mentioned, the countries’ financial deregulations started in the 80’s (Wernz, 2020), the dynamic aggre-
gated global operations, the high complexity and volatility of new products and services, the outburst of
advances in the IT field, and at the same time massive unexpected business scandalous losses, have put
Operational Risk (OR) in the spotlight. And even though, global competition, business diversification
and economy digitalization have stressed the stability and the profile of the banking industry the last
years, however they have touched off operations efficiency potentials for stakeholders and have led to a
more service-oriented banking system (Vives, 2019). It is a fact though that markets’ liberalization and
technological changes motivated financial innovations, new products and services are created, the intense
competition enhanced productivity and growth, but at the same time risks profile has been transformed
and new types of financial dangers have occurred and are needed to be taken into account.
The financial crisis commenced in 2008, spreading its shadow over the global economy, and 12 years
later with some countries still suffering by its socio-economic remains, in 2020, a global pandemic teared
down the world we knew up until then. The universal financial shake altered business and occupational
circumstances and will inevitably trigger the outbreak of new forms of operational risk. Given that, we
provide an operational risk brief yet illuminating description enriched with updated information and
experience on the matter. Within the operational risk context, we focus especially to one of its type that
over the years has turned into the business world Achilles heel, by causing massive– even fatal in some
cases – losses and major spillovers for business entities, financial fraud.

OPERATIONAL RISK

Coming along with the introduction of Basel II Accord in 2004, the stability and the insurance of the
international banking system was a top issue to be managed, while up until before, OR was vaguely
described as what was not credit or market risk. Given that OR is related to all the banking activities’
range (Chernobai et al., 2007), for the first time it constitutes a totally different kind of all other risks,
when Basel Committee gave its proper definition as “the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. This definition includes legal risk, but
excludes strategic and reputational risk” (BCBS, 2011).
Under normal conditions, OR does not cause significant losses for a financial institution, thus severe
damage is likely to occur when an operational miscarriage or an unexpected event takes place. This is
the main reason for banking institutions continuously trying to ameliorate the way they treat OR nowa-
days, especially after the major OR events that had been occurred the last decades leading a number of
well-known entities to massive financial losses (Martínez-Sáncheza et al., 2016) or even bankruptcies,
such as Bear Stearns and Lehman Brothers (Calluzzo & Dong, 2015).
However, managing risks is a highly demanding operational context, which includes significant direct
and indirect costs, in the sense of its implication but mostly under the shadow of the misleading assump-
tion that if it is not measured, it is not there. Keeping in mind that a large number of potential risks may

76

Operational Risk Framework and Fraud Management

have a significant impact on banks and at the same time there is no way to assess every possible risk
occurrence, its severity, criticality or effect on the business, through a sound Operational Risk Manage-
ment (ORM), with high quality trained staff, precise and well-designed and described processes, new
technologies know-how, along with a high-end internal control system is the best defense for a banking
institution, while operating in the contemporary dynamic global business environment.
ORM, according to BCBS (2011), is responsible to identify, measure and monitor potential risks and
evaluate risk exposures depending on the bank’s risk appetite combined to the nature, the size and the
complexity of each entity as well the business environment. In close cooperation with internal control,
ORM ensures the adequacy of capital buffer needed in real time basis and the institution’s stability, ef-
ficiency and effectiveness under the board’s business strategic, operational and compliance scopes and
objectives. Still, according to Yang and Zhang (2020), financial institutions struggle to manage handling
operational risks in an effective way.
It is significant to point out that, as OR includes a wide range of different event types, there are a few
parameters, on which it depends (Chernobai et al., 2007): a. the nature of the loss, meaning whether it’s
internally or externally originated, b. the direct or indirect impact of the loss, c. the degree of expec-
tancy, d. the risk type, event type and loss type and e. the severity and frequency of loss. Each of these
parameters show the way a risk event should be managed and the extension of capital requirement that
is needed, in order for the banking institution to be able to face such an occurrence.
Risk complexity and cross-countries business interconnection intensified the need of banking stability
and regulatory supervision. Under such circumstances, Basel Committee, though the framework of Basel
II, propose three methods for measuring OR to be adopted depending on each bank’s risk profile and
sensitivity (Cruz et al., 2015): (i) the Basic Indicator Approach (BIA), (ii) the Standardized Approach
(SA) and (iii) Advanced Measurement Approaches (AMA). Because of the Committee’s allowance of
internal models use, a plethora of different techniques are proposed in the literature for modeling OR
in the context of AMA.
While under the Basel II framework, banks are expected to measure their requirements on regula-
tory capital, their expected and unexpected losses in total, the Accord of Basel III dismiss the - before
mentioned - three approaches of operational risk measurement that Basel II engaged. In 2017, aiming to
increase safety and stability throughout the industry (Jayadev, 2013), Basel III introduced a single risk-
sensitive standardized measurement approach (SMA) for every bank to practice, from January 1st 2022
and on, in order to measure minimum capital requirements for operational risk. According to Basel III
post-crisis reforms, the SMA is based on:

1. the Business Indicator (BI) which is a financial-statement-based proxy for operational risk, involv-
ing the interest, leases and dividend component (ILDC); the services component (SC), and the
financial component (FC),
2. the Business Indicator Component (BIC), which is calculated by multiplying the BI by a set of
regulatory determined marginal coefficients (αi), as shown on Table 1., and
3. the Internal Loss Multiplier (ILM), which is a scaling factor that is based on a bank’s average
historical losses and the BIC.

As Deloitte highlights, in the SMA context, the only variable that a bank can have influence on is the
internal loss multiplier (ILM), by focusing on the quality of historical loss data, while cultivating an inside
operational risk awareness culture and adopting an operational risk management aggregated strategy.

77

Operational Risk Framework and Fraud Management

Table 1. BI ranges and marginal coefficients

Source: Basel Committee on Banking Supervision-BCBS, 2017

Going further, Aldasoro et al. (2020) came to the conclusion, after benchmarking Basel III SMA and
VaR models under Basel II AMA, that SMA seems to contribute to a decrease of estimates heterogene-
ity, when resources, like man-hours, are definitely liberated by using a simplified method, as SMA, not
only for the banks themselves but for the supervising authorities as well.

FINANCIAL FRAUD

For the assessment of operational risk, firms have to be aware and often decode the forms in which
operational risk hides in their activities. Basel Committee requires, for example banks to separate their
activities under 7 different risk categories, while measuring OR: i) internal fraud, also known as occu-
pational fraud, ii) external fraud, iii) employment practices, iv) clients, products and business practices,
v) physical assets damage, vi) business disruption and system failures and vii) execution, delivery and
process management.
Of those categories of operational risks, financial fraud, divided in either internal or external fraud
depending the origin environment of who commits it, is one of the most perilous types of risk, mostly
in case of service provision industries. This is because organizations, particularly banking institutions,
not only face the potential of losing money or other assets, but mainly suffer a much bigger threat· the
strangle of their credibility, integrity, customers’ trust and reputation, from which they will fight hard
to or even may never recover.
However, prior to analyzing the two faces of fraud, it is important to understand the nature of the
“fraud” issue. What do we really refer to when mentioning an event or behavior as fraudulent?
Financial fraud, also known as the “white-collar crime”1, was the cause of massive financial losses
over time. In this extend, Business Insider (2018) prompts that financial fraud is not the “something
new” for industries and may lead to billion dollar losses and even companies failures, while fraudsters
most of the times are driven to prison facing serious penalties.
It is worthy referring to Ramamoorti (2019) who describes a taxonomy that has been introduced for
fraud, under the acronym of A.B.C. theory, coming from “bad Apple, bad Bushel, bad Crop”. Ramamoorti
claims that, when it comes to a complex issue such a fraud, there is no point in trying to ascertain how
a fraud event has perpetrated more than to understand the motivational status of the participant(s). Not
the “how”, but preferably the “why” question need to be in light and the human factor must be decoded.
According to the A.B.C. theory as “bad apple” is the case when a person perpetrates fraud alone. When
more than one individuals take part, the act is called “bad bushel”. When the entity’s (or the industry’s)
environment is involved and high levels of the administration join, we refer to the incident as a “bad crop”.

78

Operational Risk Framework and Fraud Management

The Chartered Institute of Management Accountants – CIMA (2008) mentions that fraud can take place
anywhere, and often the effects are likely to turn out profound and may have long-term spillovers. Apart
from a few serious frauds that have attracted the media attention, huge capital losses are the overall result
of many limited-scale events, regardless the industry. From corporate scandals and substantial forgeries
to individual pyramid schemes, fraud events are likely to be caused either in the internal environment
of a company, by employees, managers, officers or even its owners, or externally by customers, traders
or other parties, and may lead the company to notably damaging situations.
Fraud is an intended unfair act to get an advantage, not necessarily in terms of money but of assets
or information, by deceiving another party. According to the Association of Certified Fraud Examiners
(ACFE), “fraud includes any intentional or deliberate act to deprive another of property or money by
guile, deception, or other unfair means”. In other words, fraud is committed when someone uses, for own
good, unfair and illegal means to take away something of value from a third party, or ever gain undeserved
benefit, while causing economic or other damage. Fraud action is also every intentional distortion, or
concealment or omission of information or the embezzlement, misuse, theft or any attempt to obtain a
person’s or an entity’s asset, unlawfully, in order to manipulate or cheat decision making processes or
public opinion, or in some cases to harm the other’s (or fuel oneself with) name and reputation.
A variety of ways to describe fraud are met in literature, but in any case one statement stays steel:
where there is money, a fraudulent act may lurk. And with being a cross-country and cross-industry
problem, fraud always will be the constant threat for business reputation and prosperity. That is the reason
for a significant ongoing international attempt to controlling factors that “favor” fraudulent behavior,
indicating the importance of the issue.
There are different ways to classify the fraud phenomenon (Kristo, 2011). There is fraud commit-
ted against individuals, where unsuspecting victims can be caught in fraudsters’ nets through different
ways they have come up to, like phishing or Ponzi schemes, on-line personal data thefts etc., but most
of the losses due to fraud occur in corporate environment. In this context, concerning the fraudster’s
source, fraud could be distinguished to internal, when the perpetrator(s) belong(s) to the corporate’s
human capital, or external, where there is no employment relations between the victim-company and
the fraudster(s). Regarding the scope, fraud may be characterized as credit or theft. In the first category,
the perpetrator remove assets without intending to return it. In the second case, the perpetrator goes for
clear stealing. Single or multiple fraud is when there is one or more than one perpetrators respectively.
Although, in order for us to fully comprehend the sense of the issue, a closer look of what do we
indeed mean by saying external or internal fraud is needed.

EXTERNAL FRAUD

ACFE denotes that external fraud can be recorded under various schemes. From fraudulent suppliers
to customers providing unreal billing information or trying to get refund by lying, and people who try
to hack a corporate’s database to third parties that try to bribe employees to extract important customer
information, there are numerous incidents where fraud risk lurks. There are 4 general types of external
fraud, even though fraudsters are always evolve their methods and embody new technology tricks, in
order to go through their scams. CICM in the Graydon’s External Fraud Report of 2019 in the UK men-
tions these types to be:

79

Operational Risk Framework and Fraud Management

1. abuse of trust. For example, a bank provides 2 or 3 small loans in a row to a customer that are
fully paid back in respect of the payments schedule. The customer gains the bank’s trust of being
a prompt payer. The fraudster applies for a significant loan and disappears, after taking the money.
Another example is when a firm trades a great deal when knowing that right after is going to forfeit
due to insolvency.
2. confidence trick. Fraudsters create fake invoices to extract money or pretend to be the firm’s man-
agers and provide authorization while urging a peculiar money transfer.
3. forgery. For example, fraudsters change and use a company’s formal information about bank ac-
counts or authorized contact person’s data to manipulate further usually financial acts, or steal
credit/debit cards details to distract deposits.
4. theft. Especially digital data can be stolen quite easily by using fake id information or email accounts.
Access authorized for staff only when stolen, it is possible to extract assets, money or confidential
info and cause huge quantitative and qualitative losses until the act is discovered.

INTERNAL FRAUD

Internal or occupational fraud refers to such acts taking place inside the corporate environment by
individuals - one or more – who have the experience of how the company operates. ACFE describes oc-
cupational fraud as “the use of one’s occupation for personal enrichment through the deliberate misuse
or misapplication of the organization’s resources or assets”.
It is rather common for banking institutions to have issues in handling the sense of OR throughout
their procedures and that OR events may occur wherever factors as personnel, processes and technology
interconnect. Surely, it is harder to vision the possibility of OR occurrence, even worst the severity and
complexity of it, which is more struggling to manage, in comparison to credit, liquidity or market risk.
At the same time, it is difficult to most banks to cultivate internal OR-aware environment, to train their
employees of how treating potential OR cases and to apply adequate targeted internal controls and after
all manage to face OR with a coordinated method under a well-designed proactive action plan, integrated
to corporate’s overall Risk Management attitude.
According to the Report to the Nations of 2020, fraud that employees commit against their employers
is the most harmful financial damage, in terms of losses, in a cross-industry level. Although cases of oc-
cupational fraud may not be reported, or even never be detected at all, the losses that the Report records
are more than $3,6 billion, conclusion that is based on data collected from 125 countries worldwide for
a time period between January 2018 and September 2019. What is deduced is that the damage caused
in an annual basis by (either internal or external) fraud is high enough to be able to provoke serious
macroeconomic extensions to global activity and economy. The “victims” of fraud lose their ability to
reserve their development rate, having at the same time an operational shake that impacts their product
and services provision. But it is not only the financial and quality damage to take into account. Indirect
costs while arise, when the company is found to have let fraud occur, in terms of legal fines by the regu-
lators (CICM, 2019). It is likely to downsize their personnel or lower their salaries, creating an overall
disappointment morale or even cut off their investments for a while. That obviously is reasonable for
an organization in order to absorb the fraud losses. Suppliers, customers, other business partners and
investors are also affected, not to mention that in some of the cases the swag may fund further illegal

80

Operational Risk Framework and Fraud Management

activity (CIMA, 2008). In the meanwhile the effects on the socioeconomic environment are obvious by
the rise of unemployment levels and the GDP restraint.
Going further, the 2020 Report to the Nations, of all the 2.504 fraud cases included in the study, in-
dicate that 70% concern for-profit companies, 44% of which belong to the private and 26% to the public
sector. The size of the companies, in terms of the number of employees, victimized by fraudsters doesn’t
seem to be a determinant factor, however the volume of losses in absolute numbers may be quite similar
(median loss about $150.000), besides the same loss value will definitely be translated in another way
for a significant big and a rather small company. It is interesting enough that of all the types of fraud
reported in the study, the most frequent of all regardless the company size is corruption. A not impressing
finding of the analysis is that banking and financial services, government and public administration, and
manufacturing are the most fraud-fragile business fields, as Table 2 demonstrates. Although this may
not be absolutely representative, as in these industries it is a fact that the most certified fraud experts
(CFE) are employed, banking and financial services organizations is verified, by the findings, to be more
fraud-fragile. As Rahman and Anwar (2014) mention, the banking sector complies with the strictest
regulations and mandates, however banking institutions for fraudsters are “the first option and the best
place to come to”, given banks’ capital related role and activities. Alongside, internal controls’ gaps or
senior management override or misguidance easily lead a public sector entity to fraud experience, in
sense of overstating, colluding with suppliers or colleagues or even direct money or assets lift, as De-
loitte states. In a Deloitte’s respective survey of 2014, the manufacturing sector is referred to as one of
the most vulnerable industries, with huge losses are reported to have been caused due to theft or misuse
of stocks, inferior product quality leading to product repeals, warranty claims fraud and IP infraction.

Table 2. Most common occupational fraud schemes in the top 3 “fraud-fragile” industries

Source: ACFE, 2020 Report to the Nations

In all the three industries that are the most fraud-affected, corruption is by far the main scheme of
concern. Given that, there is no similarity in those industries’ characteristics, it seem rather to the point
to focus on why, regardless the field of operations, corruption is being appeared and which are the rea-
sons of staff members, mostly executives as demonstrated below, to develop such fraudulent behaviors.

81

Operational Risk Framework and Fraud Management

Figure 1. The Occupational Fraud Tree

(source: ACFE, 2020)

TAXONOMY

Despite the fact that fraudsters are increasingly incorporating the possibilities offered by technology
to cover fraud, internal fraudulent behavior seems not to differentiate a lot over time, predominantly in
terms of fitting to the main categories set by ACFE: corruption, asset misappropriation and financial
statement fraud. Below, Figure 1 presents the ACFE taxonomy of the most common schemes, known
as the Occupational Fraud Tree.

82

Operational Risk Framework and Fraud Management

Corruption includes employee’s bribing, conspiracy, extortion, conflicts of interest, inappropriate

treatment of confidential data, collusive recommendations etc. Usually it is a silent activity, as those
involved keep the transactions at a level so covered that makes it hard to be revealed. As seen in the
Figure 2, 43% of the reported cases correspond to Corruption causing a median loss of $200.000.
The second category, asset misappropriations, is by far the most occurred, involving embezzlement,
procurement, theft or misuse of corporate assets, financial records, books of account and other resources.
Even though 86% of the cases reported refer to asset misappropriation, the median loss caused by these
cases is the lowest ($100.000), as in Figure 2.
Last but not least, financial statements fraud include cases of manipulated or falsified accounting
statements, forges or other document mistreatment, fictitious transactions, improper application of ac-
counting Principles and Standards etc. In an attempt to provide a usually better financial business status
for misleading stakeholders’ opinion and decision making, those cases seem to be less common, about
10% of the overall cases, attract the attention though because they cause the most (more than $950.000)
to the “victim”- entity.
Interesting enough, in PwC Global Economic Crime and Fraud Survey of 2020 customer fraud and
cybercrime are found to occupy the first 2 spots of the incidents’ frequency classification, being followed
by asset misappropriation, bribery / corruption and financial statements fraud respectively.

Figure 2. Distribution of fraud cases committed under the 2020 Report to the Nations findings by fre-
quency and loss caused
(adjusted by the authors)

THE FRAUD TRIANGLE

As the Global Head of Financial Crime Threat Mitigation at HSBC, Jennifer Shasky-Calvery points out,
when has been interviewed for Fraud Magazine in 2017, financial institutions are the frontispiece for the
defense of the international financial system against fraudulent behavior and banks’ reports are of great
importance playing a significant role while anti-fraud governmental regulations are formed. But what

83

Operational Risk Framework and Fraud Management

does really drive employees to commit fraud? It doesn’t seem necessary to be a genius to perpetrate a
fraudulent act and to deceive in order to gain something or cause loss to someone else, in a dishonest way.
Dr. Donald Cressey, in 1953, a criminologist who focused on “trust violators”, founded the Fraud
Triangle Framework (Figure 3), which later met a wide acceptance, mostly by Auditors, as being the
best properly defined way to describe the main motives that lead employees to committing fraud. The
combination of the 3 components outlined by the Framework, motive, rationalization and opportunity,
seem to have a crucial role on a fraud perpetration decision, and multiply the possibility (risk) of fraud
occurrence.
Mostly in cases of long period careers (Machado & Gartner, 2018), individuals with positions of
trust in the financial area (financial trust) may face a wide range of difficulties in their personal or social
lives, caused by need or greediness, which may under certain circumstances lead them to poor decisions.
Increased pressure is accumulated on employees that could possibly originate the motives and drive
them to trouble. Such circumstances could be a family illness where high medical expenses are needed,
or excessive loan or other debts, other personal incentives including addictions to gambling or drink-
ing, even lifestyle wishes that do not match to the person’s financial status. Performance objectives and
metrics or internal and external business expectations may also lead to fraud decisions, while the most
vicious version of all being the incurable willingness of gaining money.
By being careful when hiring personnel with compliments on their honesty and trustworthiness, the
company or banking institution must not carry on being satisfied or reassured that fraud risk is elimi-
nated forever. People, when are under extreme pressure of any kind, may believe that they are going
to return for example an amount of money stolen, or that what they extract is not significant enough to
be noticed gone. They could even feel unfairly treated and they deserve what they illegally take, that
others do it too, or that they have no other choice. The way the act of fraud is rationalized by fraudsters
is reflecting a state of mind that proceeds under pressure and subconsciously try to justify - or even
legitimize - what they go for.
Opportunity is the only of the three elements of the Tringle that is presupposed in order for a fraud
to be committed. Although the motive and it rationalization are on board, if the fraudster-to-be finds no

Figure 3. The Fraud Triangle

(Source: KPMG, 2016)

84

Operational Risk Framework and Fraud Management

suitable crack, there is no possibility of proceeding to the crime. Lack or weakness of business internal
controls, overlapping duties, supervision absence, vague position descriptions, questionable integrity and
honesty of the higher administration levels, easy intervention to corporate’s information systems, are some
of the situations that provide the proper ground for the fraud possibility to grow. To protect employees
from lapse of judgements, minimize such opportunities and face the most important Triangle element,
which simultaneously is the only that can be controlled - at the most - by companies, the management
and board have not only to implement the most possible well- designed internal controls, but also to en-
force their efficiency and to cultivate an integrated anti-fraud ethical culture to their inside environment.

TYPES OF FRAUDSTERS

When it comes to fraud, most people think is third parties to put the blame on. It is though proven
overtime that insiders cause the most significant damage to a company, when the worst being those of
higher authorities, like managerial staff (Kristo, 2011). In 2016, KPMG International released the latest
Global Profiles of Fraudsters report, after having examined 750 fraud cases at a global level, in a time
period of March 2013-August 2015.
Based on this study, it is revealed that most frequently fraudster’s profile regards to male individu-
als, belonging to the age scale of 36-55, with a working experience longer than 6 years to the deceived
institution. As often fraudsters are executives holding a position in operations, finance or general man-
agement. Alongside, it has been proven that the possibility for a fraud to be done by a collusive party of
people is doubled than by an alone wolf, and in such cases the financial damage is way more serious.
Among those who hunt in packs, the appearance of men against women is fivefold, and collusions tend
to include both insiders and outsiders, while the latest is often former employees of the victim.
Similar findings are demonstrated in the 2020 Report to the Nations, where the authors admit a found
correlation between the size of fraud loss and a) the level of authority, b) the tenure of the fraudster in
the company, c) the gender and the age of fraudster as well as d) the education level of the perpetrator.
Figure 4 aggregates those findings.
Based on CIMA’s classification, Deloitte points out, that people who carry out fraudulent activities
may be categorized in three groups, as follows:

1. pre-planned fraudsters, with the intention of committing a fraud since the beginning. This category
refers to short scale frauds like credit card cheating or to long scale frauds like compound money
laundering.
2. intermediate fraudsters, while being honest in the first place they come to be fraud culpable, often
because of a twist of circumstances, either in their personal life or in their working environment.
3. slippery-slope fraudsters, who downstream to fall into fraudulent behaving, usually out of despair.

The above classification does not include cases of physical or digital activated gangs or organized
criminals that are confronted by determinate agencies across the global.

85

Operational Risk Framework and Fraud Management

Figure 4. 2020 ACFE Report to the Nations findings

Source: (adjusted by the authors)

PREVENTION

The threat of fraud is a real, tangible matter for businesses, that is a given. Especially, for banking
institutions that are more fraud-fragile (Sanusi et al., 2015), the agility of fraudulent activity is a great
deal of a problem, notably when fraudsters are always adjusting to the circumstances and the environ-
ment they operate in. And even though, it is proved in literature that the wrongdoers find their way to
perpetrating fraud through low quality and insufficient corporate governance and internal controls, still
a dilemma stands for many companies, on what to decide on· financing preventing fraud strategies or
commit money for fraud detection.
Fraud is still, for many companies, a “sacred cow” subject, whilst in others the responsibility of fraud
prevention or detection is separated, depending the fraud type, instead of having a sound core internal
fraud regulation framework. In this context, while fraud prevention tactics require everyone involved to
take on their part, usually it is thought that banking institutions as well as merchants are loaded with the
responsibility of protection against fraud.
For a fraud scheme to be prevented, losses to be avoided and as so to keep business stability and
sustainability armored, every company or institution should have certain mandates that contain proper
and effective staff training and awareness programs and sufficient and intensely active operational con-
trol processes both to be always in alertness. A Fraud preventing strategy should also include a fraud
response plan as well as whistle-blowing policy and a reporting hotline, when at the same time staff must
be in a cultivated ethical environment that is the administration’s responsibility to develop. In general,

86

Operational Risk Framework and Fraud Management

the activities to be followed and the authorized roles in each step must be crystal clear for everyone,
especially those who have access to confidential data, even though there is no way in preventing all the
potential incidents and be totally fraud-free comforted.
It is interesting what the 2020 Report to the Nations reveals about the behavior of inside fraudsters.
More than one of the Fraud Tree main categories are perpetrated by the same fraudster in one third of
the overall cases, mentioned earlier. And yet, even in the most well prepared companies, control-wise,
potentially fraud risk is around the corner.

DETECTION

Fraud prevention measures intend to stop fraud event occurrence. On the other hand, fraud detection
techniques aim to identify, as quickly as possible, a scam when it is already happening or by far complete.
As fraud differentiates overtime, fraud detection is obligatory to be in continuous implementation and
up to date and more traditional tools like internal audit, that mainly has reactive approach, should be
seriously and adequately supported by proactive mechanisms (Othman et al., 2015).
Because of the information-oriented, complex and dynamic environment they need to operate in,
fraudsters keep on updating the means they use to avoid detection. Given that, for example, in case of
financial statements fraud, as Chen et al. (2018) and Sadgali et al. (2019) mention, a significant load of
studies evaluate the effectiveness of methods in fraud detecting, like data-mining and machine learning
techniques, descriptive or unsupervised techniques, predictive techniques, such as decision-trees, neural
networks, bayesian belief networks or support vector machines, as well as artificial and computational
intelligence methods. CIMA (2008) adds that a fraud detection system should contain, near all mentioned
analytical processes, trend analysis and ongoing risk assessment, to locate irregularities.
Of the most promising against fraud, especially for financial industry, machine learning techniques
are now used, due to their capability of using big data for the application of suitable algorithms that
process the available data of the past and learn in extremely short time to inspect, identify and distin-
guish peculiar operations versus legitimate ones. The way they “study” suspicious patterns is based on
their capability of self-teaching over past events experience and the characteristic that makes machine
learning algorithms such popular is that they are able to spot the malfunctioning faster and cheaper
than humans that were needed before for the same job. Machine learning seems to surpass humans not
only to speed, accuracy, quality or effectiveness on fraud detecting processes, but also it is proved to be
able to manage cases that when it came to experts where not even noted. Going further, how machine
learning develops is totally independent from human intervention, which means that it is unattached to
static, unchanged for a while anti-fraud program. When experts are in charge, it is reasonable a fraud
detection program to be developed and not be revised in a daily basis, as such would be impossible in
terms of time consumption and man-hours and assets’ cost. Unfortunately, having in mind that fraudsters
are trying constantly to find their way in, an organization, especially a financial institutions or even an
e-commerce firm, that does not invest in time-wise detect optimization is doomed.
Additionally, it is interesting to comprehend that, strong internal corporate controls are quite likely to
discover a fraudulent behavior, although colludes seem to dodge that kind of detection measures, becom-
ing a serious threat even for firms that are rather strong in internal proofs. This fact is strengthened by
the 2016 KPMG findings on fraudsters’ profile, according which 16% of team-fraudsters are found to
have surpassed internal controls or persuaded a colleague to do it for them, while the crucial approaches

87

Operational Risk Framework and Fraud Management

Figure 5. Fraud revealing approaches

(Source: PwC Economic Crime Survey 2008)

to revealing collusions of more than five are whistle-blowers and anonymous tip-offs, which are very
effective especially in cases of limitless power -yet corrupted- executives. In some cases, suppliers’ or
customers’ complaints may alarm an organization to activate relevant investigation.
The PwC Economic Crime Survey of 2007 found that in many cases frauds were uncovered by a
not prevention or detection function (Figure 5). Given that, it is obviously deducted that an effective
combination of all potential controls need to be activated, in order to minimize the menace of financial
fraud. Additionally, the anti-fraud efforts are strengthened by all the extra information available and get
improved even when analyzing cases of fraud that did not cause any losses (CIMA, 2008).
Having already said that it is unreal to consider that no scam is ever going to happen, no matter how
trap-proof a company believes to be, every organization must respond like the wind to a potential or -
even worst - an ongoing risk event. It is crucial to identify and address the threats directly, and dealing
with them in the best possible way with the lowest feasible impact for its stakeholders. And if keeping
in mind that the longer a fraud event is not perceived the bigger the damage for the company will be, it
is obvious that a fraud awareness corporate culture is vital, being rather better an anti-fraud master plan
must be developed.
In the firm’s anti-fraud master plan context, all the prevention and detection mechanisms, mentioned
before, are involved. And because there is always a potential of the fraudster to slip up, encouraged and
trained personnel, aware of how to react when spotting anomalies, by for example using hotlines, raising
red flags or through other responding alarms implied in the firm, without fear of being self-targeted, the
possibility of effective fraud prevention, detection and even investigation rises.
According to ACFEInsights.com, it is found that, in more than half of the investigated cases, losses
and duration of fraud events were diminished, when important internal controls were applied to fulfil
every gap of the anti-fraud defense. In such cases, a robust code of conduct and a sound internal audit

88

Operational Risk Framework and Fraud Management

unit was on board, while management substantial presence throughout the whole range of business
processes was on spot.
Especially in the banking and financial industry, where the integrity of transactions is mandatory
to be ensured, the customers’ trust and loyalty is not a given and the stability of the financial system is
highly fragile, into the fraud battle high-end risk management processes are required and national and
international regulations and compliance directives are established to minimize as possible the impact and
assist to preventing, detecting and responding to any potential scams. In some industries, like banking,
institutions are induced to share information and reports with one another, concerning from individuals
to whole countries, in order to enlighten the global business community in the race of confronting ef-
fectively fraud risk (OCC, 2019).
In Figure 6, the interaction of the three elements of an anti-fraud master plan along with basic busi-
ness environment requirements are illustrated.

Figure 6. Anti-fraud Master Plan

(Source: CIMA, 2008)

With the economic decline of the last decade and the 2020 global pandemic, the threat of fraud thrives
and the need of identifying the importance of an integrated anti-fraud corporate strategy is glaring.
Whilst internal audits and management reviews are important, seemingly means less connected directly
to fraud, like code of ethics and management presence in certification of the financial reporting and other
crucial processes, cultivates a systemic anti-fraud corporate culture and contribute to the stakeholders’
awareness of the firm’s anti-fraud ethical culture and corporate governance concern.

89

Operational Risk Framework and Fraud Management

As demonstrated in Figure 6, in order to achieve the highest possible level of fraud deterrence, needs
to have developed specific plans for fighting against fraudsters. A prevention plan, a detection plan and
a response plan are three different strategies, yet absolutely complementary to each other.
However, drawing up such plans and implementing them is not enough for any company towards
anti-fraud shielding. A mature anti-fraud environment is required for a master plan against fraudulent
behavior to maximize its effectiveness. Appropriate and targeted framework of principles and legisla-
tion must be activated to prevent and emend market imperfections. Integrated internal risk management
is needed to concentrate the suitable tools and controls to ensure adequate quantification, monitoring
and awareness of all risk potentials. Corporate governance has a highly important role by incorporating
in the business environment the directives and processes (Birol, 2019) that are needed to balance the
stakeholders’ interests and establish their private contractual relations (OECD, 2015). Pamungkas et al.
(2018) even state that corporate governance mechanisms are needed to line up ownership and management
interests, indirectly limiting management fraud incentives. Additionally, ethical culture, referring to the
behavior and decision-making at all levels, under the scope of doing things with honesty and integrity
(ACFE, 2020), invigorates an open and transparent internal business environment, which embodies
policies to business ethical values and mission, while stimulating staff comfort and confidence to com-
municate potential fraud event suspicions. As Birol (2019) also mentions, organizations with notified
ethical codes seem to diminish financial statements risk. Going further, Schwartz (2013) outlines three
principal components that play a key role in ethical culture: i. the presence of core ethical values, like
integrity, incorporated throughout the organization, ii. the implementation of a formal ethics training
framework and iii. the ceaselessly appearance of ethical leadership, an appropriate ‘tone at the top’ as
reflected by the board of directors, senior executives and managers.
Concluding, given the above, Suh and Shim (2020) underline that several studies conclude that poor
internal controls and ethical culture contribute to creating opportunities for fraud. At the same context,
Bentley et al. (2013) mention that business anti-fraud strategy is a pertinent indicator for evaluating
internal control business strength. Thereafter, it seems to be rather rational that organizations should
invest on a sound anti-fraud master plan, enhancing anti-fraud business culture and recording fraud
risk control effectiveness to comply with relevant legislation, advance business values and entrench its
development and sustainability, deterring fraudulent behaviors (KPMG, 2014).

SUMMARY

Operational risk is on the spotlight, especially in the modern highly demanding business environment,
even more nowadays that technology has complicated operations and services worldwide. Automation
as well as human capability have made the fight against operational misconducts an ongoing straggle
for the business world. Fraud, as one of the worst cases of operational risk, is an issue exhaustingly
and unstoppably analyzed by the business and the research community, because of the greatness of the
losses that it may cause, but still fraudsters see through insufficiencies and potential holes to invade the
institutions’ defense nets.
The latest economic crisis of 2008 and the 2020 global pandemic, have pulled the global landscape
– especially the banking sector – to its limits, and as KPMG aptly mentions “fraudsters never waste a
good crisis”. Although, Aldasoro et al. (2020), reckon that after 2014, a decline of fraud losses, in terms

90

Operational Risk Framework and Fraud Management

of severity, is observed, and an increase, that seems to occur in later years, refers to events that had taken
place prior to the crisis, yet were reflected to financial statements with a time delay.
Previous fraud occurrences and investigations often contribute to the anti-fraud fight knowledge,
especially in the financial sector where such demands are even higher, but still new schemes seek for
more sophisticated ways to manage situations in which, under digitalization, huge data availability and
differentiated business models, become way trickier. Previously sufficient standard analytics, now seem
to need a serious boost from predictive and adaptive models, artificial intelligence and machine learning
approaches, to fulfil to scope of preventing and detecting fraudulent events. But even though an effective
way to prevent or detect a fraud event is crucial for organizations and institutions, a holistic approach
should be implemented in order for a company to consider managing the threat. A systemic anti-fraud
master plan, including a blend of individual strategies on fraud prevention, fraud detection and fraud
response, must align with a sound ethical culture cultivated and enforced by the board of directors, a
strong corporate governance that safeguards all stakeholders’ interests and pushes through efficient risk
management and internal controls, while complying with the standing legislation, and the applicable
rules and principles. However, having everything in line, the “defense in depth”, as the Anti-Fraud Col-
laboration (AFC) highlights, in “The Fraud-Resistant Organization: Tools, Traits, and Techniques to
Deter and Detect Financial Reporting Fraud” Report of 2014, no “defense in depth” is ever going to be
achieved, if all the players of an organization do not realize and embrace their responsibility to understand
the ultimate role they have and perform the best they can, in the context of implementing the anti-fraud
master plan of the business environment they are part of.

REFERENCES

ACFE Insights. (2020). Top 4 Internal Controls That Reduce Fraud Losses. Available at: https://www.
acfeinsights.com/acfe-insights/top-4-internal-controls-that-reduce-fraud-losses
Aldasoro, I., Gambacorta, L., Giudici, P., & Leach, T. (2020). Operational and cyber risks in the financial
sector. Bank of International Settlements - Monetary and Economic Department. Working Papers No. 840.
Anti-Fraud Collaboration – AFC. (2014). The Fraud-Resistant Organization: Tools, Traits, and Tech-
niques to Deter and Detect Financial Reporting Fraud. Available at: https://www.thecaq.org/wp-content/
uploads/2019/03/the-fraud-resistant-organization.pdf
Association of Certified Fraud Examiners – ACFE. (2020a). Developing an Integrated Anti-Fraud,
Compliance, and Ethics Program. Creating a Culture of Ethics and Compliance. Available at: https://
www.acfe.com/uploadedFiles/ACFE_Website/Content/review/diafp/02-Creating-a-Culture-of-Ethics-
and-Compliance.pdf
Association of Certified Fraud Examiners – ACFE. (2020b). Report to the Nations: 2020 Global Study
on Occupational Fraud and Abuse. Available at: https://www.acfe.com/report-to-the-nations/2020/
Association of Certified Fraud Examiners – ACFE. (n.d.). What Is Fraud? Available at: https://www.
acfe.com/fraud-101.aspx
Basel Committee on Banking Supervision – BCBS. (2011). Principles for the Sound Management of
Operational Risk. Bank for International Settlements. Available at: https://www.bis.org/publ/bcbs195.pdf

91

Operational Risk Framework and Fraud Management

Basel Committee on Banking Supervision – BCBS. (2017). Basel III: Finalising post-crisis reforms.
Bank for International Settlements. Available at: https://www.bis.org/bcbs/publ/d424.pdf
Bentley, K., Omer, T., & Sharp, N. (2013). Business strategy, financial reporting irregularities, and audit
effort. Contemporary Accounting Research, 30(2), 780–817. doi:10.1111/j.1911-3846.2012.01174.x
Birol, B. (2019). Corporate Governance and Fraud Detection: A study from Borsa Instambul. Eurasian
Journal of Business and Management, 7(1), 44–64. doi:10.15604/ejbm.2019.07.01.005
Calluzzo, P., & Dong, G. N. (2015). Has the financial system become safer after the crisis? The chang-
ing nature of financial institution risk. Journal of Banking & Finance, 53, 233–248. doi:10.1016/j.
jbankfin.2014.10.009
Carozza, D. (2017). Banking on experience. Fraud Magazine. Available at: https://www.fraud-magazine.
com/article.aspx?id=4294998017
Chartered Institute of Credit Management – CICM. (2019). External Business Fraud in the UK. Graydon
Report. Available at: https://www.cicm.com/wp-content/uploads/2019/10/External-Fraud-report_FINAL.
pdf
Chartered Institute of Management Accountants – CIMA. (2008). Fraud risk management: a guide to
good practice. Available at: https://www.cimaglobal.com/Documents/ImportedDocuments/cid_tech-
guide_fraud_risk_management_feb09.pdf.pdf
Chen, Y.-J., Liou, W.-C., Chen, Y.-M., & Wu, J.-H. (2018). Fraud detection for financial statements of
business groups. International Journal of Accounting Information Systems, 32, 1–23. doi:10.1016/j.
accinf.2018.11.004
Chernobai, A., Rachev, S., & Fabozzi, F. (2007). Operational Risk: A Guide to Basel II Capital Require-
ments, Models, and Analysis. John Wiley & Sons, Inc.
Cressey, D. R. (1953). Other people’s money: a study in the social psychology of embezzlement. The
Free Press.
Cruz, M., Peters, G., & Shevchenko, P. (2015). Fundamental aspects of Operational Risk and Insurance
Analytics. A handbook of Operational Risk. John Wiley & Sons, Hoboken N. Jersey and Canada Deloite.
Basel III final rule summary. Understanding the new operational risk capital standard. Available at:
https://www2.deloitte.com/us/en/pages/risk/articles/basel-final-rules-takeaways-highlights-us-banks.html
Deloitte. (2010). Public Sector Fraud Identifying the Risk Areas. Available at: https://www2.deloitte.
com/content/dam/Deloitte/ie/Documents/Finance/Corporate%20Finance/2010_public_sector_fraud_de-
loitte_ireland.pdf
Deloitte. (2014). Decoding Frauds in the Manufacturing sector. Available at: https://www2.deloitte.com/
content/dam/Deloitte/in/Documents/finance/Forensic-Sector-Services/in-fa-manufacturing-noexp.pdf
Deloitte. (n.d.). Profiling the fraudster: understanding the threat of insider fraud. Available at: https://
www2.deloitte.com/mt/en/pages/risk/articles/mt-risk-article-profiling-the-fraudster.html

92

Operational Risk Framework and Fraud Management

Jayadev, M. (2013). Basel III implementation: Issues and challenges for Indian banks. IIMB Management
Review, 25(2), 115–130. doi:10.1016/j.iimb.2013.03.010
KPMG. (2014). Fraud risk management. Developing a strategy for prevention, detection, and response.
Available at: https://assets.kpmg/content/dam/kpmg/pdf/2014/05/fraud-risk-management-strategy-
prevention-detection-response-O-201405.pdf
KPMG. (2016a). Fraud risk increases in difficult economies. Available at: https://assets.kpmg/content/
dam/kpmg/pdf/2016/07/kpmg-forensic-focus-fraud-risk-in-difficult-economies.pdf
KPMG. (2016b). Global profiles of the Fraudster: Technology enables and weak controls fuel the fraud.
KPMG International. Available at: https://assets.kpmg/content/dam/kpmg/pdf/2016/05/profiles-of-the-
fraudster.pdf
Kristo, E. (2011). Being aware of the fraud risk. Special Conference Paper. Bank of Greece, Economic
Research Department – Special Studies Division.
Machado, M. R. R., & Gartner, I. R. (2018). The Cressey hypothesis (1953) and an investigation into
the occurrence of corporate fraud: An empirical analysis conducted in Brazilian banking institutions.
Revista Contabilidade & Finanças, 29(76), 60–81. doi:10.1590/1808-057x201803270
Marshall, C. (2001). Measuring and Managing operational risks in financial institutions. Tools, Tech-
niques and Other Resources. John Wiley & Sons.
Martínez-Sáncheza, J. F., Martínez-Palaciosa, M. T. V., & Venegas-Martínez, F. (2016). An analysis
on operational risk in international banking: A Bayesian approach (2007–2011). Estudios Gerenciales,
32(140), 208-220. Available at: https://www.sciencedirect.com/science/article/pii/S0123592316300390
Michaels, M. (2018). The most memorable and expensive financial fraud cases of all time. Business Insider.
Available at: https://www.businessinsider.com/fraud-financial-scandals-notable-and-expensive-2018-4
Organisation for Economic Co-operation and Development – OECD. (2015). G20/OECD Principles
of Corporate Governance, OECD Publishing, Paris Office of the Comptroller of the Currency – OCC
(2019). Operational Risk: Fraud Risk Management Principles. OCC Bulletin 2019-37. Available at:
https://www.occ.treas.gov/news-issuances/bulletins/2019/bulletin-2019-37.html
Othman, R., Aris, N. A., Mardziyah, A., Zainan, N., & Amin, N. M. (2015). Fraud Detection and Preven-
tion Methods in the Malaysian Public Sector: Accountants’ and Internal Auditors’ Perceptions. Procedia
Economics and Finance, 28, 59–67. doi:10.1016/S2212-5671(15)01082-5
Pamungkas, I., Ghozali, I., Achmad, T., Khaddafi, M., & Hidayah, R. (2018). Corporate governance
mechanisms in preventing accounting fraud: A study of fraud pentagon model. Journal of Applied Eco-
nomic Sciences, 13(2), 549–560.
Price Waterhouse Coopers. (2008). Fraud. A guide to its prevention, detection and investigation. Avail-
able at: https://www.pwc.com.au/consulting/assets/risk-controls/fraud-control-jul08.pdf
Price Waterhouse Coopers. (2020). Fighting fraud: A never-ending battle. PwC’s Global Economic
Crime and Fraud Survey. Available at: https://www.pwc.com/gx/en/forensics/gecs-2020/pdf/global-
economic-crime-and-fraud-survey-2020.pdf

93

Operational Risk Framework and Fraud Management

Rahman, R., & Anwar, I. (2014). Effectiveness of Fraud Prevention and Detection Techniques in Malaysian
Islamic Banks. Procedia: Social and Behavioral Sciences, 145, 97–102. doi:10.1016/j.sbspro.2014.06.015
Ramamoorti, S. (2019). Fraud. Books and Book Chapters by University of Dayton Faculty. 39. Available
at: https://ecommons.udayton.edu/books/39
Sadgali, I., Sael, N., & Benabbou, F. (2019). Performance of machine learning techniques in the detection
of financial frauds. Procedia Computer Science, 148, 45–54. doi:10.1016/j.procs.2019.01.007
Sanusi, Z. M., Rameli, M. N. F., & Isa, Y. M. (2015). Fraud Schemes in the Banking Institutions: Pre-
vention Measures to Avoid Severe Financial Loss. Procedia Economics and Finance, 28, 107–113.
doi:10.1016/S2212-5671(15)01088-6
Schwartz, M. (2013). Developing and sustaining an ethical corporate culture: The core elements. Busi-
ness Horizons, 56(1), 39–50. doi:10.1016/j.bushor.2012.09.002
Suh, J., & Shim, H. (2020). The effect of ethical corporate culture on anti-fraud strategies in South Korean
financial companies: Mediation of whistleblowing and a sectoral comparison approach in depository
institutions. International Journal of Law, Crime and Justice, 60, 100361. doi:10.1016/j.ijlcj.2019.100361
Vives, X. (2019). Competition and stability in modern banking: A post-crisis perspective. International
Journal of Industrial Organization, 64, 55–69. doi:10.1016/j.ijindorg.2018.08.011
Wernz, J. (2020). Bank Management and Control. Strategy, Pricing, Capital and Risk Management.
Springer Nature, Management for Professionals. doi:10.1007/978-3-030-42866-2
YangY.ZhangK. (2020). Operational Risk Identification: An Effective and Explainable Design Approach.
Available at: doi:10.2139srn.3603702

ENDNOTE
1
As “white-collar crimes” are described the illegal activities that are financially motivated and
contain trust abuse instead of violence.

94
95

Chapter 7
Current Trends in
Investment Analysis
Marios Nikolaos Kouskoukis
https://orcid.org/0000-0001-5840-3927
European University Cyprus, Nicosia, Cyprus

ABSTRACT
The purpose of this chapter is to review the current trends in investment management and performance
research. The adaption of both the classic CAPM and the factor models seems to continue, with the realistic
factors playing a crucial role and best represent the drivers of investment performance. Another rising
area is the search for skill, which is based on the enhanced benchmarks. The availability of quantitative
and qualitative data in the academic community has allowed for these areas to evolve in recent years
and to emerge as expected in the next decade, as well as to be explored.

INTRODUCTION

Both investment consultants and academic researchers have a deep interest in investment management
and investment performance issues. This book chapter aims to review the existing methods of evaluating
the investment management and the investment performance and highlight the developments in these
areas in the past decade. Moreover, this book chapter is trying to expand the investigation areas, which
are strongly believed to evolve shortly.
The classic theories and empirical studies of investment performance include the Capital Asset Pric-
ing Model (CAPM) of Sharpe (1964, 1967) and Jensen’s (1968) and the multi-factormodels of Fama and
French (1992, 1993) and Carhart (1997). These models play an active and important role in the current
academic research. However, they have not met the requirements of the investment industry. There is
still a need to find measurements to calculate an industry’s investment performance or a business.
Furthermore, it can be said that there is a wide range of opinions on the efficacy of such models.
On one hand, there are individuals, who broadly accept the findings of Fama and French (1992, 1993)
and use them extensively. On the other hand, some believe that these models’ assumptions and artificial

DOI: 10.4018/978-1-7998-4805-9.ch007

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Current Trends in Investment Analysis

results have no importance to evaluating the investment performance, as these measurements are not
going to be used, neither from the investors, nor from the investment managers.
A reluctance from the investment industry is observed to accept these traditional factor models and
adopt them to measure the investment performance. The refinements of these models and why the in-
vestment industry has not adopted them are topics that need to be discussed. As a result, this points out
the refinements that should be implemented in the classic benchmarks, where the models have more
resemblance to the benchmark for an investment style or a category of funds. These models have a lot
of similarities with the CAPM and the single factor models. However, with a specific benchmark, they
can represent the appropriate investment universe and align with investment practices. Such alignment
is not completely out of context with the multifactor models developed by Fama and French (1993).
Connor (1995) supported shortly after Fama and French (1993) that such models can be characterized
as fundamental factor models. These models rely on empirical findings from the worldwide bibliography
concerning the stock characteristics, such as size or book-to-market ratio. More recent studies examine,
whether such effects can be captured by the models, which use a single benchmark and are more closely
aligned with these funds.
In order to evaluate an investment skill or a manager’s value-added, a proper benchmark should be
utilized. Some important questions should be answered such as: is there a skill, what type of skill is it,
how can this skill be captured? However, the global research has moved past this stage and is trying to
answer the crucial question, if there is excess performance and if there is, is it due to skill or pure luck?
Mutual funds are investment funds in which the capital is pooled from several different investors
and then used to buy securities such as stocks, bonds or money market instruments. Although investing
in mutual funds, rather than direct investment in individual securities, still presents a certain degree of
risk, it has become more and more common practice around the world (Nandrajog, 2018).There are four
main types of mutual funds, categorized by the nature of their principal investments, namely: stock or
equity funds (whether domestic or international), bond or fixed income funds, money market funds and
hybrid funds.The biggest part of the money invested in equity mutual funds is still invested in active
management (Ferreira et. al., 2019).
The U.S. total mutual funds net assets value reached 21.25 trillion $ in January 2020 and the US mu-
tual fund industry remained the largest in the world at the year-end of 2019. The majority of US mutual
fund net assets at year-end of 2019 were in long-term mutual funds, with equity funds alone making up
53 percent of US mutual fund net assets. Domestic equity funds were the second largest category, with
39 percent of net assets (Investment Company Institute, 2020).
Despite the rapid growth of index funds and significant redemptions, actively managed funds still
account for 80% of U.S. equity funds. Specifically, at the end of 2019, the actively managed funds ac-
counted for $13.9 trillion under management in the U.S., while the passively managed funds accounted
for $8.4 trillion (Refinitiv Lipper, 2020). That implies that an abundant amount of investors believe that
investment managers have the skills to outpace the market.
Another set of questions that needs to be answered is if most investors are misinformed and do the
investors have motives or incentives that people cannot understand? Thus, a research is expected to be
implemented to discover more appropriate benchmarks and improved identification and assessment of
skill, as well as to continue the expansion in the anticipated future. Suppose the theories and the invest-
ment models are not accepted or applied by the investors and the investment industry. In that case, an
issue will occur regarding the economic impact new benchmarks and skill assessments can have.

96

Current Trends in Investment Analysis

This book chapter consists of: Section 2, which covers the literature review regarding the classic and
historical theories and major empirical studies, including the standard multifactor models. Section 3,
which assesses and adapts the classic models. Section 4, which discusses the realism in benchmarking
and investment skill. The final section, which offers a discussion regarding research areas and seems
promising to grow, as techniques improve and data become more available to the global community.

CLASSIC MODELS

The investment management and investment performance research is supported by the traditional models,
which were developed in accordance with the concepts of the Capital Asset Pricing Model of Sharpe
(1964) and Jensen (1968). Both authors focus, from one side on the performance of mutual funds and
the value-added by managers, and the other side on the performance of a passive index, representing
this way an investible universe. Half a decade later, the concepts that were originally introduced from
these research papers are still the core means of investigating investment value-added, despite that the
means of assessment have been greatly expanded.
Furthermore, the innovative work of King (1966) and Farrell (1974) highlighted that the stock price
behavior may be due to latent or common factors.
During the decade of 1990, Fama and French (1992, 1993) introduced a set of risk factors, which
represented the market’s effects, the stock size, and the stock valuation on performance. Five years later,
Carhart (1997) extended Fama and French (1992, 1993) model by adding in the set of risk factors, the
stock price momentum.
The base of the academic research of investment management and investment performance was es-
tablished through the CAPM model, the three-factor (Fama and French, 1992, 1993) and the four-factor
Carhart (1997) models. These models are widely used up to date in their original form and also a lot of
modifications have been implemented with many variants.
As Grinblatt and Titman (1992) and Goetzmann and Ibbotson (1994) highlight, during the 1990 de-
cade, an explosive growth of the mutual fund sector and a search for adequate means of benchmarking
and performance measurement appeared, because of the pension reform.
Additionally, Sharpe (1992) got involved once again with the investment performance and developed
a returns-based model of style analysis (RBSA) based on a set of passive indexes. Based on this work,
he also collaborated with index providers to establish style benchmarks that will reflect diverse invest-
ment universes. Farquhar, Rosenberg and Rudd (1982) invented the BARRA Risk Factor Analysis. This
multi-factor model measured the risk factors associated with three main components: the industry risk,
the risk from exposure to different investment themes and the company-specific risk.
Another significant event, which played an important role in the consideration of investment perfor-
mance and the factors affecting it, was Ferson and Schadt (1996) work. They tried to incorporate factors
reflecting the economy and to advocate the conditional performance evaluation.
Moreover, the investigation of mutual fund styles by Brown and Goetzmann (1997) supports that
the categorization of investment styles does not capture the different investment approaches used in the
market of investment funds. This segmented market is differentiated by size and investment style.
However, the problem of the classic factor models, which was typically used in investment perfor-
mance studies, was disclosed by Daniel, Grinblatt, Titman and Wermers (1997). Specifically, the classic
factor models were potentially unable to spot any irregular or value-added performance, if a fund’s style

97

Current Trends in Investment Analysis

characteristics were different from its benchmark. A way to confront this problem, in an effective way,
was to construct passive characteristics-based benchmarks utilizing size, price to book and the lagged
returns of actual portfolio holdings. That is an important matter discussed in Section 3, where the ap-
propriate choice of investment benchmarks is examined in more detail.
To conclude, the classic investment models have been trying to establish a benchmark to assess and
classify investment performance and be a useful guide for investment decisions. Even though, these
classic models or theories have some limitations, they still have a crucial role in the academic research.
This paper aims to point out the evolution of the current and emerging trends in investment manage-
ment and performance research and observe the reviews of the earlier periods of Cuthbertson, Nitzsche,
and O’Sullivan (2010) and Ferson (2013).

EVALUATING AND ADAPTING THE CLASSIC MODELS

The purpose of this section is to examine the attempts implemented to improve, evaluate and extend
the classic models and suggest alternative approaches. The opinions for the usefulness of the traditional
factor models are remarkably diverse. The classic models of investment performance’s findings started
a new era, whose aim was to improve benchmarking through appropriate benchmarks in investment
performance evaluation.
A large proportion of the world literature concentrates on extending the three-factor model, rather
than improving the Jensen (1968) CAPM model, having in mind that the multifactor models are CAPM’s
model extension. The study of Wagner and Winter (2013) enhanced the Fama and French (1992) and
Carhart (1997) factor models by adding two new factors, which represented the liquidity and the idio-
syncratic risk, in order to create a six-factor model. Other researches, like the one of Stivers and Sun
(2010), include economic elements into their models, trying to utilize the classic four-factor model on
the cross-sectional dispersion in stock returns under different economic conditions. The findings of this
study conclude that the value premium is countercyclical and the momentum premium is procyclical. In
addition, value stocks are often seen as defensive and have a low price-to-book ratio and a high dividend
yield, while momentum stocks tend to have high price-to-book ratios and low dividend yield. These are
consistent with the theoretical insights and empirical evidence.
The market-timing models, which were invented by Treynor and Mazuy (1966) and Henriksson and
Merton (1981), are used in combination with factor models to evaluate the performance of the invest-
ment funds. An update of these models took place by Elton, Gruber, and Blake (2012). One of their
hypothesis speculates that the marketing timing models were created in a prescribed or formalized man-
ner. Moreover, their research integrates monthly portfolio holdings and ‘bottom-up beta’ calculations.
It supports that managers can adapt their market exposure by enhancing or reducing their exposure to
specific sectors or stocks. These perceptions reveal the strategies deployed by mutual fund managers,
who have to be specialized in the market segment they invest. However, they might choose to change
the market risk through stock or sector selection.
Goetzmann, Ingersoll, Spiegel, and Welch (2007) suggested the Manipulation-Proof Performance
Measure (MPPM), having in mind a variety of performance measures including the Sharpe ratio (1967)
and Jensen’s (1968) alpha. Specifically, they claim that the MPPM can prevail over the drawbacks of a
wide range of models that measure the performance and that the fund managers can radically change
the return distribution.

98

Current Trends in Investment Analysis

Additionally, the Doubt Ratio (DR) was invented by Brown, Kang, In, and Lee (2010), which is a
diagnostic statistic derived originally from the MPPM. It is an indicator to detect funds that might have
been manipulated or whose returns were intentionally smoothed. Both the MPPM and the DR are more
suitable to hedge funds, because mutual funds reporting requirements may forbid the free investing
information.
The book chapter continues with the evaluation of the classic investment performance models. A list
of disadvantages or biases proposes that the abstractions of the investment performance models need to
be overcome, in order to have a valid impact on the investment practice.
In a research conducted by Chan, Dimmock, and Lakonishok (2009), the significant factors that
influence the benchmarking of investment managers’ performance were reported. In particular, they
investigated the main methods used in academic studies and investment practices, having in mind the
regression-based benchmarks, such as the Fama and French (1993) three-factor model and the char-
acteristics-based benchmarks, such as the Russell indexes. They advised that it is crucial to identify a
manager’s style or fund manager’s investment beliefs, like for example which are the stock characteristics
that can make an investment profitable. After this step, a benchmark should be chosen to simulate the
underlying strategy of the portfolio. Besides, they highlighted that even though some methodologies
are based on the same assumptions, like the size and market to book ratio, the results may differ. They
found out that the characteristics-based benchmarks attract actual portfolios more than the regression
based benchmarks and that the investment performance is sensitive to benchmarking methodology. The
findings of Chan, Dimmock, and Lakonishok (2009) study gave a boost to the academic community to
examine the appropriate benchmarks of each style and evaluate the investment performance.
Huij and Verbeek (2009) identified that the standard multifactor models have biases, which increase
or decrease mutual fund performance. The hypothetical stock portfolios do not integrate the transaction
costs and the impact of fund restrictions on trading. These biases are important from economic perspec-
tive for the multifactor models. The study results found a value premium and a momentum effect in the
cross-section of fund returns, but did not disclose evidence of a small-firm effect. Further, they argued
that having in mind the miscalculation of the premiums of the hypothetical portfolios, the alphas for
value funds, which result from the Fama and French (1992, 1993) three-factor model and the Carhart
(1997) four-factor model, are systematically biased downward and the alphas for growth funds are biased
upward. They concluded that factor proxies based on mutual fund returns, rather than on stock returns,
provide better benchmarks to evaluate the investment performance.
Ferson and Lin (2014) discovered that traditional alphas are not efficient indicators to point out, if a
fund is an attractive investment or not and expanded the traditional multifactor models by incorporating
investor’s utility function. They set boundaries on the expected disagreement and studied the cross‐sec-
tional relation of disagreement and investor heterogeneity, both economically and statistically significant.
Bali, Brown, and Caglayan (2014) recommended economic uncertainty indicators, as new measures
of macroeconomic risk. They observed that the resulting uncertainty betas explain a significant propor-
tion of the cross-sectional dispersion in hedge fund returns and that there is no significant relationship
for the mutual funds.
It is vital to highlight that the traditional factor models have not been adopted by the investment
industry, despite the extensive spread over the past two decades. On the other hand, the BARRA risk
models have been advertised and are broadly used in the investment industry. It is also crucial to point
out that the industry benchmark providers have shifted from the simple sorts indicated by the traditional
factor models to more cutting-edge methods of evaluating the growth-value orientation. During the last

99

Current Trends in Investment Analysis

decade, the majority of the leading index providers, such as Standard & Poor’s/Citigroup, Russell, MSCI
and Dow Jones Wilshire, have understood that the simple rankings by a single valuation multiple, like
the Price to Book or Price to Earnings, do not sufficiently reflect investment styles or do not offer the
appropriate means, in order to provide benchmarking for investors, who have a specific investment style.
Therefore, along with providing a batch of size breakpoints including the large-cap, the mid-cap and the
small cap, they provide more specialized indexes. At the same time, they have all switched towards index
calculation methods, which indicate the growth–value orientation of the underlying shares.
An update of the original Fama and French (1993) three-factor model introduced the four-factor and
the five-factor models of Fama and French (2015). Particularly, the new models add the profitability
factor (Robust minus Weak - RMW) and the investment factor (Conservative minus Aggressive - CMA)
to the existing three-factor model, which captures the size and value. RWM is the difference between the
returns on diversified portfolios of stocks with robust and weak profitability. At the same time, CMA
is the difference between the returns on diversified portfolios of the stocks of low (conservative) and
high (aggressive) investment firms. The profitability and investment factors may be viewed as growth
factors, whereas the traditional Book to Market factor is a value measure. The findings suggest that the
three-model factor is likely to have problems, when applied to portfolios with strong profitability and
investment tilts. Moreover, the four-factor model, which incorporates the market returns, the size, the
profitability and the investment captures more than the five-factor model, including the valuation.
Fama and French (2015) study compares both models with the traditional three-factor model from
July 1963 to December 2013. After testing these various models with a pool of 21 years available data,
they propose that the HML factor is unnecessary, since the effect of this value factor is captured by the
profitability and investment factors. However, they integrate it in the five-factor model to facilitate the
capture of the value premium.
Despite that these studies are well-known worldwide, they are only the tip of the iceberg, when the
topic of discussion is the suitability of a benchmark as a criterion for investment. Thus, it is important to
further and continuous develop the benchmarking and also more advanced methods should be explored,
in order to assess whether investment skill actually exists or not.

INVESTMENT SKILL

Two vital topics, which will be investigated in the future are the realistic evaluation of the restrictions that
the investment managers face and the identification of the proper benchmarks. The appropriate measures
used to assess the investment skill are analyzed in Kosowski, Timmermann, Wermers and White (2006)
and Fama and French (2010) research papers. The main question that these studies examine and try to
answer is “if abnormal returns or alpha exist and is this due to luck or actual skill? That is a topic that
will be fundamental for the future research on investment outcomes and assessment.
The recognition of market segmentation is a key element in the analysis of investment performance
and investment trends. Usually, the markets are categorized by size and investment style. In particular,
the size is the market capitalization of the stocks invested in by a fund, while the style expresses a fund
investment theory. The investment process filters the stocks, in order to create a portfolio, which reflects
these characteristics. This is a universally accepted method in a segmented market, such as the U.S.
equity market.

100

Current Trends in Investment Analysis

Wahal and Yavuz (2013) underline that the academic community has not given the appropriate atten-
tion, when style investing is pervasive among investors, from retail to institutional investors to investment
consultants. Limited research concentrates on this area, like the Barberis and Shleifer (2003) study, which
recommends the concept of diversified groups of funds offering various sets of risk return opportuni-
ties into evaluating both investment performance and investment skill. Furthermore, they highlight the
proper circumstances of a style classification scheme and the styles investing, which the investors need
to follow. They conclude that style investment has an important role in the predictability of asset returns.
The topic of investor differentiation and its impact on investment is analyzed in detail by Menzly and
Ozbas (2010). They point out the nature of market segmentation and information flows. They highlight
the nature of market segmentation and information flows, the efficient market hypothesis’s acquisitions,
and suggest a level of friction into asset price adjustments. They support that investor specialization has
a substantial effect on the configuration of the price, as it results in informational segmentation of the
markets and it is consistent with the trading behavior of the informed investors.
As Schultz (2010), Grossman and Stiglitz (1980) emphasize that the markets should be inefficient to
reward analysts or investors for the cost of their analysis. Procedures, such as collecting information, the
arbitrage and trading, cost a lot and are also risky. Thus, markets should be competitive and not provide
information. Having in mind the diverse levels of difficulty that the analysts or investors face during
the analyzing or trading of the market, it is reasonable that the rewards for the research and analysis are
higher in areas, where more time or skill is required.
Kothari and Warner (2001) and Angelidis, Giamouridis, and Tessaromatis (2013) supported the idea
that if a benchmark does not reflect an assessed fund’s investment style characteristics, then it is indefin-
able, if the fund can generate any unexpected returns or exceptional performance. The investment styles
are groups of investors with same beliefs and their portfolios have common characteristics and behave
equally under different circumstances. The determination of investment style is a multilateral issue, re-
flecting the various combinations of preference for income, growth and asset backing. Results show that
the multifactor models can not reflect the characteristics and the objectives of the evaluated fund. Huij
and Verbeek (2009) emphasize that the funds, which will be assessed by a multifactor benchmark, need
to be invested in hedge portfolios. However, because of the trading limitations and the immense costs,
this is not possible. In addition, Chan et al. (2009) highlighted the importance of using the appropriate
benchmark by arguing that different models or benchmarks can assess the investment performance not
only with different values, but also with different signs. Sensoy (2009) and Goetzmann et al. (2007)
claimed that the benchmarks used to evaluate the funds, should be supported in the economic theory.
Cremers, Petajisto and Zitzewitz (2012) underlined that a valuable benchmark should provide “the
most accurate estimate of a portfolio manager’s added value relative to a passive strategy” and suggested
the use of stock market indicators, which are broadly known as the factors in investment performance
evaluation. Moreover, Cremers and Petajisto (2009) pointed out the importance of identifying the proper
benchmark or index to analyze the active managers. This is critical, because using an improper bench-
mark can lead to false information in tracking an error and can make difficult to evaluate performance.
Angelidis et al. (2013) proposed using managers’ designated benchmarks rather than the traditional
factor models to assess the investment performance. The use of proper benchmarks is controlled by the
investment consultants and the organizations, whose business is to distribute investment funds’ informa-
tion to their clients. Additionally, they discovered that the traditional factor models underestimate skill
and the stock selection seemed to be the main reason of lower performance. Their findings have resulted
from a returns-based perspective, rather than an asset holding-based perspective.

101

Current Trends in Investment Analysis

Hunter, Kandel and Wermers (2014) recommended the concept of active peer benchmarks (APB),
which enhanced the traditional multifactor models to evaluate the mutual fund performance. Their main
advantage was that there were more aligned with the investors and the industry practice. They noticed that
the investment consultants and organizations produce similar peer groups, but without a formal model.
The reference group for each separate investment style follows the same strategy. One of the benefits
of this technique is that it recognizes any common elements in changing bets over time. The outcomes
of their study emphasized that skill does not exist for some categories of funds and that the active peer
benchmarks (APB), help in a great way, the identification of the skilled funds.
More than that, fund data availability has led to further research of the determinants of the flow of
funds in and out of mutual funds.
Berk and Green (2004) developed a “rational” model, which included the past performance and the
fund flows. Their theoretical model demonstrated the connection between fund flows and performance,
consistent with the high average levels of skill. That showed that it is significant to seek the identification
of value-added investment skill. Their results imply that the managerial skill is scarce and it is difficult
to find it.
Further, Glode (2011) model broadened the idea that, where active returns vary with the state of the
economy, the decision to invest in an actively managed fund depends on a performance measure, which
does not specify the pricing core of mutual funds and might underestimate the value-added of active man-
agement. The whole idea of this concept was structured to the findings of Berk and Green (2004) paper.
As a conclusion, it can be considered that the move towards adopting more specific factors has widely
been accepted by the worldwide community and particularly by the authors applying benchmarks, which
reflect the investment universe and the investment restrictions of funds with more accuracy. It can be
said, that this trend will keep evolving and the more realistic the benchmark, which is used, is, the more
useful the pronouncement of manager skill will be. Assessing funds, contrary to their investors’ expecta-
tions, should have more economic benefit, despite that the utilizing benchmarks are neither used by the
investment funds nor their clients.
There has been a lot of debate over whether some managers possess skill or whether skill is found
under certain occasions. The real question is, if managers make a value-added contribution to fund per-
formance in a random way, which cannot be explained. Specifically, Carhart (1997) found few evidence
of value-added skill and Berk and Tonks (2007) discovered that persistence tends to be found among
the funds, which underperform. These findings were aligned with some earlier studies, such as the
Goetzmann and Ibbotson (1994) study, which identified persistence among the worst performers and the
Fama and French (2010) study, which revealed evidence of persistence by the high-performance funds.
In addition to the question, if fund managers possess skill in general or not, there is also another ques-
tion raised, if fund managers possess certain types of skill. Baker, Litov, Wachter and Wurgler (2010)
presented data of stock-picking skills, despite that this skill is neutralized by trading costs and fees. They
found out that the stocks, which were bought before the earnings announcements, outperformed those
sold by the mutual fund managers and concluded that this happened because of the managers’ ability
to forecast the earnings.
Kacperczyk, Nieuwerburgh, and Veldkamp (2014) made a considerable contribution to assessing
investment skill. They concluded that the skilled managers can effectively do the tasks of stock picking
and market timing and also add significantly to the insights in how managers add value for their clients.
That reflects perfectly a practitioner’s point of view that a skilled manager can make abnormal returns
in good times and sustain them in bad times. Their study, which was based on Grinblatt and Titman

102

Current Trends in Investment Analysis

(1993) and Daniel et al. (1997) findings, defined skill as the cognitive ability to process public or private
information, in order to achieve superior risk-adjusted returns.
Moreover, Kosowski et al. (2006) underlined the need for benchmarks to evaluate, if fund managers
have the value-creating ability to generate alpha and if this is due to skill or luck. Alpha estimates can
capture both skill and luck. In particular, they utilized bootstrapping techniques and they observed that
a “sizeable minority” of funds created added value net of costs and the superior alphas of these funds
persisted.
Fama and French (2010) redefined the bootstrap techniques of Kosowski et al. (2006) in their study.
The results showed that net of fees aggregate fund returns underperformed a set of benchmarks, such
as the CAPM, the three-factor and the four-factor benchmarks by nearly the amount extracted for fees.
A critical factor was that they excluded the most important findings for funds compared to the CAPM
model, considering that these were created by the factors integrated into the three-factor model.
Busse et al. (2010) used the bootstrap technique of Fama and French (2010) to institutional fund data.
They concluded that for the average fund, there is no value-added performance contribution. Furthermore,
they highlighted that the majority of actively managed funds produced positive or zero-alpha. This made
the actively managed funds look as attractive as the passive funds, but there was an important minority
of value-destroying funds, which managed to survive long-term.
Last, Agyei-Ampomah, Clare, Mason and Stephen Thomas (2015) underlined that the use of standard
multifactor models underrates managerial ability and overestimates the portion of funds, whose abnormal
performance can be charged to chance rather than skill.

CONCLUSION

This book chapter examines the recent trends in the analysis of investment management and invest-
ment performance. It should be noted that there are abundant and high-quality papers regarding this
topic and more specific for the newer improvements and emerging trends in the sector. Many of these
new improvements in this area were supported by the Fama and French (1992, 1993) research. They
investigated factors, which could explain the nature and the performance of the investment portfolios in
more detail. This book chapter also considers the realism, meaning the substituting factors, in order to
surrogate the investment universe and investment restrictions more closely than the earlier set of factors,
which might have not taken into account particular aspects of the nature of the investment management.
It is important to mention that 23 years after the initial three-factor model of Fama and French, they
introduced new factors in 2015 to enrich and replace the earlier factors.
The analysis of the recent literature of investment funds and investment performance leads to the
conclusion that the realism and the skill are factors that will influence the future research. These factors
include the improvements in benchmarking, which will keep on going to bear in mind the actual nature
of investing with its associated restrictions. In the worldwide literature, the increasing application of
benchmarking can improve the assessment of performance, whether this can be due to actual skill or
external factors.
Additionally, the late literature underlines the weaknesses of traditional evaluations of investment
opportunities, which will keep on thriving. Cremers et al. (2012) made very significant additions in
this area and particularly they observed that some benchmark indicators had alpha. On the other hand
Kosowski et al. (2006) work initiated a new investigation, in order to make a clear distinction between

103

Current Trends in Investment Analysis

the actual skill and the pure luck. Further, Kacperczyk et al. (2014) discovered a substantial new area
of research and came to the conclusion that the skilled managers can effectively do the tasks of stock
picking and market timing.
The recent developments in the technological area are making more and more quantitative and quali-
tative data available in the worldwide scientific community. Moreover, it is generally acknowledged that
the investment industry has evolved rapidly, since the appearance of these innovative researches. It seems
that the accepted academic measures of evaluation, the CAPM and the multi-factor models, which play
an active and important role in the current academic research, will keep being integrated in the future
studies, in order to add value.

REFERENCES

Agyei-Ampomah, S., Clare, A., Mason, A., & Stephen Thomas, S. (2015). On luck versus skill when
performance benchmarks are style-consistent. Journal of Banking & Finance, 59(10), 127–145.
Angelidis, T., Giamouridis, D., & Tessaromatis, N. (2013). Revisiting mutual fund performance evalu-
ation. Journal of Banking & Finance, 37(5), 1759–1776.
Baker, M., Litov, L., Wachter, J. A., & Wurgler, J. (2010). Can mutual fund managers pick stocks?
Evidence from their trades prior to earnings announcements. Journal of Financial and Quantitative
Analysis, 45(5), 1111–1131.
Bali, T. G., Brown, S. J., & Caglayan, M. O. (2014). Macroeconomic risk and hedge fund returns. Journal
of Financial Economics, 114(1), 1–19.
Barberis, N., & Shleifer, A. (2003). Style investing. Journal of Financial Economics, 68(2), 61–199.
Berk, J. B., & Green, R. C. (2004). Mutual fund flows and performance in rational markets. Journal of
Political Economy, 112(6), 1269–1295.
Berk, J. B., & Tonks, I. (2007). Return persistence and fund flows in the worst performing mutual funds.
National Bureau of Economic Research, Working Paper No. w13042.
Brown, S. J., & Goetzmann, W. N. (1997). Mutual fund styles. Journal of Financial Economics, 4(3),
373–399. doi:10.1016/S0304-405X(96)00898-7
Brown, S. J., Kang, M., In, F. H., & Lee, G. (2010). Resisting the manipulation of performance metrics:
An empirical analysis of the manipulation-proof performance measure. Finance and Corporate Gov-
ernance Conference.
Carhart, M. M. (1997). On persistence in mutual fund performance. The Journal of Finance, 52(1),
57–82. doi:10.1111/j.1540-6261.1997.tb03808.x
Chan, L. K., Dimmock, S. G., & Lakonishok, J. (2009). Benchmarkingmoney manager performance:
Issues and evidence. Review of Financial Studies, 22(11), 4553–4599.
Connor, G. (1995). The three types of factor models: A comparison of their explanatory power. Financial
Analysts Journal, 51(3), 42–46. doi:10.2469/faj.v51.n3.1904

104

Current Trends in Investment Analysis

Cremers, K. M., & Petajisto, A. (2009). How active is your fund manager? A new measure that predicts
performance. Review of Financial Studies, 22(9), 3329–3365.
Cremers, M., Petajisto, A., & Zitzewitz, E. (2012). Should benchmark indices have alpha? Revisiting
performance evaluation. Critical Finance Review, 2(1), 1–48.
Cuthbertson, K., Nitzsche, D., & O’Sullivan, N. (2010). Mutual fund performance: Measurement
and Evidence1. Financial Markets, Institutions and Instruments, 19(2), 95–187. doi:10.1111/j.1468-
0416.2010.00156.x
Daniel, K., Grinblatt, M., Titman, S., & Wermers, R. (1997). Measuring mutual fund performance with char-
acteristic-based benchmarks. The Journal of Finance, 52(3), 1035–1058. doi:10.1111/j.1540-6261.1997.
tb02724.x
Elton, E. J., Gruber, M. J., & Blake, C. R. (2012). An examination of mutual fund timing ability using
monthly holdings data. Review of Finance, 16(3), 619–645. doi:10.1093/rof/rfr007
Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. The Journal of Finance,
47(2), 427–465. doi:10.1111/j.1540-6261.1992.tb04398.x
Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal
of Financial Economics, 33(1), 3–56. doi:10.1016/0304-405X(93)90023-5
Fama, E. F., & French, K. R. (2010). Luck versus skill in the cross-section of mutual fund returns. The
Journal of Finance, 65(5), 1915–1947.
Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Econom-
ics, 116(1), 1–22.
Farquhar, T., Rosenberg, B., & Rudd, A. (1982). Factor-related and specific returns of commonstocks: Serial
correlation and market inefficiency. The Journal of Finance, 37(2), 543–554. doi:10.1111/j.1540-6261.1982.
tb03575.x
Farrell, J. L. Jr. (1974). Analyzing covariation of returns to determine homogeneous stock groupings.
The Journal of Business, 47(2), 186–207. doi:10.1086/295630
Ferreira, M. A., Keswani, A., Miguel, A. F., & Ramos, S. B. (2019). What determines fund performance
persistence? International evidence. Financial Review, 54(4), 679–708. doi:10.1111/fire.12202
Ferson, W., & Lin, J. (2014). Alpha and performance measurement: The effects of investor disagreement
and heterogeneity. The Journal of Finance, 69(4), 1565–1596.
Ferson, W. E. (2013). Ruminations on investment performance measurement. European Financial Man-
agement, 19(1), 4–13. doi:10.1111/j.1468-036X.2012.00657.x
Ferson, W. E., & Schadt, R. W. (1996). Measuring fund strategy and performance in changing economic
conditions. The Journal of Finance, 51(2), 425–461. doi:10.1111/j.1540-6261.1996.tb02690.x
Glode, V. (2011). Why mutual funds underperform. Journal of Financial Economics, 99(3), 546–559.

105

Current Trends in Investment Analysis

Goetzmann, W., Ingersoll, J., Spiegel, M., & Welch, I. (2007). Portfolio performance manipulation and
manipulation-proof performance measures. Review of Financial Studies, 20(5), 1503–1546. doi:10.1093/
rfs/hhm025
Goetzmann, W. N., & Ibbotson, R. G. (1994). Do winners repeat? Journal of Portfolio Management,
20(2), 9–18. doi:10.3905/jpm.1994.9
Grinblatt, M., & Titman, S. (1992). The persistence of mutual fund performance. The Journal of Finance,
47(5), 1977–1984. doi:10.1111/j.1540-6261.1992.tb04692.x
Grinblatt, M., & Titman, S. (1993). Performance measurement without benchmarks: An examination
of mutual fund returns. The Journal of Business, 47–68.
Grossman, S. J., & Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. The
American Economic Review, 70(3), 393–408.
Henriksson, R. D., & Merton, R. C. (1981). On market timing and investment performance. II. Statistical
procedures for evaluating forecasting skills. The Journal of Business, 54(4), 513–533. doi:10.1086/296144
Huij, J., & Verbeek, M. (2009). On the use of multifactor models to evaluate mutual fund performance.
Financial Management, 38(1), 75–102.
Huij, J., & Verbeek, M. (2009). On the use of multifactor models to evaluate mutual fund performance.
Financial Management, 38(1), 75–102.
Hunter, D., Kandel, E., Kandel, S., & Wermers, R. (2014). Mutual fund performance evaluation with
active peer benchmarks. Journal of Financial Economics, 112(1), 1–29.
Investment Company Institute. (2020). Investment Company Fact Book. Author.
Jensen, M. C. (1968). The performance of mutual funds in the period 1945–1964. The Journal of Finance,
23(2), 389–416. doi:10.1111/j.1540-6261.1968.tb00815.x
Kacperczyk, M., Nieuwerburgh, S. V., & Veldkamp, L. (2014). Time-varying fund manager skill. The
Journal of Finance, 69(4), 1455–1484.
King, B. F. (1966). Market and industry factors in stock price behavior. The Journal of Business, 39(1),
139–190. doi:10.1086/294847
Kosowski, R., Timmermann, A., Wermers, R., & White, H. (2006). Can mutual fund starsreally pick
stocks? New evidence from a bootstrap analysis. The Journal of Finance, 61(6), 2551–2595.
Kothari, S. P., & Warner, J. B. (2001). Evaluating mutual fund performance. The Journal of Finance,
56(5), 1985–2010.
Mason, A. (2013). Equity investment styles. In H. K. Baker & G. Filbeck (Eds.), Portfolio theory and
management. Oxford University Press. doi:10.1093/acprof:oso/9780199829699.003.0023
Menzly, L., & Ozbas, O. (2010). Market segmentation and cross-predictability of returns. The Journal
of Finance, 65(4), 1555–1580.

106

Current Trends in Investment Analysis

Nandrajog, A. B. (2018). Mutual fund performance: An empirical analysis of growth schemes. Finance
India, 32(4), 1287–1300.
Refinitiv. (2020). Lipper Fund Performance Data. Author.
Schultz, P. (2010). Rational cross-sectional differences in market efficiency: Evidence from mutual fund
returns. Journal of Financial and Quantitative Analysis, 45(4), 847–881.
Sensoy, B. A. (2009). Performance evaluation and self-designated benchmark indexes in the mutual fund
industry. Journal of Financial Economics, 92(1), 25–39.
Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The
Journal of Finance, 19(3), 425–442.
Sharpe, W. F. (1967). Portfolio analysis. Journal of Financial and Quantitative Analysis, 2(2), 76–84.
doi:10.2307/2329895
Sharpe, W. F. (1992). Asset allocation: Management style and performance measurement. Journal of
Portfolio Management, 18(2), 7–19. doi:10.3905/jpm.1992.409394
Stivers, C., & Sun, L. (2010). Cross-sectional return dispersion and time variation in value and mo-
mentum premiums. Journal of Financial and Quantitative Analysis, 45(4), 987–1014. doi:10.1017/
S0022109010000384
Treynor, J., & Mazuy, K. (1966). Can mutual funds outguess the market? Harvard Business Review,
44(4), 131–136.
Wagner, N., & Winter, E. (2013). A new family of equity style indices and mutual fund performance:
Do liquidity and idiosyncratic risk matter? Journal of Empirical Finance, 21, 69–85. doi:10.1016/j.
jempfin.2012.12.005
Wahal, S., & Yavuz, M. D. (2013). Style investing, comovement and return predictability. Journal of
Financial Economics, 107(1), 136–154.

107
108

Chapter 8
A Study on Various Applications
of Data Mining and Supervised
Learning Techniques in
Business Fraud Detection
Amit Majumder
JIS College of Engineering, India

Ira Nath
JIS College of Engineering, India

ABSTRACT
Data mining technique helps us to extract useful data from a large dataset of any raw data. It is used
to analyse and identify data patterns and to find anomalies and correlations within dataset to predict
outcomes. Using a broad range of techniques, we can use this information to improve customer rela-
tionships and reduce risks. Data mining and supervised learning have applications in multiple fields of
science and research. Machine learning looks at patterns of data and helps to predict future behaviour
by learning from the patterns. Data mining is normally used as a source of information on which ma-
chine learning can be applied to solve some of problems in our daily life. Supervised learning is one
type of machine learning method which uses labelled data consisting of input along with the label of
inputs and generates one learned model (or classifier for classification type work) which can be used to
label unknown data. Financial accounting fraud detection has become an emerging topic in the field of
academic, research and industries.

DOI: 10.4018/978-1-7998-4805-9.ch008

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

1. INTRODUCTION

Fraud is measured as an intentional thing that searches for guarantying its writer or a third party for
giving an unlawful advantage, to the disadvantage of an individual. At the business level, it can be
specified through changed economic data, misuse of properties, unsuitable expenditures and revenue,
amongst others. The significances of a business fraud are financial losses, image and disbelief of clients
and stockholders.

1.1 Introduction on Business Fraud

Corporate fraud indicates to happenings commenced by a personal or company that are executed in an
untruthful or unlawful way and are calculated to give a benefit to the perpetrating individual or company.
Corporate fraud schemes go beyond the scope of an employee’s stated position and are marked by their
complexity and economic impact on the business, other staffs, and outside parties.
Some examples of business frauds that have happened in the world have been: Enron, the energy
company that tried to hide its true level of indebtedness through complex transactions with its subsidiary
companies; WorldCom, a telecommunications firm that recorded expenditures of close to 4,000 million
dollars as delayed overheads, in order to hide its actual losses; Global Crossing, a fiber optic company
that recorded revenue as revenue that should be deferred; Vivendi, European communications entity
that manipulated its Ebitda in the consolidation of its data with the business group, in order to acquire
superior debt capacity; and Adelphia Communications, cable television society that was undercapitalized
by granting enormous individual loans to its members with the agreement of its directors. These, among
many others, are some of the most tarnished cases in the world of business fraud.

1.2 Introduction on Data Mining

Data Mining is a set of technique that applies to huge and composite databases. This is to eradicate
the arbitrariness and determine the unseen outline. These data mining techniques are almost always
computationally rigorous. We usage data mining tools, practices, and concepts for revealing designs in
information. There are too many driving militaries existing. And, this is the cause why data mining has
developed such a vital zone of education.
As data mining is having spacious applications. Thus, it is the young and promising field for the pres-
ent generation. It has attracted a great deal of attention in the information industry and in society. Due
to the wide availability of huge amounts of data and the imminent need for turning such data into useful
information and knowledge. Thus, we use information and knowledge for applications ranging from
market study. This is the cause why data mining, recognized as knowledge detection from information.

1.3 Introduction on Machine Learning Using Supervised Approach

Machine Learning is indisputably one of the most powerful and influential skills in today’s world. More
significantly, we are distant from watching its complete possibilities. There is no uncertainty that it will
continue to be making headlines for the foreseeable future. This article is designed as an introduction to
the Machine Learning concepts, covering all the fundamental ideas without being too high level.

109

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Machine learning is a tool for turning information into knowledge. In the past 50 years, there has
been an explosion of data. This mass of data is useless unless we analyse it and find the patterns hidden
within. Machine learning techniques are used to automatically find the valuable underlying patterns
within complex data that we would otherwise struggle to discover. The hidden patterns and knowledge
about a problem can be used to predict future events and perform all kinds of complex decision making.
Two of the most widely adopted machine learning methods are supervised learning which trains
algorithms based on example input and output data that is labelled by humans, and unsupervised learn-
ing which provides the algorithm with no labelled data in order to allow it to find structure within its
input data.

2. BUSINESS FRAUD DETECTION: WHY?

Fraud is a billion-dollar business and it is growing every year. The PwC global economic crime survey
of 2018 initiated that half (49 percent) of the 7,200 companies they surveyed had practiced fraud of some
kind. This is an growth from the PwC 2016 study in which slightly more than a third of organizations
surveyed (36%) had experienced economic crime.
Fraud possibilities co-evolve with technology, esp. Information technology Business reengineering,
reorganization or downsizing may weaken or eliminate control, while new information systems may
exist with extra chances to commit fraud.
Traditional techniques of data analysis have long been utilized to identify fraud. They necessitate
complex and laborious researches that deal with various fields of knowledge like financial, economics,
business practices and law. Fraud often consists of many occurrences or instances connecting repeated
transgressions using the same method. Fraud instances can be similar in content and appearance but
usually are not identical.
The first industries to utilize data analysis methods to stop fraud were the telephone companies, the
insurance companies and the banks (Decker 1998). One early example of successful implementation of
data analysis techniques in the banking industry is the FICO Falcon fraud assessment system, which is
based on a neural network shell.
Retail industries also suffer from fraud at POS. Some supermarkets have started to make usages of
digitized closed-circuit television (CCTV) together with POS data of most vulnerable transactions to fraud.

3. SURVEY ON BUSINESS FRAUD CASES AND ITS DETECTION METHODS

In the period of Internet, a huge amount of information is stored and transmitted from one location to
another. Data transmitted online is most likely susceptible to attack. As there is a noticeable growth of
fraud that is leading to damage of many billions of dollars worldwide every year; different modern ways
in identifying fraud are repeatedly suggested and applied to numerous business fields. The foremost job
of Fraud detection is to observe the actions of tons of users to detect unsolicited behaviour. To detect
these different kinds of data mining methods have been suggested and executed to diminish down the
attacks. In this chapter a deep literature survey is tabled on various methods for fraud detection applying
data mining techniques.

110

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Authors in (Ghosh & Reilly, 1994) have proposed an innovative technique using neural network for
credit card fraud detection. A detection technique is implemented which is skilled and it is checked on a
large amount of model of labelled credit card account transactions. The study demonstrated that due to
its power to discover fake patterns on credit card accounts, it is easy to achieve a lessening of from 20%
to 40% in total fraud losses, at importantly reduced caseload for human assessment.
A database mining model named CARDWAT CH is suggested by authors in (Aleskerov et al., 1997)
which can be implemented for credit card fraud detection. Neural network is used to train the specific
historical used data & then neural network model is generated in the system. It was developed to notice
fraudulence.
A credit card fraud detection system (Maes et al., 2002) is proposed using Bayesian & neural network
methods to find out models of fraudulent credit card transactions.
Authors in (Kim & Kim, 2002),(Magalla, 2013) found that there are two principal causes for the com-
plexity of credit card fraud detection i.e. inclined distribution of data & mix of legitimate & fraudulent
transactions. Fraud density of real transactions data is used a confidence values & generate the weighed
fraud score to cut down the number of misdetections. All abovementioned approaches do not concern
to convert the training data into confidence value before putting into neural network. Furthermore, a
fixed threshold is set to find abnormal and normal spending pattern in the above-mentioned approaches
without concerning the cost problem derived from false positive and false negative. The Threshold can-
not be adjusted dynamically based on frequency of fraudulent either. NNM combining with confidence
and ROC analysis technology for fraud detection is introduced in detail by the authors. Fraud detection
system is the next layer of protection; which is also the concern of this chapter.
Authors in (Belo & Vieira, 2011) explains the ways in which fraud can be used versus organizations.
They also evaluated the limitations and drawbacks of current systems & methods to detect & prevent fraud.
Fraud detection tries to discover and identify fraudulent activities as they enter the systems and report
them to a system administrator (Behdad et al., 2012).
In previous years, manual fraud audit techniques such as discovery sampling have been used to detect
fraud, such as in (Tennyson, 2001).
Authors in (Li et al., 2008) proposed an effective computerized & automated FDS. Because of com-
plicated & time-consuming techniques there is need of system which can help the fraud detection. The
developed FDS capabilities were limited which was the drawback of the system.
Understanding these drawbacks more complex FDS with more accurate and precise data mining
methods were developed for efficient fraud detection (Edelstein, 1997).
The used method involves AI, machine learning and statistical methods. These methods helps to
collect and identify the needed information from the huge databases Implementing this system will give
following advantages: capturing fraud patterns from the data, stipulation of fraud likelihood for every
case, accordingly that effort in exploring shady cases can be placed, and finding new fraud types which
have not been recorded yet(Akhilomen, 2013). The main categories in data mining are clustering, outlier
detection, classification, regression, prediction and visualization. A specific technique is supported by
each of these methods. Like SVM & neural network are used for data mining classification and k means
for data clustering method.
Various mechanisms are implemented for outlier detection (Hung & Cheupg, 1999), authors in this
paper use unsupervised learning approach. Mostly they obtained results of unsupervised learning will
lead to improve the future decisions. In these strategies there’s no need of antecedent knowledge of
fraudulent & non-fraudulent transactions in database. It detects if any uncommon behaviour happens.

111

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

All the models in supervised strategies are aimed to isolate among fraudulent & non-fraudulent manner
in order that new readings are often assigned to classes. correct identification of fraudulent transactions
in database is needed in supervised strategies and this could solely be used to detect the frauds that have
occur earlier that why most of the researchers prefer using unsupervised strategies as the undiscovered
forms of fraud are often detected.
In (Bolton & Hand, 2001) researchers have presented an unsupervised credit card fraud detection
which utilizes outlier detection technique. The potential fraud cases which can be named as outliers are
Abnormal spending behaviour & frequency of transactions.
A deep survey is presented in (Phua et al., 2010) for fraud detection methods. The authors have
distinct the fraudster, its types and subtypes and they also posed the nature of data evidence collected
from the industries.
In (Padhy et al., 2012) authors stated the application of data mining is anomaly detection.
Authors in (Chauhan et al., 2011) showed readymade data mining approaches which can be imposed
to detect intrusion.
Authors in (Garcia-Teodoro et al., 2009) surveyed all the network intrusion detection systems; they
also provide techniques which are potentially deployed to notice the fraud.
Many data mining methods are explained in (Issa & Vasarhelyi, 2011), (Thiprungsri & Vasarhelyi,
2011), (Jans et al., 2007), (Donoho, 2004). In (Jyotindra & Ashok, 2011), (Le Khac & Kechadi, 2010),
(Panigrahi et al., 2009) clustering is the only tool which is used with complex data mining.
Authors in (Hao et al., 2010) proposed clustering visualization techniques for financial fraud detection.
K-means & its variations for outlier detection techniques are explained in (Jans et al., 2007) most
cases where standalone clustering methods are being used make use of k-means and its variations for
outlier detection. In most cases, Euclidian distance is getting used because the dissimilarity metric.
(Issa & Vasarhelyi, 2011) Implements k-means with the intent of identifying fraudulent refunds within
a telecommunication company with fraudulent transactions being considered outliers.
K-means is implemented in (Thiprungsri & Vasarhelyi, 2011) for fraud filtering during an audit.
Similar features are sorted together & small clusters are flagged for further processing.
Based on ANOVA analysis k means is implemented on newly added attributes, authors in (Jans et
al., 2007) identified 3 fraud schemes related to purchasing, double payment, changing purchasing order
after release.
To detect the early symptoms of insider trading (Donoho, 2004) employs k-means n- option markets
before any news release.
A technique proposed which mines the transaction data using the text document in monetary vec-
tor (Zhang et al., 2003). Computed monetary vectors are either clustered via k-means or projected to a
histogram. Another case group standing out consists of clustering methods used for training classifiers.
Due to proliferation of enterprise resource planning systems and an ever-growing amount of available
data to be studied, manually labelling training data for various classifiers has become unfeasible in
many cases. In these situations, a clustering technique is first used on the uncategorized data in order to
automatically split it into meaningful categories. Each cluster/category is labelled (usually manually)
and then classifiers are being trained on each cluster/category. The majority of papers found are mostly
using classifiers implemented on decision trees, neural networks & SVMs.
Authors in (Wu et al., 2010) manually splits the information into numerous large classes from the
dataset and showed raw class analysis on it and also accomplish k mean with Euclidian distance as differ-
ence metric on each class. Subclasses are produced by this local clustering process with relatively stable

112

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

sizes within each main class, sub-classes used later on for training an SVM classifier. The recommended
scheme is confirmed on neural networks and decision trees and the results describe this technique pro-
duces higher estimate on infrequent classes as compare to other schemes.
Authors in (Le Khac & Kechadi, 2010) generates new composite attributes from transaction data
& uses them in k-means clustering to divide transactions into suspicious and unsuspicious, most being
unsuspicious. For training of classifiers like neural networks & decision trees on identified cluster the
full set attributes are used.
(Chang & Chang, 2010) Discerns sorts of behaviour changes from different impostors with the sup-
port of x-means clustering technique. Later on, C4.5 decision trees are implemented for receiving the
guidelines of the labelled clusters.
(Jurek & Zakrzewska, 2019) Accomplishes k-means on insurance data and trains a NB classifier on
each found cluster.
In (Virdhagriswaran & Dakin, 2006) authors suggest a technique to distinguish fraud to look like
normal activities in domains with associations like accounting fraud detection for rating & investment
and attacks on corporate networks, health care insurance fraud. To classify k-means classifier is used.
There are cases where clustering methods are implemented to group already flagged, possible fraudulent
entries by classifiers. The clustering goal in this condition is to define taxonomy of the already identified
fraud entries in order to implement counter measures for each found fraud category. In some situations,
some categories may be even found to contain legitimate data, wrongly labelled by the classifier due to
inadequate training to such cases.
Authors in (Ghani & Kumar, 2011) suggested a system to search the faults in payments in insurance
claims by executing ranked frictional clustering on entities flagged as fraudulent via SVM.
In (Deng & Mei, 2009) the author computes economic ratios from utilizing the statements from
companies. Here a pre-defined map neural network is applied with economic ratios as its input vector,
along with that k-means is executed on self- organizing map node vector.

4. BASIC CONCEPT OF DATA MINING AND SUPERVISED MACHINE LEARNING

Data mining is a efficient and powerful technique widely used by organizations to enhance their busi-
nesses and gain a competitive advantage over their competitors. The data mining process helps in ex-
tracting and analyzing various data patterns, information or trends from large databases. Various data
mining techniques are available to conduct the data mining process. Data mining techniques are used
in a variety of applications, one of which is the detection and prevention of different types of frauds.
Data Mining technique involves different types of task like Classification, Regression, Clustering etc.
Classification is a task of supervised learning technique. It is a classic data mining technique based on
supervised machine learning method involving a function that maps (or classifies) a data item into one
of the predefined classes. On the other hand, regression is a data mining technique which is used to fit
an equation to a dataset. It can be used to predict a real value such as profit, mortgage, temperature, or
distance. Clustering (or unsupervised learning) is a data mining technique that makes meaningful or
useful cluster of objects based on similar characteristics.

113

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

5. MAJOR AREAS OF FRAUD DETECTION

Frauds can arise in different areas like telecommunication, credit and debit transaction, insurance, health-
care etc. Fraud cases are increasing day by day. We should come up with some effective approaches to
solve these types cases which are very harmful for individual person as well as small to big organizations.

Figure 1.

5.1 Telecommunication

There are many forms of telecommunication fraud occurring in sector of telecommunication. One of
these types fraud is subscription fraud in which fraudsters obtain telecommunication accounts without
paying any service for that. Second one is superimposed fraud. In this fraud cases the fraudster takes over
the account of a legitimate subscriber and all the call charges are billed to that legitimate subscriber. It
includes cellular cloning, calling card theft and cellular handset theft. This type of telecommunication
fraud is most challenging for telecommunication companies. Most telecommunication companies, such
as AT&T have dedicated research to develop effective detection methods for this type of telecommuni-
cation fraud (Shmais & Hani, 2011).

5.2 Computer Fraud

Computer fraud is the use of computers, the Internet, Internet devices, and Internet services to defraud
people or organizations of resources. Illegal computer activities include phishing, social engineering,
viruses, and DDoS attacks are some examples used to disrupt service or gain access to another’s funds.
See our computer crime page for a list of additional examples.
Phishing is a cybercrime in which a target or targets are contacted by email, telephone or text mes-
sage by someone posing as a legitimate institution to lure individuals into providing sensitive data such
as personally identifiable information, banking and credit card details, and passwords.
Social engineering refers to the psychological manipulation of people so that they perform actions
or divulge confidential information. Fraudsters are usually looking for the victim to give up sensitive
information such as login details, or trick the victim into carrying out a fraudulent payment themselves.

114

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

A computer virus is a type of computer program that, when executed, replicates itself by modifying
other computer programs and inserting its own code. When this replication succeeds, the affected areas
are then said to be infected with a computer virus.
A distributed denial-of-service (DDoS) attack is a malicious attempt to disrupt normal traffic of a
targeted server, service or network by overwhelming the target or its surrounding infrastructure with a
flood of Internet traffic. DDoS attacks achieve effectiveness by utilizing multiple compromised computer
systems as sources of attack traffic. Exploited machines can include computers and other networked
resources such as IoT devices. From a high level, a DDoS attack is like a traffic jam clogging up with
highway, preventing regular traffic from arriving at its desired destination.

5.3 Credit and Debit Card Transaction

Credit card fraud detection is a method of identifying and monitoring the transaction done by the cus-
tomers. There are different types of credit card frauds like application fraud, assumed identity fraud,
financial fraud, fraud using skimming technology, magnetic card skimming etc. Nowadays most of the
customers use their credit card or debit card for purchasing products online or recharging their mobiles,
DTH connections, pay Tax, electric bill etc. There is always risk of fraud cases.

5.4 Insurance

Insurance frauds are the types of frauds which occur in different insurance companies. It involves an
insurance company, agent or other persons who are deceived by individuals in an attempt to achieve
monetary gains to which they are not entitled. Insurance fraud is said to have happened when someone
has put false information on an insurance application or if any incorrect information is given or if any
important information is deleted in an insurance claim or transaction. There are different areas of in-
surance. Some of the important insurances are Healthcare insurance, automobile insurance, corporate
insurance etc. The data collected from these insurance companies can be used for different purposes like
data analysis, finding correlation, prediction of fraud cases by machine learning approaches.

5.5 Health Care

Health care is the maintenance or improvement of health via the prevention, diagnosis, treatment, recovery,
or cure of disease, illness. Health care is delivered by health professionals in different areas of health.
Physicians and physician associates are associated with healthcare as health professionals. Dentistry,
pharmacy, midwifery, nursing, medicine, optometry, audiology, psychology, occupational therapy, physi-
cal therapy, athletic training and other health professions are all part of health care. It includes work done
in providing primary care, secondary care, and tertiary care, as well as in public health.
Healthcare and medical insurance is a rich area for fraud schemes . It is due to the fact that the pro-
cess of healthcare requires many approvals and verifications from the persons or authorities assigned for
that work. Both hospitals and insurance companies are suffering from these issues. To fix the different
fraudulent issues we can apply data analysis and machine learning methods.
There are different subareas of frauds occurring in healthcare like in Upcoding, in Medical receipts
and bills, in Personal identity etc.. Upcoding is a specific type of fraud where a healthcare provider or a
healthcare worker tries to charge more to a patient or an insurance company. Personal identity indicates

115

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

one’s information that indentifies himself/herself. Personal identity fraud cases are very dangerous for
human being and should be overcome strict rule, regulation and strong security. Image recognition
algorithms can be used for fraud prevention at the personal identification stage. Machine learning can
solve the problem of ID verification by applying face and fingerprint recognition.

6. DATA MINING IN FRAUD DETECTION

Data mining refers to extracting or mining knowledge from large amount of data. It as the process of dis-
covering patterns in data There are a number of data mining techniques like clustering, neural networks,
regression, multiple predictive models. The process of data mining must be automatic or (more usually)
semi automatic. The patterns discovered must be meaningful in that they lead to some advantages, usu-
ally an economic advantage.
There are various steps that are involved in mining data as shown in the picture.

Figure 2. Steps to apply data mining on any raw data

1. Data Integration: Data are collected from different sources. Normally data should be collected
from sources of same domain for any specific type of application. Data can be raw text data, audio
data, video data or of any other format of data.
2. Data Selection: As data are collected from different sources. There may be several redundant data
which may not be so useful for the intended purpose. Useful data are identified and then selected
for further action.
3. Data Cleaning: The collected data may contain some missing values, noise or error. It may contain
inconsistent data. Therefore, some techniques should be applied to clean the data.
4. Data Transformation: The data which is generated after applying cleaning process are not exactly
suitable for mining as it needs to be transformed into appropriate format for mining. The techniques
which are used to accomplish data transformation are aggregation, smoothing, normalization etc.
5. Data Mining: After applying selection, cleaning and transformation, we should apply data min-
ing techniques on the data to find out the interesting patterns hidden in the data. Techniques like
clustering and association analysis are among the many different techniques used for data mining.
6. Pattern Evaluation and Knowledge Presentation: This step involves visualization of the pattern
generated by data mining. The result can be visualized by graph bar chart or other plotting methods.
7. Decisions / Use of Discovered Knowledge: This step makes a decision from results of previous
step. The decision can be in the format of yes or no normally, though, multiple options may be
there for decision making.

116

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

7. SUPERVISED MACHINE LEARNING METHODS FOR FRAUD DETECTION

Supervised learning is the machine learning task of learning a function that maps an input to an output
based on example input-output pairs. It infers a function from labeled training data consisting of a set of
training examples (Russell & Norvig, 2010). In supervised learning, each example is a pair consisting of
an input object (typically a vector) and a desired output value. A supervised learning algorithm analyzes
the training data and produces an inferred function, which can be used for mapping new examples. Some
supervised machine algorithms are Decision Tree, Random Forest, Support Vector Machine, K-Nearest
Neighbour, Neural Networks and Deep Learning. All these algorithms are described below.

7.1 Decision Tree

Decision Trees (DTs) are a supervised learning technique that predict values of responses by learning
decision rules derived from features. They can be used in both a regression and a classification context.
DT models are an example of a more general area of machine learning known as adaptive basis func-
tion models. These models learn the features directly from the data, rather than being pre-specified, as
in some other basis expansions. However, unlike linear regression, these models are not linear in the
parameters and so we are only able to compute a locally optimal maximum likelihood estimate (MLE)
for the parameters (Murphy, 2012).

7.2 Random Forest

Random forests or random decision forests are an ensemble learning method for classification, regression
and other tasks that operate by constructing a multitude of decision trees at training time and outputting
the class that is the mode of the classes (classification) or mean prediction (regression) of the individual
trees.(Forests, 1995)[41] Random decision forests correct for decision trees’ habit of overfitting to their
training set.(Hastie, 2001)
The random forest is a model made up of many decision trees. Rather than just simply averaging the
prediction of trees (which we could call a “forest”), this model uses two key concepts that gives it the
name random:

1. Random sampling of training data points when building trees

2. Random subsets of features considered when splitting nodes

When training, each tree in a random forest learns from a random sample of the data points. The
samples are drawn with replacement, known as bootstrapping, which means that some samples will be
used multiple times in a single tree. The idea is that by training each tree on different samples, although
each tree might have high variance with respect to a particular set of the training data, overall, the entire
forest will have lower variance but not at the cost of increasing the bias.
At test time, predictions are made by averaging the predictions of each decision tree. This procedure
of training each individual learner on different bootstrapped subsets of the data and then averaging the
predictions is known as bagging, short for bootstrap aggregating.

117

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

7.3 Support Vector Machine

In machine learning, support-vector machines (SVMs, also support-vector networks(Cortes & Vapnik,
1995)) are supervised learning models with associated learning algorithms that analyze data used for
classification and regression analysis. Given a set of training examples, each marked as belonging to one
or the other of two categories, an SVM training algorithm builds a model that assigns new examples to
one category or the other, making it a non-probabilistic binary linear classifier (although methods such

Figure 3. SVM (Many Hyperplanes)

Figure 4. (Optimal Hyperplane)

118

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

as Platt scaling exist to use SVM in a probabilistic classification setting). An SVM model is a represen-
tation of the examples as points in space, mapped so that the examples of the separate categories are
divided by a clear gap that is as wide as possible. New examples are then mapped into that same space
and predicted to belong to a category based on the side of the gap on which they fall.
In addition to performing linear classification, SVMs can efficiently perform a non-linear classification
using what is called the kernel trick, implicitly mapping their inputs into high-dimensional feature spaces.
Support vector machine algorithm finds one hyperplane in an N-dimensional space that distinctly
classifies all the data points. Here N is the number of features used in the dataset.
Here we are considering data which have two possible classes. For separating these data points, there
are many possible hyperplanes that could be chosen. SVM algorithm finds a plane that has the maximum
margin. Maximum margin indicates maximum distance between the data points of both classes.

7.4 K-Nearest Neighbour

K-Nearest Neighbors(KNN) is one of the most basic yet essential classification algorithms in Machine
Learning. It belongs to the supervised learning domain and finds intense application in pattern recogni-
tion, data mining and intrusion detection.
KNN algorithm performs predictions or classifications by considering all the training dataset. It
considers whole training dataset to predict the output for every example. Due to this, this algorithm
takes more time to predict or classify several test examples. Basically, this algorithm does not generate
a model or classifier like other classification algorithms. In KNN algorithm, predictions are made for
a new instance (say, x) by searching through the entire training set and find K number of most similar
instances (the neighbors). Then, it summarizes the output variable for those K instances.
To determine which of the K instances in the training dataset are most similar to a new input a dis-
tance measure is used. For real-valued input variables, the most popular distance measure is Euclidean
distance. If K = 1, then the case is simply assigned to the class of its nearest neighbor.

Table 1. Distance measuring function in KNN

Name of Function Mathematical Formula

∑ (x − yi )
2
Euclidean Distance d (x , y ) = i
i =1

n
Manhattan Distance d = ∑ x i − yi
i =1

1/ p
 n 
 p

∑ x i − yi
Minkowski Distance 
i =1


119

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Choosing the optimal value for K is best done by first inspecting the data. In general, a large K value
is more precise as it reduces the overall noise but there is no guarantee. Cross-validation is another way
to retrospectively determine a good K value by using an independent dataset to validate the K value.
Historically, the optimal K for most datasets has been between 3-10. That produces much better results
than 1NN.

7.5 Neural Networks and Deep Learning

An artificial neutral network (ANN) is a system which is similar to biological neural network. The ANN
creates one computational environment of network which is like biological neural network. An ANN
is formed with a network of artificial neurons. These nodes are connected to each other. Three types of
neurons available in ANN are input nodes, hidden nodes, and output nodes.

Figure 5.

Figure 6.

120

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

The input nodes take information, in the form which can be numerically expressed. This information
is then passed throughout the network. The input value is weighted by the weight assigned in a connec-
tion. On a particular node all these weighted inputs are summed up and this sum is passed through on
activation function..

Transfer (Activation) Functions

The transfer function or activation function converts the received input to one output. Different types of
activations are mentioned below.

Unit Step (Threshold)

In this method one threshold value is considered. The output of the function is 1 or 0 depending on
whether the total input is greater than or less than one predefined threshold value.

Sigmoid Function

The sigmoid function can be of tyo types logistic and tangential. For logistic function range of the output
value varies from 0 and 1 and for tangential function it is from -1 to +1
Hyperbolic Tangent function- Tanh: Its mathematical formula is

Figure 7.

Figure 8.

121

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

2
f (x ) = tanh(x ) = −1
1 + e −2 x

ReLu- Rectified Linear: Its mathematical formula is

f(x) = max(0,x)

8. CONCLUSION

As business frauds are very harmful for individual person and business organization, it needs to removed
from every areas or sectors having possibility to be involved in fraud cases. Using Data Mining and
Supervised Learning techniques, it is possible to develop a system which will continuously monitor all
the transactions occurring in different sectors. One fraud detector system whose performance is very
good in detecting fraud cases will make human life free of tension related to fraud cases.

REFERENCES

Akhilomen, J. (2013). Data mining application for cyber credit-card fraud detection system. Lecture
Notes in Engineering and Computer Science, 1537–1542.
Aleskerov, E., Freisleben, B., & Rao, B. (1997). CARDWATCH: A Neural Network Based Database
Mining System for Credit Card Fraud Detection. Proc. IEEE/IAFE: Computational Intelligence for
Financial Engineering, 220-226. 10.1109/CIFER.1997.618940
Behdad, M., Barone, L., Bennamoun, M., & French, T. (2012). Nature-inspired techniques in the context
of fraud detection. IEEE Trans. Syst. Man Cybern. Part C (Appl. Rev.), 42(6), 1273–1290. doi:10.1109/
TSMCC.2012.2215851
Belo, O., & Vieira, C. (2011). Applying User Signatures on Fraud Detection in Telecommunications
Networks. Academic Press.
Bolton, R. J., & Hand, D. J. (2001). Unsupervised profiling methods for fraud detection. In Conference
of Credit Scoring and Credit Connol VII, Edinburgh, UK.
Business Study Notes. (n.d.). Auditing. https://www.businessstudynotes.com/finance/auditing/fraud-in-
business/
Chang, W.-H., & Chang, J.-S. (2010). Using clustering techniques to analyze fraudulent behavior changes
in online auctions. 2010 International Conference on Networking and Information Technology (ICNIT),
34-38. 10.1109/ICNIT.2010.5508564
Chauhan, A., Mishra, G., & Kumar, G. (2011). Survey on Data mining Techniques in Intrusion Detec-
tion. International Journal of Scientific and Engineering Research, 2(7), 1–4.

122

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Cortes, C., & Vapnik, V. (1995). Support-Vector Networks. Machine Learning, 20(3), 273–297.
doi:10.1007/BF00994018
Data Flair. (n.d.). https://data-flair.training/blogs/data-mining-tutorial
Deng, Q., & Mei, G. (2009). Combining self-organizing map and K-means clustering for detecting
fraudulent financial statements. IEEE International Conference on Granular Computing, 126-131.
10.1109/GRC.2009.5255148
Donoho, S. (2004). Early detection of insider trading in option markets. Proceedings of the tenth
ACM SIGKDD international conference on Knowledge discovery and data mining, 420–429.
10.1145/1014052.1014100
Edelstein, H. (1997). Data Mining: Exploiting the Hidden Trends in Your Data. DB2Online Mag., 2, 1.
Forests, R. D. (Ed.). (1995). Proceedings of the Third International Conference on Document Analysis
and Recognition. IEEE Computer Society.
Garcia-Teodoro, P., Diaz-Verdejo, J., Maciá-Fernández, G., & Vázquez, E. (2009). Anomaly-based
network intrusion detection: Techniques, systems and challenges. Computers & Security, 28(1), 18–28.
doi:10.1016/j.cose.2008.08.003
Ghani, R., & Kumar, M. (2011). Interactive learning for efficiently detecting errors in insurance claims.
Proceedings of the 17th ACM SIGKDD international conference on Knowledge discovery and data min-
ing, 325–333. 10.1145/2020408.2020463
Ghosh, S., & Reilly, D. L. (1994). Credit Card Fraud Detection with a Neural Network. Information
Systems: Decision Support and Knowledge-Based Systems, 3, 621-630. 10.1109/HICSS.1994.323314
Hao, M. C., Dayal, U., Sharma, R. K., Keim, D. A., & Janetzko, H. (2010). Bibliothek der Universität
Konstanz. Visual Analytics of Large Multi-Dimensional Data Using Variable Binned Scatter Plots.
Bibliothek der Universität Konstanz.
Hastie, T. J. (2001). The Elements Of Statistical Learning. Academic Press.
Ho, T. K. (1998). The Random Subspace Method for Constructing Decision Forests. IEEE Transactions
on Pattern Analysis and Machine Intelligence, 20(8), 832–844. doi:10.1109/34.709601
Hung & Cheupg. (1999). Parallel Algorithm for Mining Outliers in Large Database. http: l/citeseer.
nj.nec.comihung99parallel.hbnl
Issa & Vasarhelyi. (2011). Application of Anomaly Detection Techniques to Identify Fraudulent Refunds.
Academic Press.
Jans, Lybaert, & Vanhoof. (2007). Data Mining for Fraud Detection: Toward an Improvement on Internal
Control Systems. Academic Press.
Jurek, A., & Zakrzewska, D. (2019). Improving Naïve Bayes models of insurance risk by unsupervised
classification. Computer Science and International Journal of Applied Engineering Research, 14(7),
137–144.

123

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Jyotindra, N. D., & Ashok, R. P. (2011). A Data Mining with Hybrid Approach Based Transaction Risk
Score Generation Model (TRSGM) for Fraud Detection of Online Financial Transaction. International
Journal of Computers and Applications, 16(1), 18–25. doi:10.5120/1977-2651
Kim, M. J., & Kim, T. S. (2002). A Neural Classifier with Fraud Density Map for Effective Credit Card
Fraud Detection. Lecture Notes in Computer Science, 2412, 378-383. 10.1007/3-540-45675-9_56
Le Khac, N. A., & Kechadi, M.-T. (2010). Application of Data Mining for Anti-money Laundering Detec-
tion: A Case Study. IEEE International Conference on Data Mining Workshops. 10.1109/ICDMW.2010.66
Li, J., Huang, K.-Y., Jin, J., & Shi, J. (2008). A survey on statistical methods for health care fraud detec-
tion. Health Care Management Science, 11(3), 275–287. doi:10.100710729-007-9045-4 PMID:18826005
Machine Learning Mastery. (n.d.). https://machinelearningmastery.com/supervised-and-unsupervised-
machine-learning-algorithms/
Maes, S., Tuyls, K., & Vanschoenwinkel, B. (2002). Credit Card Fraud Detection Using Bayesian and
Neural Networks. In First International NAISO Congress on Neuro Fuzzy Technologies, Havana, Cuba.
Magalla, A. (2013). Security, Prevention and Detection of Cyber Crimes. Tu-Maini University Iringa
University College.
Murphy, K. P. (2012). Machine Learning A Probabilistic Perspective. MIT Press.
Padhy, N., Mishra, P., & Panigrahi, R. (2012). The Survey of Data Mining Applications and Feature
Scope. International Journal of Computer Science. Engineering and Information Technology, 2(3), 43–58.
Panigrahi, S., Kundu, A., Sural, S., & Majumdar, A. (2009). Credit card fraud detection A fusion ap-
proach using Dempster-Shafer theory and Bayesian learning. Information Fusion, 10(4), 354–363.
doi:10.1016/j.inffus.2008.04.001
Phua, C., Lee, V., Smith, K., & Gayler, R. (2010). A comprehensive survey of data mining-based fraud
detection. Research, 1-14.
Russell, S. J., & Norvig, P. (2010). Artificial Intelligence: A Modern Approach (3rd ed.). Prentice Hall.
Shmais & Hani. (2011). Data Mining for Fraud Detection. Academic Press.
Tennyson, S. (2001). Claims Auditing in Automobile Insurance. Procedia Technol., 9, 1252–1264.
Thiprungsri & Vasarhelyi. (2011). Cluster Analysis for Anomaly Detection in Accounting Data: An
Audit Approach. The International Journal of Digital Accounting Research, 11.
Virdhagriswaran, S., & Dakin, G. (2006). Camouflaged fraud detection in domains with complex re-
lationships. Proceedings of the 12th ACM SIGKDD international conference on Knowledge discovery
and data mining, 941–947. 10.1145/1150402.1150532
Wu, J., Xiong, H., & Chen, J. (2010, January). COG: Local decomposition for rare class analysis. Data
Mining and Knowledge Discovery, 20(2), 191–220. doi:10.100710618-009-0146-1

124

A Study on Various Applications of Data Mining and Supervised Learning Techniques in Business

Zhang, Z. M., Salerno, J. J., & Yu, P. S. (2003). Applying data mining in investigating money laundering
crimes. Proceedings of the ninth ACM SIGKDD international conference on Knowledge discovery and
data mining, 747–752. 10.1145/956750.956851

125
126

Chapter 9
Detection and Prevention of
Fraud in the Digital Era
Evrim Vildan Altuk
https://orcid.org/0000-0003-2139-8081
Trakya University, Turkey

ABSTRACT
It is essential for businesses to keep up with the technological advances. Today nearly all the businesses
depend on computer technologies and the Internet to operate as technological developments have in-
troduced many practical methods for businesses. Yet, transformation of businesses technologically also
presents new means for the criminals, which has led to new types of fraud. It is crucial for businesses to
take measures to prevent fraud. Traditional methods to prevent or to detect fraud seems to be ineffective
for new types of fraud in the digital era. Therefore, new methods have been used to prevent and detect
fraud. This chapter reviews fraud as a form of cybercrime in the digital era and aims to introduce the
methods that have been used to detect and prevent it.

INTRODUCTION

Fraud is an old story and has been there since the existence of human beings. The nature of fraud has
changed over time. Fraud has become much more prevalent compared to the past. Many methods have
been developed to prevent fraud but fraudsters have always been one step ahead. With the digital trans-
formation of companies, fraud has also gone through transformation. Technological developments have
enabled companies to present their products and services to meet customers’ needs but fraudsters also
perpetrate fraud through technological opportunities and there remains just a bit of imagination. Thus,
technology seems to have two aspects: “good and bad”. With the technological developments, some gaps
have also emerged in the transactions that companies make, which also encourages fraudsters.
The invention of the Internet has introduced many investment opportunities. While the Internet has
made information accessible more easily and given everything more transparency, it has also created
more opportunities for fraudsters. Fraudsters often deceive unaware victims by promising spectacular
returns (Cross, 2013).

DOI: 10.4018/978-1-7998-4805-9.ch009

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Detection and Prevention of Fraud in the Digital Era

In a digital world, companies often face both internal and external threats. Insider frauds can be
perpetrated by employees of companies whereas outsider frauds are incidences, such as computer hack-
ing and computer viruses. Some fraudsters are also capable of adapting old fraud schemes to the digital
environment.
The term “cybercrime” has been introduced in this new era. Cybercrime is criminal activities in which
a computer or network of computers is an integral part of the crime including activities such as spam-
ming, theft of electronic intellectual property and other financial frauds. On the other hand, computer
programmers have developed data analysis software that enables users to sift mass of information and
transactions to detect fraudulent activities.
Cybercrime involves any crime committed through the Internet. This chapter reviews only cyber-
crimes against businesses. The present study also reviews the methods to prevent and detect fraud in
the digital era.

BACKGROUND

There is not a common definition of fraud. Fraud involves a wide range of activities united by some
form of misrepresentation by a party to provide that party with an advantage or cause a disadvantage to
others including criminal, civil and regulatory acts of deviance (Button and Cross, 2017).
Fraud incorporates four basic elements:

• “A false representation of nature of material

• Intent or knowledge that the representation is false, or intentional disregard for the accuracy
• Reasonably and justifiably relying on the representation
• Financial damages as a result of the preceding elements” (Skalak, Golden, Clayton &Pill, 2011:
p.2).

Fraud is defined as an intent to cheat or gain an unmerited benefit including a broad set of acts. The
American Institute of Chartered Public Accountants (AICPA) describes two main categories of fraud,
which are deliberate misstatement of financial information, and misappropriation of assets (or theft).
The definition of fraud might be extended as follows:
“Fraud consists of an illegal act (the intentional wrongdoing), the concealment of this act (often only
hidden via simple means), and the deriving of a benefit (converting the gains to cash or other valuable
commodity)” (Coderre, 2009: p.3). From a business standpoint, fraud may be defined as the misuse of
assets in an organization and misrepresentation of financial statements.
Although there are various types of fraud, it can broadly be divided into employee fraud or misap-
propriation of assets and financial statement fraud (Skalak, Golden, Clayton &Pill,2011: p.5)
Employee fraud or misappropriation of assets might be perpetrated by any officer and employer
working for an organization. Examples of this type of fraud are pilfering of cash and inventory, skim-
ming revenues, payroll fraud, and embezzlement.
Financial Statement fraud is the intentional misrepresentation or omissions of amounts or disclo-
sures in financial reports to deceive the people who use financial statements. Particularly, it includes
manipulation, falsification, or alteration of accounting records or supporting documents that are used to

127

Detection and Prevention of Fraud in the Digital Era

create financial statements. It also refers to the deliberate misappropriation of accounting principles to
manipulate results. (ACFE, 2014; Skalak, Golden, Clayton & Pill,2011: p.5).
Many organizations may be damaged by fraud independent of their size, location or the industry they
operate in (Skalak, Golden, Clayton &Pill,2011: p.3). According to PwC’s report on Global Economic
Crime and Fraud Survey of 2020, which was answered by more than 5.000 respondents all around the
world, fraud has the second highest level (47%) of incidents in the past twenty years (PwC, 2020). The
report identifies fraud as a growing issue.
Today almost all businesses make use of computer systems to assist their operations, including staff
or financial management (ACFE- Fraud Examiners Manual, 2011), which makes businesses vulnerable
to cyber-attacks.
Technological developments have paved the way for new types of fraud that did not exist before
or were much more difficult to detect. The rapid developments in technology (such as computers, the
internet, mobile phones) has also offered completely new ways of doing business and providing ser-
vices. New payment methods, such as online banking or automated telephone systems have made paper
checks mostly a thing of the past. The number of loans, social security benefits, grants, tax returns,
and passports which have been secured through online and automated telephone technologies is also
growing day by day. Traditional face-to-face interactions have also been replaced by email and other
modern forms of communication between companies, their staff and customers. Traditional methods of
business, communication and knowledge production have been interrupted by the Internet revolution
(Button and Cross, 2017).

Nick Tranto, Headquarters Excise Tax Policy Manager for the Internal Revenue Service (retired) sug-
gests that there are three periods of fraudulent activities. The eras are “Paleolithic Era”, “Neolithic
Era” and “Geek-olithic Era”. In the Paleolithic Era fraudulent activity refers to laundering cash and
evading taxes. In the Neolithic Era, bad guys realized that an accountant could steal more than many
criminals armed with guns. Perpetrators were generally first-generation college students and sons of
mobsters. While tax evasion and money laundering were the focus of organized crime, this era included
some traditional organizational forms such as legitimate casino business, other cash-heavy businesses
and the interaction between legitimate and illegitimate activities. The perpetrators of the last period
“the Gleek-olithic Era” are much more talented such as computer specialists, attorneys, MBAs, Wall
Street professionals and other professionals who can use some techniques like offshore bank accounts,
jurisdictional differences around the world and technology to move and hide billions of dollars of cash (as
cited in Kranacher et al., 2010). Now many organizations are face to face with more talented fraudsters.

A web search query based on the term “fraud” may yield more diverse results, including “internet
fraud”, “computer fraud”, “cyber fraud” and cybercrime. However, cybercrime is the most common
term to define crimes on the Internet.
Cybercrime involves criminal acts committed with the help of computers and networks. Cybercrime
is a generic term which expresses a wide-range of acts from hacking to denial of service attacks that
cause businesses to lose money (Kratchman et al. 2008). Hence, cybercrimes require a decent knowledge
of how computers work (Kävrestad, 2018).
The word ‘cybercrime’ has been used by ‘cybercriminals’ referring to crimes committed on com-
puters on the Internet. With new technologies like ‘grooming’, ‘phishing’ and ‘pharming”, cybercrime
practices have gone beyond the traditional crimes. It also covers traditional crimes (such as in supply

128

Detection and Prevention of Fraud in the Digital Era

chain and fraud) plus hugely topical cases of hijacking. Although there have been these kinds of attacks
and cybercrime wars, cybercrime is the primary tool of fraud in the modern world mainly used for intel-
lectual property theft, trade-secret theft, patents, impersonation and direct theft. With the technological
developments in the 21st century technology has become an essential part of daily life. However, this
also led to a huge increase in the crimes committed on the Internet, including some serious crimes, such
as child pornography and cyber terrorism. For our purposes we will deal with fraud‐related cybercrime.
(Ross, 2015).
Cybercrime has expanded the boundaries of traditional crimes with activities such as spreading
computer viruses, stalking phishing, perpetrating insider threats and causing a denial-of-service (DoS)
attack (when a perpetrator seeks to prevent intended users from accessing information or services),
pharming (AICPA, 2017; Ross, 2015). Cybercrime involves a wide spectrum of serious crimes such as
intellectual property theft, software piracy, online gambling, hate crimes, espionage, and cyber terrorism
(Ross, 2016; Singleton & Singleton, 2010).
DoS attacks are cyber crimes where the perpetrator’s goal is to make a computer or other types of
electronic devices unavailable to its users. In DoS attacks, a computer network is often overloaded with
massive amounts of data in a very short time to make the servers unable to hold up the data that is being
transmitted. Distributed denial of service (DDoS) attacks which often make use of botnets that can be
remotely controlled are even more threatening to information systems. This helps a perpetrator to attack
multiple networks and areas simultaneously. DoS and DDoS attacks can do a hefty amount of financial
loss and damage the reputation of a business as people might think that the business is incapable of
preventing DoS and DDoS attacks (McQuade, 2009).
Cybercrime involves a wide spectrum of serious crimes such as intellectual property theft, software
piracy, online gambling, hate crimes, espionage, and cyber terrorism (Ross, 2015; Singleton & Single-
ton, 2010).
Individuals and organizations manage their funds using the Internet, which makes them targets of
fraudsters (Wall, 2011). PwC’s report on Global Economic Crime and Fraud Survey of 2020 reveals
that there are four basic types of fraud where cybercrime ranks second in the list. Cybercrime takes the
first place in healthcare by 16% and technology, media and telecommunications by %20 (PwC, 2020).
Businesses must be cautious against cybercrime risks and keep up with the latest developments in
technology or they might confront cyber theft of information like intellectual property or customer data
(Ernst & Young, 2015).
Singleton and Singleton (2010) identify activities such as identity theft, blackmail, denial of service
attack, and email attacks as cyber crimes. Pearson and Singleton (2008) state that cyber-crimes may
involve for example denial of service which is an unauthorized intrusion, certain organized crimes, credit
card fraud, telecommunications fraud, online extortion, intellectual property rights, money laundering
using the Internet, identity theft, viruses and worms. They may also include any types of crime commit-
ted on the Internet such as online narcotics, cyber-terrorism, online gambling, some international issues.
Basically, there are four types of cybercrimes according to AICPA (2017), which are corporate ac-
count takeover, identity theft, data theft and ransomware.
Corporate account takeover may have quite costly effects on all the businesses regardless of the
business sizes or type. In this type of cybercrime perpetrators acquire a business’s financial banking
credentials through social engineering and use malware to hijack the business’s computers to steal funds
from that business’s bank accounts (AICPA, 2017).

129

Detection and Prevention of Fraud in the Digital Era

Identity theft: Identity theft is a way to get the information about a person and uses the information to
apply for accounts, credits or identity cards in the name of that person (Luell, 2010). Although identity
theft is not a new type of crime, it has attracted public attention recently because it has become more
prevalent due to the increasing use of the Internet (Sommariva & Martin, 2007). Many people submit
their personal information, such as names, e-mail addresses, credit card numbers and telephone numbers
voluntarily to use banking and shopping applications. Also, some forms of malware may be used to
obtain personal information (Chen, 2010). In identity theft, fraudsters aim to obtain a victim’s personal
information to get the victim’s money or property (Cross & Shinder, 2008). Shell companies are also
formed for identity theft. Fake companies are often formed by an organized group of criminals who are
engaged in the processing or collection of personal financial information through fictitious businesses
ranging from debt collection to insurance agents (Britz, 2013). Identity theft paves the way for other
cybercrimes, such as tax-refund fraud, credit-card fraud and loan fraud (AICPA, 2017).
There are two common ways to steal one’s personal information that are phishing and pharming
(Padgett, 2014).
“Phishing is an e‐mail fraud method in which the perpetrator sends out legitimate‐ looking email in
an attempt to gather personal and financial information from recipients. (Definition provided by Search
Security)” (as cited in Ross, 2015). Malware emails can be used for phishing (Pickett, 2012).
Pharming is “a series of actions that redirects victims to a fraudulent Web site designed to look like
a legitimate organization’s site for the purpose of collecting private data” (Wells, 2010). Pharming is
an advanced form of phishing but it is used rarely because it requires more technical capabilities (Britz,
2013; Lallie et al., 2020).
Data Theft: Sensitive data, such as unencrypted credit-card information a business keeps, personally
identifiable information, intellectual property, customer information and employee records, is subject to
cybercrime (AICPA, 2017). Digital era has introduced remarkable innovations in industries including
mass production of intellectual property as in software companies (Britz, 2013). Intellectual property
describes intangible assets such as patents, trademarks, designs, copyrights, databases, trade secrets,
inventions, technologies, artworks (Kizza, 2010; Karius, 2016).
Ransomware: Ransomware is one of the latest threats to individuals and corporations. Ransomware is
a malware program which encrypts a victim’s files and makes the system or files inaccessible or inoper-
able unless the victim refuses to pay a ransom. Unlike the majority of malware which aims to disguise
themselves, ransomware threatens the victim at the very beginning demanding money from its victims
and aiming for further criminal interests (Britz, 2013). Ransomware encrypts digital resources. However,
unstolen data does not guarantee that it is safe from cyber criminals as they might hold the data hostage
to demand a fair amount of money (AICPA, 2017). Ransomware uses scare tactics to trick people to pay
a ransom by threatening messages and setting a time limit to pay before the ransom increases. Ransom-
ware can appear in different forms with some being more harmful than others; however, all ransomware
has the same goal (Singh et al., 2019).

PREVENTION AND DETECTION OF FRAUD

It may be hard to detect cybercrime cases for fraud examiners because traditional paper audit trail is often
unavailable and examiners have to understand computer technology and may need computer specialists
to assist them (ACFE, 2014). Crimes committed online are capable of capturing so much information

130

Detection and Prevention of Fraud in the Digital Era

that was impossible or very hard to cover by traditional crimes (Kävrestad, 2018). Measures taken to
prevent cybercrime such as passwords, firewalls, encryption and other procedures may help to discour-
age fraudsters to some extent. If these measures prove deficient, then detection methods can be useful
including tripwires, configuration-checking tools or anomaly detection systems (Smith and Smith, 2008).
With the help of digital transformation of companies, digital information involving information in
emails, notes made in computer files, electronic files the fraudster erased, has become more prevalent
to detect a fraud (Singleton & Singleton, 2010).
The traditional fraud detection is usually a reactive approach which is employed when a symptom is
detected. The fraud investigator waits for an anonymous tip to emerge, then the fraud investigator begins
to investigate. However, data-driven fraud detection has an anticipatory nature because the schemes
and symptoms might be predicted before the attack so there is no need to wait for a tip. It is a kind of a
hypothesis-testing approach where the investigator develops and tests hypotheses (Albrecht et al., 2011).
Albrecht et al. (2011) proposed a proactive method for fraud detection, which are analytical steps,
technology steps, investigative steps. Analytical steps involve understanding the business, identifying
possible frauds that could exist and categorizing possible fraud symptoms. Technological steps include
using technology to gather data about symptoms and analyzing results whereas investigative steps con-
tain investigative symptoms. The first analytical step, which is understanding the business, is learning
about how the business operates. Identifying possible frauds, which is the second step, is about risk
assessment. Fraud types sometimes may be unique to a business. Therefore, understanding the nature of
frauds, how they emerge, and the symptoms they reveal is of utmost importance. The third step involves
dividing fraud symptoms into groups. Gathering data about symptoms is one of technological steps.
Data extraction may be supported by many resources such as corporate databases and Web sites. This
step helps to find the data that match with the identified symptoms. The last part of technological steps
is to analyze results which define anomalies that are likely to be signs of fraud. While analyzing results,
both traditional and computer - based methods may be used. The final step is investigating symptoms,
where the most promising indicators are probed (Albrecht et al., 2011).
Machine learning which is one of the methods to detect fraud, has been used more prevalently to
detect corporate fraud, credit card fraud, money laundering, mortgage fraud, mass marketing fraud and
commodities fraud compared to financial statement fraud (Song et al., 2014). It is often difficult to
detect financial statement fraud by using traditional analytical and statistical methods because the data
in the financial statements are summarized and aggregated (Whiting, Hansen, McDonald, Albrecht, &
Albrecht, 2012). Song et al. (2014) state that computational models are often more accurate than human
judgment to assess the financial statement fraud risk because these models can automatically assess and
merge risk factors to generate a comprehensive judgment.
Albrecht, Albrecht, Albrecht & Zimbelman (2011) assessed the capacity of advanced statistical learn-
ing and data mining methods to detect fraud proactively and found that recently developed data mining
algorithms present opportunities for discovering and maybe mitigating financial fraud. They used an
ensemble method, which combined predictions from multiple models employing boosting, bagging, or
related approaches. The results for ensemble models have shown significant improvements in accuracy
and proved their practical potential.
Song, Hu, Du and Sheng (2014) proposed an approach where they developed a system of financial
and non-financial risk factors, and a hybrid assessment method that combines machine learning methods
with a rule-based system. They collected data from Chinese companies by four classifiers (logistic re-
gression, back-propagation neural network, C5.0 decision tree and support vector machine) and made an

131

Detection and Prevention of Fraud in the Digital Era

ensemble of those classifiers. They tested the effectiveness of the proposed approach by assessing the risk
of financial statement fraud. They compared four classifiers, both individually and in combination and
then applied the proposed approach to improve the prediction results obtained from the classifier system.
According to Sitaraman and Venkatesan (2006), there are three main steps, or three A’s, of the inves-
tigation process, which are Acquire, Authenticate, and Analyze. The suspect drive from a hacked com-
puter is copied to be analyzed to identify valuable evidence, such as reconstructed files and deleted files.
Acquire the Evidence: There may be various approaches to collect evidence depending on the case.
For instance, determining the location of the evidence might be challenging because it can be the hard
disk or the RAM. The methods employed to obtain and secure evidence depend on the available tech-
nologies, the nature of the fraud and the skills and knowledge of the investigator. It is also of utmost
importance to acquire the data without damaging it to be able to use it in court. The steps of acquiring
the evidence might be outlined as follows (Sitaraman & Venkatesan, 2006):
Chain of Custody: Maintaining the chain of custody is of vital importance because it shows that the
evidence has chronological integrity and has not been manipulated while in custody. It documents all
the procedures performed on the evidence, including the person who collected or analyzed the evidence
and why it should be considered as evidence.
Identification: The investigator should have the skills and knowledge to see the potential evidence
because evidence might be hidden anywhere in the hardware and software, including operating systems,
file systems, and cryptographic algorithms.
Collection/Preservation: The evidence should be collected as soon as possible because of the risk of
losing valuable information. Sometimes, the evidence needs to be duplicated with the use of a special
software or hardware, which is called imaging. However, it is necessary to show the court that the copy
is exactly the same as the original evidence and the imaging process has not made any changes on the
evidence.
Transportation and Storage: The data obtained should be sealed to show that it has not been changed
and protected from physical, mechanical and electromagnetic damage. Every piece of evidence should
have a chain of custody document.
Authenticate the Evidence: The investigator should be able to prove that the evidence remains in
its original form at the time of the crime and it has not been damaged, modified or manipulated with.
Simple time-stamping techniques might be used for the authentication of the evidence (Sitaraman &
Venkatesan, 2006).
Analyze the Evidence: Although it is possible to use multiple tools, they must be reliable and valid.
Some of the activities are reading the partition table, searching existing files for relevant information
such as keywords, system state changes, or text strings, retrieving information from deleted files, check-
ing for data hidden in the boot record, unallocated space, slack space or bad blocks in the disk, cracking
passwords, etc. (Sitaraman & Venkatesan, 2006).
Report Generation: Reporting is one of the most crucial steps. The investigator should be able to ex-
press sophisticated terms and procedures in the simplest way for each step of the analysis and underline
the important results (Sitaraman & Venkatesan, 2006).
Technological developments yield substantial outcomes for organizations which they must respond
to. Hence, organizations need professionals equipped with skills with knowledge to deal with digital
stuff. (Kranacher et al., 2010). Digital media and information have become pervasive in virtually every
aspects of an organization’s life which addresses the need for cyberforensic specialists (Zabihollah &
Riley, 2010). Another tool to respond might be the sophisticated digital forensics techniques that have

132

Detection and Prevention of Fraud in the Digital Era

emerged in the last two or three decades because the prevalence of digital media and information in every
aspect of an organization underlines the growing need for cyber forensic specialists whose job involves
capturing, preserving, identifying, extracting, analyzing, documentating, and preparing cases related to
digital data and events (Kranacher et al., 2010).
Mohay, et al. (2003) note that there are two basic types of forensics related to computer frauds, which
are computer forensics and intrusion forensics. They point out that computer forensics is related to the
investigation of computer-based (digital) or electronic evidence of a crime or suspicious behavior which
may be of any type, quite possibly not otherwise involving computers whereas intrusion forensics is
related to the investigation of attacks or suspicious behavior targeting the computers only.
The difference between cyber forensics and digital investigation is that the former refers to forensic
science applied to digital information while the latter refers to investigations made in the digital domain
(Årnes, 2018).

Cyber Forensics

Researchers use cyber forensics and digital forensics interchangeably. Cyber forensics is a branch of
forensic science which focuses on the recovery and investigation of material found in digital devices
to investigate a computer crime (Ross, 2015). Cyber forensics refers to the effectual capture, preserva-
tion, identification, extraction, analysis, and case documentation of digital data and events (Singleton
& Singleton, 2010; Zabihollah & Riley, 2010). Cyber forensics should keep up with the latest changes
in the digital landscape to make more effective and efficient investigations. Although the process often
remains unchanged there might be some challenges in the complexity and resource demands for each
step (Flaglien, 2018).
“(1) Information stored or transmitted in (2) binary form that (3) may be relied on in court.” These
three steps which look very simple might get too complicated indeed as “smart” devices, or evidence,
is everywhere and it is quite different to collect data from a smartphone than from a computer or even
a smart refrigerator as Ross
One perspective on cyber forensics is that it is like any other type of forensic investigation where
the forensic evidence, such as a fingerprint, will be presented to a court of law to identify the perpetra-
tor (Singleton & Singleton, 2010). Any digital action leaves a digital print behind which perpetrators
may or may not be able to conceal their identities. There is some commercial software which enables
companies to analyze a mass amount of data in a very short time to detect unusual activity as early as
possible (Coenen, 2009).
Every digital transaction leaves behind a trail of digital evidence, which a fraudster may not necessar-
ily be able to dissociate herself or himself from. Commercially available software has made it possible
for companies to analyze a huge amount of data in a very short period of time, increasing the chances
that unusual activity will be detected quickly (Coenen, 2009). Collecting evidence is the first thing to
do in any forensic investigation. For example, there are three steps of collecting electronic evidence in
a computer hacking. First step is the collection of stored evidence from third-party servers, next step is
prospective surveillance and the last step is forensic investigation of the suspect’s computer (Kerr, 2005).
Collecting electronic information is the first step in digital evidence examination. However, there
might be some undesirable legal outcomes unless the legal procedures related to digital capture is fol-
lowed. To carry out an effective cyber forensics investigation, a professional should have both computer
skills and knowledge of the legal system and regulations. For instance, turning on a confiscated computer

133

Detection and Prevention of Fraud in the Digital Era

can make all the evidence on that computer inadmissible in a courtroom, because this simple act alters
the hard drive, thus breaking the chain of custody. Therefore, people with expertise in cyber forensics
are needed to capture digital evidence (Kranacher, 2010). In order to gather digital evidence a forensic
accountant should work with an IT professional and a legal counsel (Albrecht, Albrecht, Albrecht &
Zimbelman, 2011).
Digital evidence is often obtained from hard drives, mobile devices or other carriers of digital infor-
mation, which presupposes that anything that holds digital information can be investigated and should
be treated as evidence. Because it is not possible to know beforehand what data will be used during the
examination, all data should be treated as evidence to get the most accurate results (Kävrestad, 2018). The
sources of digital evidence today include cell phones, personal digital assistants (PDAs), Blackberrys
and similar phones, trinkets with digital storage (watches, USB pens, digital cameras, etc.), jump drives,
media cards, e-mail, voicemail, CDs, DVDs, printer memory, RAM, slack space, removable drives, iPods/
MP3 players, and XM/Sirius radio players. The traditional sources are laptops, office computers, home
computers and external drives, servers on the Internet that store e-mail messages, and the entity’s own
servers. Special software and hardware tools are available to capture digital evidence (Kranacher, 2010).

“Some sources of digital evidence that the nontechnically savvy professional may not be aware of include:

• Digital ‘‘fingerprints’’ in metadata, e-mail headers, and electronic cookies

• Hidden data located on storage devices
• The ability to recover deleted files
• Data located in unused space, temporary files, random access memory (RAM), and various logs
• The possibility of retrieving data that was overwritten with new data” (Zabihollah and Riley,
2010).

CONCLUSION

We are witnessing a new era of machine learning and everything is interconnected. We are just surrounded
by technology. In order to make the most of technology, one must keep up with the latest developments
and trends. New age frauds are just like old fashioned crimes with only disguised forms. Frauds in the
modern world, where learning machines and artificial intelligence have been widely used, are called
cybercrimes and can only be committed by fraudsters who are skilled at computer and software and are
called cybercrime. Cyber Crime involves a wide range of activities from telecommunications fraud to
cyberterrorism. The prevention of fraud is of utmost importance for the businesses to survive. Because
of that business should take some measures against cybercrime.
While technological developments present new opportunities for fraudsters, they also present new
methods against frauds of new era. Some researches have proved that methods combined with machine
learning can be helpful to detect frauds. Besides some methods used to prevent and detect fraud, cyber
forensics also has a substantial role to detect anomalies and it presents a systematical method

134

Detection and Prevention of Fraud in the Digital Era

REFERENCES

Association of Certified Fraud Examiners. (2014). Fraud examiners manual

AICPA. (2017). https://www.aicpa.org/InterestAreas/InformationTechnology/Resources/Privacy/Cyber-
Security/DownloadableDocuments/Top-5-CyberCrimes.pdf
Albrecht, W. S., Albrecht, C. O., Albrecht, C. C., & Zimbelman, M. F. (2011). Fraud examination.
Cengage Learning.
Arnes, A. (2018). Introduction. In A. Arnes (Ed.), Digital Forensics (pp. 1–10). John Wiley & Sons, Inc.
Britz, M. T. (2013). Computer Forensics and Cyber Crime: An Introduction. Pearson.
Chen, T. M. (2010). Identity Theft Through the Web. In Handbook of Research on Computational Forensics,
Digital Crime, and Investigation: Methods and Solutions (pp. 379-395). IGI Global. doi:10.4018/978-
1-60566-836-9.ch016
Coderre, D. (2009). Computer-Aided Fraud Prevention and Detection: A Step-by-Step Guide. John
Wiley & Sons, Inc.
Coenen, T. L. (2009). Expert Fraud Investigation: A Step-by-Step Guide. John Wiley & Sons, Inc.
Cross, C. (2013). Anatomy of a Ponzi: Scams past and present. Slice Publishing.
Cross, M., & Shinder, D. L. (2008). Scene of the cybercrime. Syngress Pub.
Ernst & Young. (2015). Creating trust in the digital world: EY’s Global Information Security survey
2015, Flaglien, O. A. (2018). The digital forensics process. In A. Arnes (Ed.), Digital Forensics (pp.
13–48). John Wiley & Sons, Inc.
Goldmann, P. D., & Kaufman, H. (2009). Anti-Fraud Risk and Control Workbook. John Wiley & Sons.
Kanellis, P., Kiountouzis, E., Kolokotronics, N., & Markatos, D. (2006). Digital Crime and Forensic
Science in Cyberspace. Idea Grroup Pub. doi:10.4018/978-1-59140-872-7
Karius, T. (2016). Intellectual property and intangible assets: Alternative valuation and financing ap-
proaches for the knowledge economy in Luxembourg (No. 3). EIKV-Schriftenreihe zum Wissens-und
Wertemanagement.
Kävrestad, J. (2018). Fundamentals of Digital Forensics: Theary, Methods, and Real - Life Applications.
Springer International Publising AG. doi:10.1007/978-3-319-96319-8
Kerr, O. S. (2005). Digital Evidence and the New Criminal Procedure. Columbia Law Review, 105(1),
279–318.
Kizza, J. M. (2010). Ethical and Social Issues in the Information Age. Springer.
Kranacher, M. J., Riley, R., & Wells, J. T. (2019). Forensic accounting and fraud examination. John
Wiley & Sons.

135

Detection and Prevention of Fraud in the Digital Era

KratchmanS.SmithJ. L.SmithM. (2008). The Perpetration and Prevention of Cybercrimes. Available at

SSRN 1123743
McQuade, S. C. (2009). Encyclopedia of cybercrime. Academic Press.
Mohay, G., Anderson, A., Collie, B., Vel, O. D., & McKemmish, R. (2003). Computer and intrusion
forensics. Artech House.
Pearson, T. A., & Singleton, T. W. (2008). Fraud and forensic accounting in the digital environment.
Issues in Accounting Education, 23(4), 545–559. doi:10.2308/iace.2008.23.4.545
Pickett, K. H. S. (2012). Fraud Smart. John Wiley & Sons, Inc. doi:10.1002/9781119208853
PwC’s Global Economic Crime and Fraud Survey. (2020). https://www.pwc.com/gx/en/services/advisory/
forensics/economic-crime-survey.html
Ross, I. (2015). Exposing fraud: Skills, process and practicalities. John Wiley & Sons.
doi:10.1002/9781119177494
Singh, A., Ikuesan, A. R., & Venter, H. S. (2019). Digital Forensic Readiness Framework for Ransomware
Investigation. In F. Breitinger & I. Baggili (Eds.), Digital Forensics and Cyber Crime. doi:10.1007/978-
3-030-05487-8_5
Singleton, T. W., & Singleton, A. J. (2010). Fraud auditing and forensic accounting. John Wiley & Sons.
doi:10.1002/9781118269183
Skalak, S. L., Golden, T. W., Clayton, M., & Bill, J. (2011). A guide to forensic accounting investiga-
tion. John Wiley & Sons.
Song, X. P., Hu, Z. H., Du, J. G., & Sheng, Z. H. (2014). Application of machine learning methods
to risk assessment of financial statement fraud: Evidence from China. Journal of Forecasting, 33(8),
611–626. doi:10.1002/for.2294
Wall, D. (2011). Micro frauds: Virtual robberies, stings and scams in the information age. Academic Press.
Whiting, D. G., Hansen, J. V., McDonald, J. B., Albrecht, C., & Albrecht, W. S. (2012). Machine learn-
ing methods for detecting patterns of management fraud. Computational Intelligence, 28(4), 505–527.
doi:10.1111/j.1467-8640.2012.00425.x
Zabihollah & Riley. (2010). Financial Statement Fraud: Prevention and Detection (2nd ed.). John Wiley
& Sons, Inc.

136

Detection and Prevention of Fraud in the Digital Era

KEY TERMS AND DEFINITIONS

Denial of Service (DoS): DoS attacks are cyber crimes where the perpetrator’s goal is to make a
computer or other types of electronic devices unavailable to its users. In DoS attacks, a computer net-
work is often overloaded with massive amounts of data in a very short time to make the servers unable
to hold up the data that is being transmitted. Distributed denial of service (DDoS) attacks which often
make use of botnets that can be remotely controlled are even more threatening to information systems.
This helps a perpetrator to attack multiple networks and areas simultaneously. DoS and DDoS attacks
can do a hefty amount of financial loss and damage the reputation of a business as people might think
that the business is incapable of preventing DoS and DDoS attacks (McQuade, 2009).
Intellectual Property: Intellectual property (IP) describes intangible assets such as patents, trade-
marks, designs, copyrights, databases, trade secrets, inventions, technologies, artworks (Kizza, 2010;
Karius, 2016). Digital era has introduced remarkable innovations in industries including mass production
of intellectual property as in software companies (Britz, 2013).
Phishing: “Phishing is an e‐mail fraud method in which the perpetrator sends out legitimate‐looking
email in an attempt to gather personal and financial information from recipients” (definition provided
by Search Security, as cited in Ross, 2016). Malware emails can be used for phishing (Pickett, 2012).
Phishing does not only targets customers or clients, it also targets.

137
138

Chapter 10
Downside Risk Premium:
A Comparative Analysis

Kanellos Stylianou Toudas

National and Kapodistrian University of Athens, Greece

ABSTRACT
The purpose of this chapter is to address the main developments and challenges on risk assessment and
portfolio management. The former innovation in modern portfolio theory, Markowitz, has been succeeded
from linear and non-linear optimization techniques that improve portfolio efficiency. Special emphasis is
given on Roy’s seminal work on “Safety First Criterion” which advocates that the safety of investments
should be prioritized. Thus, an investment should be chosen in a way that it has the lowest probability
of falling short of a required threshold of investors. This motivated Markowitz to advocate a downside
risk measure based on semivariance. It captures the notion of risk as failure to meet some minimum
target. It is influenced by returns below the target rate. It focuses on investors’ concern with downside
variability and loss reduction. This chapter offers a critical reflection of these recent developments and
could be of interest for individual and institutional investors.

INTRODUCTION

There has been a rekindlement of interest and a surge in researching the downside risk especially from
the portfolio optimization perspective or the development of advanced asset pricing models. Investors
welcome upside gains and dislike downside losses. They do not like stocks that covary with the market
when the market declines. Stocks that covary with market downturn have higher downside risk. Investors
place greater weight or emphasis on downside risk and are averse to downside risk and losses. There-
fore, downside risk is priced. Stocks that covary with market during market downturn are unattractive
securities and investors are reluctant to hold them unless being rewarded or compensated for the risk.
This demand for additional compensation, in the form of higher expected return, for holding stocks that
covary with market downturn is known as downside risk premium.
Stocks with high covaration conditional on upside movement of market tend to trade at a discount
whereas stocks with high covariation conditional upon downside movement of market offer premium

DOI: 10.4018/978-1-7998-4805-9.ch010

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Downside Risk Premium

for bearing downside risk. Therefore, downside risk closely corresponds to how individual investors
actually perceive risk.
Ang, Chen and Xing (2005) find that cross-section of stock returns reflects a premium for bearing
downside risk equal to 6% per annum. They find that this reward for bearing downside risk is different
from compensation for regular market beta, coskewness, liquidy risk, size or book-to-market and momen-
tum risk. Earlier researchers found little evidence of downside risk premium due to issues related to data
and methodology. Some researchers in earlier studies do not arrive at an unambiguous conclusion due
to the fact that they did not focus on measuring the downside risk premium using all individual stocks
in the cross-section. According to Ang et.al. (2005), Jahankhani (1976) fails to find any premium for
downside beta because the examined time period was short, from 1951 to 1969. Furthermore, he only
uses portfolio formed from regular CAPM betas. It was further pointed out by Post, Vliet and Lansdorp
(2009) that this short time span does not include some important bear markets of the 1930s, 1970s and
2000s. The examination of bearish periods is of vital importance for the investigation of downside risk
premium, because during these periods investment risks are high and investors demand additional com-
pensation due to their risk aversion profiles.
The objective of this paper is to comparatively investigate the downside risk premium and address
any limitation and/or space for further development. Special emphasis is given on the critical reflection
of the financial considerations of the downside risk premium.

LITERATURE REVIEW

Downside Risk Measures

There are several downside risk measures in the literature. It was Roy (1952) who came out with the
earliest downside risk measure. In his published paper entitled “Safety First Criterion”, Roy (1952)
advocates that the safety of investments should be prioritized in any investments. According to Roy
(1952), an investment should be chosen in a way that it has the lowest probability of falling short of a
required threshold of investors. Later, Nobel prize laureate for Economics in 1990, Markowitz (1959)
advocates a downside risk measure based on semivariance. Even though Markowitz (1959) then pro-
poses the famous mean-variance, EV model of risk measure, he also argues that semivariance is a more
appropriate measure of risk. According to Markowitz (1959), variance is proposed and used simply
for the reason of its convenience, familiarity and it is a computational efficient risk measure. The most
prominent feature of semivariance as a downside risk measure is that it is based on recognizing risk as
a deviation below a critical target rate of return. It captures the notion of risk as failure to meet some
minimum target. It is influenced by returns below the target rate. It focuses on investors’ concern with
downside variability and loss reduction. Only a subset of return distribution is used. Minimization of
semivariance concentrates on the reduction of losses. It is much more consistent with the perception
of risk of investors and financial manager. They perceive risk as a failure to meet some minimum or
target rate rather than in terms of deviations from expectations or not even in terms of deviations below
expectation. Thus, downside risk measure is intuitively appealing and it closely corresponds to how
individual investors actually perceive risk.

139

Downside Risk Premium

Over the past decades different theoretical models on downside risk measures have been developed
and several other downside risk measures emerge. It is worth noting that the aforementioned downside
risk measures are associated with the second moment of returns’ distribution.
Hogan and Warren (1974) developed an equilibrium assets pricing model using semivariance in
much the same way the Capital Asset Pricing Model was formed. As a result, the fundamental struc-
ture of CAPM is retained and the equilibrium expected return of an efficient portfolio continues to be
a linear function of the measure of portfolio risk, and the equilibrium expected return of an individual
security remains a linear function of the measure of relative security risk. The security risk measure was
derived and denoted as cosemivariance and standard semideviation is substituted for standard deviation
to measure portfolio risk.
The equilibrium Capital Market Model developed known as ES-CAPM is as follow:

E (Rm ) − Rf
E (Ri ) = Rf + CSVR (R (1)
SVR (Rm ) f m
,Ri )
f

where:

E (Ri ) = equilibrium expected rate of return on asset i,

E (Rm ) = equilibrium expected rate of return on the market portfolio,
SVR (Rm ) = semivariance of returns below Rf on the market portfolio, and
f

CSVR (R ,Ri )
= cosemivariance below Rf of returns on the market portfolio with returns on security
f m

+∞ Rf
i=∫
−∞ ∫ (R
−∞ m
− Rf ) (Ri − Rf ) jf (Ri , Rm )dRmdRi

where

jf (Ri , Rm ) = joint probability density function of returns on asset i and returns on the market portfolio.

Jahankhani (1976) conduct an empirical study on ES model proposes by Hogan and Warren (1974)
above and standard mean-variance, EV model. According to his findings, the two models indicates that
the relationship between expected return and the beta coefficient is linear and that non-beta measure of
risk have no significant effect on the expected return.
However, the estimates of the intercept and the slope varied over time and were not consistent with
the traditional form of the EV and the ES models. In both models, the intercept was greater than the
risk-free rate of return. The slope was less than its hypothesized value, E (Rmt ) − Rf . The conclusion is
that the traditional form of the EV and ES model is inconsistent with the data. According to Jahankhani
(1976), the source of the problem may be the assumption of unlimited riskless borrowing opportunities
or errors of measure of Rf .

140

Downside Risk Premium

The results of this study indicate that the ES model is more sensitive to the measure of Rf than the
EV model. The sensitivity of βsi, according to Jahankhani (1976) may occur because, unlike βi which
is independent of Rf , βsi is affected directly by the value of Rf since

E Min (0, Rmt − Rf ) (Rit − Rf )

βst =  
2
(2)
E Min (0, Rmt − Rf )

 

Rf affects both numerator and the denominator of the βst formula. Since βst is a function of Rf ,
error of measure in R may distort… β
f st
Black, Jensen and Scholes (1972) have developed a zero-beta portfolio for estimating the risk-free
rate of return in an EV framework. The question of how the risk-free rate in ES framework should be
estimated, however, remains unanswered.
It was later point out by Ang et.al. (2005) that the main source of problem of the studies of Jahankhani
(1976) is due to short time span of the data which was only from July 1947 to June 1969. Jahankhani
does not directly estimate a downside risk premium by demonstrating that assets which covary more
when the market declines have higher average returns.
Early researchers have found weak evidence of a downside risk premium because they did not focus
on measuring the downside risk premium using all individual stocks in the cross section. The study of
Jahankhani is one of the obvious example. Jahankhani (1976) fails to find any improvement over the
traditional CAPM by using downside betas because his investigation uses portfolios formed from regular
CAPM betas.
Nantell and Price (1979) study and compare the relationship between mean-semivariance, ES-CAPM
model and mean-variance, EV-CAPM model. Semivariance, SVh , which is defined as follows:

SVh (Rp ) = ∫ (R − h ) f (R)dR

2
p
(3)
−∞

where

fp (R ) = probability density function of return for portfolio p.

h = target rate.

The researchers suggested that this target rate is the risk-free rate. It is found that when target rate
is set at the mean return of the portfolio, semivariance loses its appeal because semivariance below the
expected return is half the portfolio’s variance for a normal distribution of returns. Therefore, variance
which we are familiar with is a better measure.
When the target rate is not portfolio’s expected rate, the relationship between the equilibrium rates
of return derived from these notions of risk has not been all clear.

141

Downside Risk Premium

The researchers have pointed out analytically that under the assumption of bivariate normal distribution
of returns for an asset and the market, equilibrium rates or return are equal whether we use a variance
or semivariance notion of portfolio risk. They proved that the measures of relative asset risk (asset risk
relative to efficient portfolio risk) are equal in the two models. Although this equality might have been
expected if the target rate used in the semivariance notion of risk was the portfolio’s mean return, it is
somewhat surprising to find that it is also true when the risk-free rate is the target.
Using stochastic dominance rules, Bawa and Lindenberg (1977) develop an equilibrium asset pric-
ing model on Lower Partial Moment (LPM). Under LPM, many popular notations of risk measures like
variance and semi-variance become a special case under the lower partial moment framework.
With the condition n=1 and 2, the market equilibrium price is:

E (Rj ) − rF = βj E (R ) − R  j=1,2..M
mlpmn
 m f 
(4)

where

mlpmn
CLPM n (RF ; M , j )
βj =
LPM n (RF ; M )
CLPM n (RF ; M , j ) = colower partial moment of order n between return the return Rj on security j and
RM on the market portfolio M is as follows:

rF α
(r − rj )df (rj , rM )
n −1
CLPM n = (rF ; M , j ) = ∫ ∫ (r
F
− rM ) F
(5)
rM rj =−α

It is worth noting that asset pricing under mean-lower partial moment is identical to the traditional
CAPM except beta in the CAPM is replaced by βjmlpm .
It should be noted that the market portfolio M has positive risk i.e. LPM n (rF ; M ) > 0 only when
the return of that portfolio has some positive probability of falling below rF . A particular security con-
tributes to the market’s risk only when its return and market returns are below rF . When Rj < rF and
RM < rF , security j reduces the risk of M. When the market’s return > rF , individual security return
contribute nothing to the market’s risk regardless of whether Rj is more or less than rF .
Bawa and Lindenberg (1977) managed to show that downside risk in terms of lower power moment
provides a much more general or perhaps better measure of risk. Risk is perceived as a negative deviation
from target rate of return. The target rate of return is specified to be risk-free interest rate.
Nantell, Price and Price (1982) address the empirical relationships between the mean-variance capital
asset pricing model (EV-CAPM) and mean-lower partial moment (EL-CAPM) model by Bawa. Normal
econometric technique of ordinary least squares is then applied to estimate the coefficient. According to
Nantell et.al. (1982), the lower partial moment model appears to describe the actual pricing of securi-
ties in that its empirical risk-return relationship is a positive linear one in which no rewards are given
for taking unsystematic lower partial moment risks. Different assumptions of security returns would

142

Downside Risk Premium

affect the analytical relationship between the two models. Under the assumption that the distribution
of returns is bivariate normal, the EL measure of systematic risk is equivalent to the EV measure of
systematic risk i.e., CLPM/LPM=COV/V. In other words, it means that if bivariate normality is descrip-
tive of security markets, then EL-CAPM is analytically and, presumably, empirically indistinguishable
from the widely used EV-CAPM. According to Nantell et.al (1982), the lower partial moment model
is empirically distinguishable from its variance counterpart in that the intercepts of the two models are
significantly different. The lower partial moment intercept is lower than the variance intercept as long
as the distribution of market returns is not significantly negatively skewed. When there is not significant
negative skewnewss in the distribution of the market portfolio, the intercept is not significantly different
from the risk-free interest rate.
Furthermore, Harlow and Rao (1989) expand the mean lower partial moment model of Bawa and
Lindenberg (1989) and developed a generalised Mean Lower Partial Moment (MLPM) model. A gen-
eralised Mean-Lower-Partial Moment (MLPM) equilibrium that can use any prespecified target rate of
return is introduced here by Harlow and Rao (1989). The special feature of this new framework is that a
wide class of asset pricing models can be derived from it. The equilibrium model proposed is:

E (Rj ) = Rf + βj E (R ) − R 
mlpmn ( τ )
(6)
 m f 

where

τ α

∫ ∫ n (τ − R ) (R − R )dF (R , R )
n −1

mlpmn ( τ ) m f j j m
βj = −α −α
α

∫ n (τ − R ) (R − R )dF (R )
n −1

−α m f m m

The nth-order generalized co-lower partial moment between two assets X and Y about τ and Rf is
as follows:

τ α
GCLPM n (τ, Rf ; X ,Y ) = ∫ (R − RY )dF (RX , RY )
n −1
∫ n (τ − RX ) f
(7)
−α −α

The generalized nth order lower-partial moment for asset X about τ and Rf , implies that:

mlpmn ( τ )
GLPM n (τ, Rf ; M , j )
βj = (8)
GLPM n (τ, Rf ; M )

Recently, Ang et.al. (2005) developed a downside risk measure using covariance conditional on
market downwards movement. According to this model, investors treat risk asymmetrically and care
more about downside risk than upside gains. Ang et.al (2005) reintroduce the downside beta which was
initially introduced by Bawa and Lindenberg (1977):

143

Downside Risk Premium

Cov (ri , rm | rm < µm )

β− = (9)
Var (rm | rm < µm )

where ri (rm ) is security i’s (the market) excess return, and µm is the average market excess return.
Conventional sorting was carried out also on regular beta, downside beta, upside beta, relative upside-
beta1 and relative downside beta2, relative beta between upside and downside beta denoted by β + − β −
and different other risk exposure like coskewness risk, exposure to cokurtosis risk, exposure to aggregate
liquidity risk.
Similarly, the upside beta is given as shown below:

Cov (ri , rm | rm > µm )

β+ = (10)
Var (rm | rm > µm )

According to Ang et.al (2005), the purpose of computation of different betas and relative beta is to
disentangle the different effect of upside risk and downside risk. Regular beta, downside and upside beta
are, by construction, not independent of each other:

Rp − Rf = a + bm (Rm − Rf ) + bSMBSMB + bHMLHML + bm− (Rm − Rf )

where bm, bm− , bSMB , bHML are the coefficients estimated by General Moment Method. The coefficient
bm− in particular, reveals the exposure of the test portfolios to downside risk. The empirical findings
suggest that not only do individual stocks sorted directly on β¯ loadings reveal a large reward for stocks
with high downside risk exposure, but other portfolios commonly used in asset pricing, for example,
size and book-to-market portfolios also exhibit downside risk exposure.

Empirical Studies on Downside Risk

A few empirical studies that were carried out on downside risk recently were mainly based on the spirit
of Ang et.al (2005) where different characteristics like size, value, liquidity, kurtosis, momentum and
so on were controlled for.
Abu-Ghunmi (2008) examines the conditional downside risk in the cross section of the UK equities
by allowing the downside risk premium to vary with the state of the world. Besides, the researcher also
examines the importance of size, value, industry factors and data frequency in deciding the existence
and significance of the downside beta.
Stocks are sorted into five quintiles portfolios based on their realised beta. She investigates downside
risk based on Disappointment Aversion Utility Function of Gul (1991). To examine if risk premium of
downside risk varies between bad and good times, she divides portfolio into two states of the world;
expansion and recession based on Coincident Index which tracks the business cycle and run Fama-
MacBeth (1973) cross sectional regression for each period. She finds that conditioning the risk premium
of downside risk on the state of the economy improves the role of downside beta in explaining the cross

144

Downside Risk Premium

section of return. She finds that there is an increasing pattern between the downside beta and average
excess return during the expansion period. During recession, there is no relation between downside risk
and return. She finds no relation (thus downside beta is not priced) between the realized excess return
and downside beta or CAPM beta. This could be due to the short recession period in the study sample.
The result shows that the unconditional relationship between the downside risk and realised returns is
positive and significant but not monotonically increasing, with 4.3% annual risk premium. When the
risk premium is allowed to vary with the business cycle conditions, she finds a monotonically increasing
pattern of stock’s return and downside risk during expansion time with a risk premium of approximately
5%. Also she finds that the downside risk is an appropriate measure of risk for small, value (but not large
and growth stock) and cyclical stocks. Downside beta plays role in pricing small and value stocks .She
found firm’s industry (most cyclical industries), size (especially small and value) and book-to-market
ratio are important factors in deciding the reward for bearing downside risk. A summary of the findings
is given below. Among different variables that are considered in this study, industry is the only factor
that distinguishes between CAPM and downside beta. Downside beta seems to better in explaining the
cross section of returns on stock in travel and leisure, automobiles and parts, food and beverage and retail
industries where CAPM beta seems to be better in explaining the cross section of returns on industrial
goods and services, media and basic resources industries. It is worth mentioned that downside beta and
CAPM beta provide opposite results for the retail industry. While downside beta has a significantly
positive relationship with the realized returns, the corresponding CAPM beta has a negative relationship
with the realized returns. Besides, she also finds that that downside beta is a useful measure of risk in
explaining the cross section of returns when the distribution of returns is more asymmetric; this includes
high frequency data and small firms.
Post, Vliet and Lansdorp (2009) provide rigorous empirical analysis of the role of downside beta
for the cross-section of US stock returns using conventional double sorting method. They use the most
comprehensive data from January 1926 to December 2008 from CRSP. The researchers analyse the role
of downside risk in four historical subsamples of 19 and 20 years, 1931-1949, 1950-1969, 1970 -1988
and 1989-2008. The advantage of this is that it includes major bear periods in the studies. Double sorting
routine is applied to disentangle the effect of the different (downside) risk measures. For example, the
method can be used to separate the effect of regular beta and downside beta from the effect of other sort-
ing variables that are known to be relevant for explaining cross-section of risk and return: co-skewness,
volatility, idiosyncratic volatility, size, value, reversal and momentum. Sorting stocks by semivariance
beta leads to an annual cross-sectional mean spread of 5.5% compared to 3.7% for sorting by regular
beta. They get this result despite the fact that downside beta is based on fewer return observations and
is more difficult to estimate and predict than regular beta. Post et.al (2009) also discuss various ways to
define and estimate downside beta. They find that downside risk when properly defined and estimated,
drive stock prices. They then introduce the downside beat that is consistent with the theoretical mean-
semivariance model. They showed that ARM regressions and covariance-based definition generally do
not produce the semivariance beta. It is only semivariance downside risk measure that is consistent with
the theoretical mean-semivariance model. Therefore, the right measure of downside risk, according to
Post et.al (2009), is semivariance downside risk. Semivariance beta also dominates regular beta after
controlling for other stock characteristics, including firm-level size, value and momentum. Using ARM
regression or covariance-based definition leads to markedly different results. The ARM results are very
close to those obtained with the standard market beta and do not seem to reflect systematic downside

145

Downside Risk Premium

risk. Using downside-covariance betas leads to more noisy estimates of systematic downside risk and a
significant deterioration of the cross-sectional mean spread.

CONCLUSION

This paper critically reflects on the foundations of the downside risk premium and sheds much light on
the explanation of investors’ risk aversion profile. Investors would welcome favourable upside gain and
dislike unfavourable downside risk in stock markets. Stocks that covary strongly with falling market have
higher downside risk making them unattractive for investors who would impose an additional compensa-
tion or rewards for bearing stocks with higher downside risk. Investors who are willing to bear downside
risk, therefore, would be rewarded with downside risk premium. Thus, downside risk is a more relevant
risk measure as it is in line with the perception of risk of investors.

REFERENCES

Abu Ghunmi, D. N. A. E.-H. (2008). Stock return, risk and asset pricing, Durham theses, Durham Uni-
versity. Available at Durham E-Theses Online: http://etheses.dur.ac.uk/1921/
Ang, A., Chen, J., & Xing, Y. (2006). Downside Risk. Review of Financial Studies, 13(4), 1191–1239.
doi:10.1093/rfs/hhj035
Bawa, V., & Lindenberg, E. B. (1977). Capital market equilibrium in a mean-lower partial moment
framework. Journal of Financial Economics, 5(2), 189–200. doi:10.1016/0304-405X(77)90017-4
Black, F. (1972). Capital market equilibrium with restricted borrowing. The Journal of Business, 45(3),
444–455. doi:10.1086/295472
Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. Journal of Political
Economy, 81(3), 607–636. doi:10.1086/260061
Gul, F. (1991). A Theory of Disappointment Aversion. Econometrica, 59(3), 667–686. doi:10.2307/2938223
Harlow, W. V., & Rao, R. K. S. (1989). Asset pricing in a generalized mean-lower partial moment
framework: Theory and evidence. Journal of Financial and Quantitative Analysis, 24(3), 285–311.
doi:10.2307/2330813
Hogan, W. W., & Warren, J. M. (1974). Toward the development of an equilibriumcapital-market model
based on semivariance. Journal of Financial and Quantitative Analysis, 9(1), 1–11. doi:10.2307/2329964
Jahankhani, A. (1976). E-V and E-S capital asset pricing models: Some empirical tests. Journal of Fi-
nancial and Quantitative Analysis, 11(4), 513–528. doi:10.2307/2330199
Markowitz, H. M. (1952, March). Portfolio Selection. The Journal of Finance, 7, 77–91.
Nantell, T. J., & Price, B. (1979). An analytical comparison of variance and semivariance capital market
theories. Journal of Financial and Quantitative Analysis, 2(2), 221–242. doi:10.2307/2330500

146

Downside Risk Premium

Nantell, T. J., Price, K., & Price, B. (1982, December). Mean-Lower Partial Moment Asset Pricing
Model: Some Empirical Evidence. Journal of Financial and Quantitative Analysis, 17(5), 763–782.
doi:10.2307/2330861
Post, T., Vliet, P., & Lansdorp, S. (2009). Sorting out downside beta. Academic Press.
Roy, A. D. (1952). Safety first and the holding of assets. Econometrica, 20(3), 431–449. doi:10.2307/1907413

ENDNOTES
1
Relative upside beta is the difference between upside beta relative to the regular beta, denoted by
β+ − β .
2
Relative down beta is the difference between downside beta relative to the regular CAPM beta,
denoted by β + − β .

147
148

Chapter 11
Impact of Corporate Fraud on
Foreign Direct Investment?
Evidence From China

Radwan Alkebsee
Xi’an Jiaotong University, China

Gaoliang Tian
Xi’an Jiaotong University, China

Konstantinos G. Spinthiropoulos
University of Western Macedonia, Greece

Eirini Stavropoulou
University of Western Macedonia, Greece

Anastasios Konstantinidis
University of Western Macedonia, Greece

ABSTRACT
The capital market reputation attracts foreign investment. Corporate fraud phenomenon is one of the
most crucial aspects that threaten foreign investors. This study investigates the impact of corporate fraud
on foreign direct investment FDI. Using data of Chinese listed firms, over the period 2009 to 2017, the
results show that corporate fraud is negatively associated with foreign direct investment. This suggests
that corporate fraud declines foreign shareholders ratio, and foreign investors avoid investing in a risky
environment where their wealth may be expropriated. Further, we explore the impact of having foreign
shareholders on corporate fraud. We find that increasing foreign shareholders may help in curbing
corporate fraud due to diversified corporate experience and risk-taking behavior. However, the findings
remain robust after controlling for the potential endogeneity problem. Our findings have important im-
plications for policymakers and governments as it shows that corporate fraud is a crucial determinant
to the cause of foreign direct investment.

DOI: 10.4018/978-1-7998-4805-9.ch011

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Impact of Corporate Fraud on Foreign Direct Investment?

1. INTRODUCTION

The current competition among developed countries to attract foreign investors has resulted in a pool of
incentives for foreign investors, including paving the road for them by doing reforms in their markets.
China is one of those countries. According to the new economic policy of China, to be a free and opened
market has led the government to make relaxed regulations and allow foreign investors to possess shares
in Chinese listed firms. To this end, the Chinese government has to gain foreign investors’ trust in the
capital market of China by improving capital market regulations, law enforcement, corporate gover-
nance, and quality of financial reporting. One of the severe threats that threaten investors is corporate
fraud. Ethically, corporate fraud represents an ethical failure of management to bide its duties towards
investors (Conyon and He, 2016).
The consequences of corporate fraud have been documented in the literature. For instance, economi-
cally, fraud firms suffer a decrease in firm value (Karpoff and Lott Jr, 1993), and unfavorable customer
behaviors (Klein and Leffler, 1981, Johnson et al., 2014), an unfavorable stock market reaction (Karpoff
et al., 2008, Palmrose et al., 2004), an increase in the cost of debt(Graham et al., 2008). Managerially,
scholars contend that management turnover increases after fraud revelation(Agrawal and Cooper, 2017).
Corporate fraud may cause employees to lose their jobs and pensions(Zahra et al., 2005). In terms of
investment decisions, Using survey data from China’s context, Niu et al. (2019) find that corporate fraud
influences the decisions of household investment where household with more corporate fraud experience
is more likely to invest in real estate and less likely to invest in securities. Which suggests that Chinese
investors are likely to avoid investing in stock markets and more likely to choose a safe market. In line
with this research line, we believe that investigation of the impact of corporate fraud on foreign direct
investment is worthwhile and interesting. Especially, empirical evidence regarding the consequence of
corporate fraud on foreign direct investment has not existed. Thus, in this study we address the concern
question of whether the corporate fraud phenomenon in China affects foreign direct investment or not.
Theoretically, the ownership, location, and internalization (OLI) paradigm explain how foreign direct
investment work(Dunning, 2015). In addition to the three factors above that drive foreign investors’ deci-
sions, we believe that assigning an incremental factor would expand our knowledge of further causes and
its influence on foreign direct investment. Thus, given the consequences of corporate fraud, making us
expect that corporate fraud is an additional factor that may drive foreign direct investment in the China
context. Where foreign investors avoid investing in costly and risky market(Robertson and Watson, 2004).
We focus on China’s context because the acute competition of attracting foreign investment faced
China along with the severe fraud corporate consequences in this context. Chen et al. (2006) report that
the fraud phenomenon is severe in China, since its capital market regulations and law enforcement are
weaker than those of developed countries. Further, unlike other developed countries, China is character-
ized by weak law enforcement and investor protection(Ding et al., 2012), which creates a low level of
trust in China’s capital market by foreign investors. Therefore, exploring how the likelihood of corporate
fraud, in the largest emerging market, drives foreign direct investment in the policy point view is very
important. Given the variety of Chinese listed firms’ shares (on average around 30% of listed firms’
shares owned by the government and its agencies where these shares are untradeable, while the other
types of shares (A, B, H) are owned by individuals and are tradeable in two security markets(Xu, 2004),
making it more interesting to examine the heterogeneity effect in corporate fraud across different shares’
type. Additionally, China is considered to be a free trade market along with the recent reforms in the

149

Impact of Corporate Fraud on Foreign Direct Investment?

capital market (Jia et al., 2009). Further, the lack of investigations on the effect of corporate fraud on
foreign direct investment creates important implications of this study for policymakers and regulators.
Using a sample of Chinese listed firms from 2009 to 2017, that corporate fraud is negatively associated
with foreign direct investment, suggesting that the corporate fraud phenomenon in China declines the
foreign direct investment inflow. We also find that having foreign shareholders is negatively associated
with the likelihood of corporate fraud. This indicates that foreign investors may enhance monitoring of
management, in turn, help to curb the likelihood of corporate fraud by enhancing governance and the
monitoring role of the board. However, our findings remain consistent and robust after controlling for
potential endogeneity problems.
This study contributes to the literature in several aspects. First, theoretically, this study contributes
to the OIL paradigm of foreign direct investment activities by identifying corporate fraud as an incre-
mental factor that drives foreign direct investment. Second, empirically, this study is the first attempt
that investigates the effect of corporate fraud on foreign direct investment and provides strong empirical
evidence on this effect. Third, it contributes to foreign ownership literature by providing empirical evi-
dence that corporate fraud clogs the flow of foreign investment. In addition, it contributes to corporate
fraud consequences literature by providing empirical evidence that increasing the likelihood of corporate
fraud declines foreign direct investment in China. Fourth, our findings have implications, to regulators
and policymakers in improving the efficiency and effectiveness of current regulations and improving the
foreign investment law. To China’s government in perceiving an additional factor that may lead foreign
investors to keep their wealth away from China’s capital market. In turn, helping the government to do
more effort in attracting foreign investors by promoting enforcement actions and encouraging domestic
firms to improve corporate governance mechanisms.

2. INSTITUTIONAL CONTEXT OF CHINA

In 1904, the Chinese government promulgated a set of regulations that created a modern framework,
Western-style and limited-liability corporations. Until the nineteenth century, private firms run as family-
owned businesses. State-owned companies monopolize some sectors like salt production and imperial silk
and porcelain manufacturers. Many of the family firms were financially successful, running throughout
the local, regional, and interregional markets(Goetzmann and Koll, 2005). In 1860 Foreign investors
registered companies for doing business in China. At that time, Shanghai Stock Exchange served as a
sponsor for domestic and foreign investments for the next seventy years in China. After the so-called Self-
Strengthening Movement between 1862 and 1874, it was not allowed to foreigners to own shares in any
company in China (Goetzmann and Koll, 2005). Between 1904 and 1908, around 272 firms applied to
register in China, but only around half of the applicants became as joint-stock firms with limited liability
(Chan, 1977). Chinese government reformed company law several times to attract foreign investment.
In 1914, they made registration requirements and procedures easier.
China has centralized political control and decentralized economic management. This gives rise to
classic principal-agent conflict. Due to the concentrated ownership of China, public firms suffer from
a secondary agency problem (Jiang et al., 2010b, Boycko et al., 1996). However, In July 1999 China’s
Securities Law released the first complete securities legislation. Such legislation gave CSRC the author-
ity to organize and unify the regulations regarding securities markets, then CSRC became responsible
for establishing policies and regulations, monitoring the centralized securities supervisory system of

150

Impact of Corporate Fraud on Foreign Direct Investment?

China, investigating and enforcing fines on firms that engage in activities of violation of the securities
and futures laws and regulations (Huang, 2008). Moreover, Shanghai and Shenzhen stock exchanges are
also allowed to issue their listing rules. In 1990, they both became effective. Therefore, in the case listed
firms violate these listing rules and commit fraud, they will be penalized by stock exchanges. According
to Chen et al. (2005) Chinese listed firms engage in several kinds of corporate fraud such as, inflation
of profits, fake accounting record, embezzlement, false disclosures, and expropriating minority’s equity.
Practically, fraud could only be committed where there are incentives and opportunities. The institutional
context of China is characterized by the existence of both such as financial and regulatory pressures and
a dynamic changing environment (Chen et al., 2016). For example, a firm should consecutively generate
profit for two years in order to be listed in the stock exchange market (Aharony et al., 2000). For issuing
new shares the firm must gain at least return on equity ROE by 10% for three years consecutively (Chen
and Yuan, 2004). Additionally, the law situation in China, regulations of the financial capital market,
and CSRC’s enforcement actions are weak and biased (Zhang, 2004, Chen et al., 2011, Wang et al.,
2017). Those weaknesses along with pressures motivate the management to engage in illegal behaviors.
That is, firms that operate in a rapidly changing environment and transitional economies are more likely
to engage in fraudulent and illegal activities because of the variation in the rules over time (Jia et al.,
2009). Although China’s government has paved the road for foreign investors, expropriation possibility
has existed. Therefore, China’s government has to do more effort to mitigate the likelihood of corporate
fraud in order to attract foreign investment. Accordingly, we expect that an investigation on the impact
of corporate fraud on foreign direct investment has significant implications.

3. LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

Theoretically, foreign investors’ decisions influenced by the ownership, internalization, and location
(OIL) paradigm (Dunning, 2015). Much literature has examined those factors e.g., (Habib and Zurawicki,
2002, Robertson and Watson, 2004, Chuang and Lin, 1999, Dahlquist and Robertsson, 2001). Several
studies have examined further factors that may drive foreign direct investment in the host country. For
example, Habib and Zurawick (2002) find that corruption is negatively associated with foreign direct
investment. Kandilov and Senses (2016) examine the impact of employment protection regulations ad-
opted in the US on foreign direct investment transactions. They find a negative association between the
implementation of employment protection measures and both the efficiency and effectiveness of margins
of foreign direct investment in the US. In line with this research line, identifying further factors that
drive foreign direct investment can expand our understanding of how foreign direct investment operates
along with the OIL paradigm. Given the increasing attention in the past two decades to corporate fraud
consequences by scholars and policymakers as well as the investors, we suggest that corporate fraud is
a strong drive of foreign direct investment.
Corporate fraud consists of either deliberate financial fraudulent behaviors or actions taken by
management to cheat or deceive shareholders, investors, and information users (Brennan and McGrath,
2007, Zahra et al., 2005). Corporate fraud takes several ways such as cooking books, tunneling, breaking
rules and inside trading and all of these are crucial threats to investors. Extant literature has explored
antecedes and consequences of corporate fraud (Conyon and He, 2016). For instance, Beasley (1996)
finds an association between the quality of directors’ board and corporate fraud. Wu et al. (2018) find a
positive relationship between internal control quality and corporate fraud. Johnson et al. (2003) contend

151

Impact of Corporate Fraud on Foreign Direct Investment?

that executives’ equity incentives are positively associated with corporate fraud. On the other hand, many
studies have explored the consequences of corporate fraud, for example, Karpoff et al. (2014) document
that the individual perpetrators of financial fraud face significant disciplinary actions. Johnson et al.
(2014) conclude that fraud firms face customers’ reputational penalties and sometimes it even goes to
termination of the business relationship with fraudulent firms. A study finds that accounting fraud in U.S.
firms gives rise to shareholders loss by 27%(Karpoff et al., 2008) , after fraud punishment cost of debt
and equity increase(Lin et al., 2013, Deng et al., 2014). Fraud firms face an unfavorable stock market
reaction as well (Palmrose et al., 2004). Albring et al. (2013) find that firm growth ratio decreases after
fraudulent accounting restatement.
Several Chinese scholars have focused on the consequence of corporate fraud in China. For example,
similar to other developed countries China’s fraudulent firms are strongly and negatively associated with
security market reactions (Firth et al., 2011). Conyon and He (2016) find that top executives of Chinese
listed firms are more likely to be financially panelized by reducing their compensation after fraud revelation
than being replaced. Further, the loans’ cost of private firms issued by state-owned banks significantly
increases after fraud revelation (Haß et al., 2019). Xin et al. (2018) find that fraud companies suffer a
decrease in sales income by 11.9–17.1%, and gross profit margin by 2.4–2.8%, in the three years after
enforcement action. Niu et al. (2019) find that corporate fraud influences the decisions of household
investment where household with more corporate fraud experience is more likely to invest in real estate
and less likely to invest in securities. In general, consequences of fraud in China within five days after
the fraud announcement is considered to be a wealth loss of around 1–2% (Chen et al., 2005, Haß et al.,
2019). Given the consequences of corporate fraud documented in the literature, we expect that foreign
investors would keep their own money away from markets where fraudulent behaviors are dominated.
Unlike other developed countries (e.g., U.S., UK), China’s institutional context is characterized by
state-owned shares that are not tradeable versus several types of shares that are tradeable (i.e., A, B, H,
and N share). Foreign investors can own B and H shares. Which creates a little slice for foreign inves-
tors. Besides, China’s stock market is characterized by concentrated ownership. That is, the secondary
agency problem is dominated in the Chinese institutional context, suggesting that minority’s equity may
be expropriated by controlling shareholders(Jiang et al., 2010a, Wu et al., 2016). Further, China is also
characterized by weak governance, inactive investor protection, and a dynamic changing market which
leads to increasing the likelihood of corporate fraud(Chen et al., 2006), resulting in an increasing the
probability of minority’s equity expropriation. In turn, foreign investors are unlikely to target such a
market as the best choice. Based on the argument aforementioned, we propose the following hypothesis.

H: A high likelihood of corporate fraud declines foreign direct investment in Chinese listed firms.

4. RESEARCH METHODOLOGY AND DATA

4.1. Data

Sample selection procedures are reported in Table 1. The data of our study involves all China’s firms
listed in the Shenzhen and Shanghai stock exchanges over the period from 2009 to 2017 in order to avoid
the mortgage financial crisis effect on the foreign direct investment we set 2009 as a starting point. Data
of foreign direct investment is obtained from the WIND Economic Database of China. Corporate fraud’

152

Impact of Corporate Fraud on Foreign Direct Investment?

and control variables’ data are obtained from the Dong Jianguo sub-database (DJG) provided by China’s
Security Market and Accounting Research (CSMAR) database. However, the final sample of our study
consists of 2482 Firms and 18049 firm-year observations.

4.2. Measurement of Variables

The dependent variable in our study is foreign direct investment (FDI), following previous studies
(Tsang et al., 2019, Khalil et al., 2019) we measure the foreign direct investment by the ratio of foreign
shareholders in a firm (i) at the end of the year (t).The independent variable is corporate fraud. Follow-
ing prior studies (Cohen et al., 2012, Persons, 2012, Liao et al., 2019) we measure corporate fraud as
dummy variable equals one if the firm committed fraud in a year (t), zero otherwise. CSMAR database
collects fraud data from the announcement disclosed by CSRC and Shanghai and Shenzhen stock ex-
change regarding fraud-firms.
In the selection of control variables, we select our firm-specific control variables based on the extant
literature (Persons, 2012, Conyon and He, 2016, Schuchter and Levi, 2016, Liao et al., 2019, Kong et
al., 2019, Bruner et al., 2008). Therefore, we include firm size, the return on total assets, total loss and
earnings per share. We also control for the opportunities that may motivate the firms to commit fraud,
such as internal control weaknesses and the event whether the firm is audited by one of the big four audit
firms. We include the corporate governance characteristics into our model, such as board size, board
independence, CEO duality and number of board meetings. Finally, we use SOEs as binary variables to
control for ownership structure. For more details see Table 2.

4.3. Empirical Model

To capture the corporate fraud effect on the foreign direct investment, we estimate the linear model by
using the ordinary least squares (OLS) regression. For doing so, we use the following model:

FDI i,t = β0 + β1Fraudi,t + ∑ânControlsi,t + åi,t (1)

i =1

Where i refers to a firm, t refers to the year, FDI i,t is the ratio of foreign shareholders in the firm,
Fraudi,t is the dummy variable equals one if the firm committed fraud in year (t), zero otherwise,
Controlsi,t refers to all controls variables used in the empirical models. For more details see Table 2.

5. RESULTS

5.1. Descriptive Statistics and Correlation

Table 3 presents descriptive statistics for all variables of our empirical model. The average foreign
ownership ratio (FDI) is 0.0192. While in the period between 1999-2005 the foreign ownership was
0.0112 (Meng et al., 2018), suggesting that although China’s government has paved the road to foreign

153

Impact of Corporate Fraud on Foreign Direct Investment?

investors, the foreign direct investment has slightly increased. The average corporate fraud (Fraud) is
0.12. This indicates that 12% of our sample firms are engaged in illegal activities (e.g., cooking books,
tunneling, breaking rules, and inside trading). The mean board’s independence is 37.2%. The average
Board_size is around 9 members. The mean number of board meetings is 8 times a year. The average
BTM is 0.84. The mean ROA is around 0.044, while the mean firm’s Leverage is around 0.453. The
average Firm_size is 21.9. Around 18.7% of our sample firms has a deficiency in internal control system
(InternalControlW). Only 4.5 of our sample is audited by big four auditor. Finally, 39.1% of our firm
sample is controlled by government.
Using Pearson correlation test, Table 4 presents the correlation leaner between all variables of our
empirical models. The correlation between foreign ownership and corporate fraud is negative and sig-
nificant. In terms of control variables some are positively correlated with foreign ownership and cor-
porate fraud, and some are negatively correlated with foreign ownership and corporate fraud. However,
all coefficients are below 50%, suggesting that collinearity issue is not a severe issue in our model, for
more details see Table 4.

5.2. Regression Results

Table 5 reports the results of OLS and logit regressions. In model 1 of Table 5, the coefficient of corpo-
rate fraud is -0.011 a negative and significant value at p< 5%. This finding indicates that corporate fraud
is negatively associated with foreign direct investment, suggesting that highly likelihood of corporate
fraud declines foreign direct investment inflow in China’s institutional context. Economically, we can
interpret this finding that if corporate fraud increased by 1% the FDI declines by 0.011. This finding
supports our hypothesis H. As for control variables, model 1 of Table 5 shows that FDI is positively
related to corporate governance characteristics (Board_ind, Board_size, and Number of meeting) and
BTM, firm size, Big4, and SOE. While it is negatively associated with internal control system weak-
nesses and leverage of the firm.

5.3. Additional Test

According to stakeholders’ theory, the directors’ board should manage the firm in the interest of all
shareholders (Evan and Freeman, 1988). This suggests that the directors’ board intends to behave in favor
of foreign shareholders as well. Therefore, when there are foreign investors it is more likely to influence
a firm’s outcomes (Gillan and Starks, 2003). Moreover, the agency theory proposes that ownership
structure may mitigate the agency problems in the firm(Yoshikawa et al., 2010), suggesting that nation-
diverse ownership could strengthen the monitoring role in the firm. Consistent with that, prior studies
document that foreign direct investment is positively associated with corporate governance quality (Kim
et al., 2010, Dahlquist and Robertsson, 2001, Mangena and Tauringana, 2007) and financial reporting
quality (Gill-de-Albornoz and Rusanescu, 2018, Guo and Ma, 2015, Vo, 2016). Empirically no evidence
on the impact of foreign shareholders on the likelihood of corporate fraud has documented. Therefore,
another important gap comes out. That is, we also investigate whether the existence of foreign sharehold-
ers influences the firm polices or not. To capture the effect of foreign shareholders on the likelihood of
corporate fraud we use logit regression as follows:

154

Impact of Corporate Fraud on Foreign Direct Investment?

Fraudi,t = β0 + β1FDI i,t + ∑ânControlsi,t + åi,t (2)

i =1

All symbols mentioned in the eq.2 are defined in the eq.1 above.
The inconsistent and limited evidence, on the effect of foreign shareholders on financial reporting
quality, provided by the previous study has created a curiosity to explore such an impact in the Chinese
institutional context. There are two views regarding the effect of foreign shareholders. First, foreign
shareholders have a positive effect on organizational outcomes because they have expertise advantage
(Khanna and Palepu, 2000, Guo and Ma, 2015). Second, foreign shareholders may have a negative effect
on organizational outcomes because foreign shareholders lack the informational advantage, for example,
less knowledge about accounting standards and other related regulations (Dvorak, 2001, Gill-de-Albornoz
and Rusanescu, 2018, Tsang et al., 2019). We extend the extant literature on foreign ownership and finan-
cial reporting quality (Khalil et al., 2019, An, 2015). Therefore, we believe that the existence of foreign
shareholders will influence a firm’s decisions. Directly by using their rights in shareholders’ meeting,
indirectly by threatening management to sell their own stocks (Gillan and Starks, 2003). Consistent with
this, Colpan and Yoshikawa (2012), using Japanese data, find that foreign ownership positively moder-
ates the relationship between profitability and bonus pay. Drawing on the argument above, we adopt the
first view, and expect that having foreign shareholders improve the firm governance which in turn will
curb the opportunistic behavior by managers. To capture the impact of foreign ownership we regress the
model in the eq. 2, Table 5 presents the results.
Model 2 in Table 5 reports the results of the association between foreign shareholders and the likeli-
hood of corporate fraud. In model 2 of Table 5, we find the coefficient of FDI is -0.031 negative and
significant at P<1%. This finding reveals a negative association between foreign ownership and the
likelihood of corporate fraud, suggesting that having foreign shareholders may curb corporate fraud by
enhancing corporate governance.

6. ROBUSTNESS

Controlling for potential endogeneity problems, such as a self-selection bias and the causality effect, is
a challenge especially in management and accounting research. Our study shows that corporate fraud
declines foreign direct investment. In order to prove the causal effect of corporate fraud on FDI, we use
the following models to address potential endogeneity problems.

6.1. Propensity Score Matching (PSM) Model

Our main results may have a potential endogeneity problem that the level of foreign investor’s ratio is
affected by the sample selection process, suggesting that our sample might be biased for the firms that
have foreign shareholders and non-fraud firms and vice versa. We use the propensity score matching
model (PSM) to control for such a possible problem. The primary purpose of PSM(Shipman et al., 2016,
Heinrich et al., 2010) is to find a set of fraud firms (treatment) versus a set of non-fraud firms (control),
and then we match both groups based on the rest of our model variables. Panel A of Table 6 reports the
results of the matching process. We find the t-statistics of all variables is insignificant, implying that

155

Impact of Corporate Fraud on Foreign Direct Investment?

the matching process successfully resulted in a balance. We specifically focus on the matched group
since the two groups statistically are similar in terms of firm characteristics that may affect the foreign
direct investment. Next, we regress our model based on the optimal PSM sample. Model 1 in Panel B of
Table 6 reports the regression results of PSM. In model 1 of panel B, we find the coefficient of Fraud
is -0.223 negative and significant at p< 0.05. This suggests that our main findings are consistent and
robust for the selection bias problem.

6.2 Two-stage Least Square (2SLS) Model

Due to the endogenous nature of corporate fraud, some of the determinants of this event are likely to be
associated with foreign ownership choice. Thereby, the negative association between corporate fraud
and foreign direct investment may be driven by omitted variable or measurement errors. We, thus, seek
to prove the causal effect in this association. Statistically, if the endogeneity problem is not controlled,
the main proposition regarding the properties of the error terms is violated, which results in inconsis-
tent estimates(Larcker and Rusticus, 2010, Guo et al., 2015). To control for this potential issue we use
instrumental variable specifications (so-called 2SLS). For doing so, we must have a valid instrumental
variable. Following Guo et al. (2015), to mitigate the bias resulted in unobserved characteristics, we use
previous-year corporate fraud as an instrumental variable because current-corporate fraud is correlated
with previous-year corporate fraud.
Model 1 of Table 6 shows the estimates of the first stage of the 2SLS model. In Table 6’s model 1, we
find the coefficient of lag_fraud is 0.068 positive and significant at P< 1%, suggesting that Lag_fraud
is highly correlated with Fraud. This means our instrument is valid. In the second stage, we rerun our
model instrumented by Lag_fraud. In model 2 of Table 6, we find the coefficient of Fraud is -0.010
negative and significant at P< 10%. This suggests that the negative impact of corporate fraud on foreign
direct investment is robust and consistent with previous results.

7. CONCLUSION

Due to the acute competition among developed countries to attract foreign investors in order to benefit
their capabilities, the fraud phenomenon is one of the most severe threats that threaten the investors
either domestic or foreign. So, this study investigates the impact of corporate fraud on foreign direct
investment using a sample of listed Chinese firms from 2009 to 2010. After controlling the board and
firm-specific characteristics, we find a negative significant association between corporate fraud and
foreign direct investment, suggesting that a higher likelihood of corporate fraud declines foreign direct
investment since foreign investors avoid investing their wealth in an illegal and risky market. We ad-
ditionally, examined the impact of foreign shareholders on the likelihood of corporate fraud, and find
a negative relationship between foreign ownership and the likelihood of corporate fraud, suggesting
that foreign shareholders could be used as further monitoring of the firm in mitigating the likelihood of
corporate fraud in Chinese listed firms by enhancing firm corporate governance. However, our findings
remain consistent and robust after controlling for endogeneity problems.
As discussed in the introduction, this study contributes to the literature in several aspects. First, theo-
retically, this study contributes to the OIL paradigm of foreign direct investment activities by identify-

156

Impact of Corporate Fraud on Foreign Direct Investment?

ing corporate fraud as an incremental factor that drives foreign direct investment. Second, empirically,
this study is the first attempt that investigates the effect of corporate fraud on foreign direct investment
and provides strong empirical evidence on this effect. Our findings have implications, to regulators and
policymakers in improving the efficiency and effectiveness of current regulations and improving the
foreign investment law. To China’s government in perceiving an additional factor that may lead foreign
investors to keep their wealth away from China’s capital market. In turn, helping the government to do
more effort in attracting foreign investors by promoting enforcement actions and encouraging domestic
firms to improve corporate governance mechanisms. However, the findings should be cautiously general-
ized since this study has been conducted in the emerging market “China”. This implies that our findings
could be generalized only for whose markets “settings” in which that have similar characteristics such as
concentrated ownership, less investors’ protection, and multiple-shares ownership. Accordingly, further
research is needed to be conducted in those settings where that have not similar traits.

REFERENCES

Agrawal, A., & Cooper, T. (2017). Corporate governance consequences of accounting scandals: Evidence
from top management, CFO and auditor turnover. The Quarterly Journal of Finance, 7(1), 1650014.
doi:10.1142/S2010139216500142
Aharony, J., Lee, C.-W. J., & Wong, T. J. (2000). Financial packaging of IPO firms in China. Journal
of Accounting Research, 38(1), 103–126. doi:10.2307/2672924
Albring, S. M., Huang, S. X., Pereira, R., & Xu, X. (2013). The effects of accounting restatements on firm
growth. Journal of Accounting and Public Policy, 32(5), 357–376. doi:10.1016/j.jaccpubpol.2013.06.005
An, Y. (2015). Does foreign ownership increase financial reporting quality? Asian Academy of Manage-
ment Journal, 20.
Beasley, M. S. (1996). An empirical analysis of the relation between the board of director composition
and financial statement fraud. The Accounting Review, 443–465.
Boycko, M., Shleifer, A., & Vishny, R. W. (1996). A theory of privatisation. Economic Journal (London),
106(435), 309–319. doi:10.2307/2235248
Brennan, N. M., & Mcgrath, M. (2007). Financial statement fraud: Some lessons from US and European
case studies. Australian Accounting Review, 17(42), 49–61. doi:10.1111/j.1835-2561.2007.tb00443.x
Bruner, D., Mckee, M., & Santore, R. (2008). Hand in the cookie jar: An experimental investigation of
equity-based compensation and managerial fraud. Southern Economic Journal, 261–278.
Chan, W. K. (1977). Merchants, mandarins, and modern enterprise in late Chʻing China. Harvard Univ Pr.
Chen, D., Jiang, D., Liang, S., & Wang, F. (2011). Selective enforcement of regulation. China Journal
of Accounting Research, 4(1-2), 9–27. doi:10.1016/j.cjar.2011.04.002
Chen, G., Firth, M., Gao, D. N., & Rui, O. M. (2005). Is China’s securities regulatory agency a toothless
tiger? Evidence from enforcement actions. Journal of Accounting and Public Policy, 24(6), 451–488.
doi:10.1016/j.jaccpubpol.2005.10.002

157

Impact of Corporate Fraud on Foreign Direct Investment?

Chen, G., Firth, M., Gao, D. N., & Rui, O. M. (2006). Ownership structure, corporate governance,
and fraud: Evidence from China. Journal of Corporate Finance, 12(3), 424–448. doi:10.1016/j.jcorp-
fin.2005.09.002
Chen, J., Cumming, D., Hou, W., & Lee, E. (2016). Does the external monitoring effect of financial
analysts deter corporate fraud in China? Journal of Business Ethics, 134(4), 727–742. doi:10.100710551-
014-2393-3
Chen, K. C., & Yuan, H. (2004). Earnings management and capital resource allocation: Evidence
from China’s accounting-based regulation of rights issues. The Accounting Review, 79(3), 645–665.
doi:10.2308/accr.2004.79.3.645
Chuang, Y. C., & Lin, C. M. (1999). Foreign direct investment, R&D and spillover efficiency: Evi-
dence from Taiwan’s manufacturing firms. The Journal of Development Studies, 35(4), 117–137.
doi:10.1080/00220389908422583
Cohen, J., Ding, Y., Lesage, C., & Stolowy, H. (2012). Corporate fraud and managers’ behavior: Evi-
dence from the press. Entrepreneurship, governance and ethics. Springer.
Colpan, A. M., & Yoshikawa, T. (2012). Performance Sensitivity of Executive Pay: The Role of Foreign
Investors and Affiliated Directors in Japan. Corporate Governance, 20(6), 547–561. doi:10.1111/j.1467-
8683.2012.00923.x
Conyon, M. J., & He, L. (2016). Executive compensation and corporate fraud in China. Journal of Busi-
ness Ethics, 134(4), 669–691. doi:10.100710551-014-2390-6
Dahlquist, M., & Robertsson, G. (2001). Direct foreign ownership, institutional investors, and firm
characteristics. Journal of Financial Economics, 59(3), 413–440. doi:10.1016/S0304-405X(00)00092-1
Deng, S., Willis, R. H., & Xu, L. (2014). Shareholder litigation, reputational loss, and bank loan contract-
ing. Journal of Financial and Quantitative Analysis, 49(4), 1101–1132. doi:10.1017/S002210901400057X
Ding, S., Jia, C., Li, Y., & Wu, Z. (2012). Reactivity and passivity after enforcement actions: Better late
than never. In Entrepreneurship, Governance and Ethics. Springer.
Dunning, J. H. (2015). The eclectic paradigm of international production: a restatement and some pos-
sible extensions. In The Eclectic Paradigm. Springer.
Dvorak, T. (2001). Do domestic investors have an information advantage. Evidence from Indonesia.
Evan, W. M. & Freeman, R. E. (1988). A stakeholder theory of the modern corporation: Kantian capi-
talism. Academic Press.
Firth, M., Rui, O. M., & Wu, W. (2011). Cooking the books: Recipes and costs of falsified financial
statements in China. Journal of Corporate Finance, 17(2), 371–390. doi:10.1016/j.jcorpfin.2010.09.002
Gill-De-Albornoz, B., & Rusanescu, S. (2018). Foreign ownership and financial reporting quality in
private subsidiaries. Spanish Journal of Finance and Accounting. Revista Española de Financiación y
Contabilidad, 47(2), 181–213. doi:10.1080/02102412.2017.1394104

158

Impact of Corporate Fraud on Foreign Direct Investment?

Gillan, S., & Starks, L. T. (2003). Corporate governance, corporate ownership, and the role of institu-
tional investors: A global perspective. Journal of Applied Finance (JAF), 13. doi:10.2139srn.439500
Goetzmann, W. N., & Koll, E. (2005). The history of corporate ownership in China: State patronage,
company legislation, and the issue of control. A history of corporate governance around the world:
Family business groups to professional managers. University of Chicago Press.
Graham, J. R., Li, S., & Qiu, J. (2008). Corporate misreporting and bank loan contracting. Journal of
Financial Economics, 89(1), 44–61. doi:10.1016/j.jfineco.2007.08.005
Guo, F., & Ma, S. (2015). Ownership characteristics and earnings management in China. Chinese
Economy, 48(5), 372–395. doi:10.1080/10971475.2015.1067086
Guo, J., Huang, P., Zhang, Y., & Zhou, N. (2015). Foreign ownership and real earnings management:
Evidence from Japan. Journal of International Accounting Research, 14(2), 185–213. doi:10.2308/
jiar-51274
Habib, M., & Zurawicki, L. (2002). Corruption and foreign direct investment. Journal of International
Business Studies, 33(2), 291–307. doi:10.1057/palgrave.jibs.8491017
Haß, L. H., Vergauwe, S., & Zhang, Z. (2019). State-ownership and bank loan contracting: Evidence from
corporate fraud. European Journal of Finance, 25(6), 550–567. doi:10.1080/1351847X.2017.1328454
Heinrich, C., Maffioli, A., & Vazquez, G. (2010). A primer for applying propensity-score matching.
Inter-American Development Bank.
Huang, C. (2008). Company law and the independent director system in contemporary China. Hastings
International and Comparative Law Review, 31.
Jia, C., Ding, S., Li, Y., & Wu, Z. (2009). Fraud, enforcement action, and the role of corporate gover-
nance: Evidence from China. Journal of Business Ethics, 90(4), 561–576. doi:10.100710551-009-0061-9
Jiang, G., Lee, C. M., & Yue, H. (2010). Tunneling through intercorporate loans: The China experience.
Journal of Financial Economics, 98(1), 1–20. doi:10.1016/j.jfineco.2010.05.002
Johnson, S. A., Ryan, H. E., & Tian, Y. S. (2003). Executive compensation and corporate fraud (Un-
published paper). Lousiana State University, Baton Rouge, LA.
Johnson, W. C., Xie, W., & Yi, S. (2014). Corporate fraud and the value of reputations in the product
market. Journal of Corporate Finance, 25, 16–39. doi:10.1016/j.jcorpfin.2013.10.005
Kandilov, I. T., & Senses, M. Z. (2016). The effects of wrongful discharge protection on foreign multina-
tionals: Evidence from transaction‐level data. The Canadian Journal of Economics. Revue Canadienne
d’Economique, 49(1), 111–146. doi:10.1111/caje.12192
Karpoff, J. M., Lee, D. S., & Martin, G. S. (2008). The cost to firms of cooking the books. Journal of
Financial and Quantitative Analysis, 43(3), 581–611. doi:10.1017/S0022109000004221
Karpoff, J. M., & Lott, J. R. Jr. (1993). The reputational penalty firms bear from committing criminal
fraud. The Journal of Law & Economics, 36(2), 757–802. doi:10.1086/467297

159

Impact of Corporate Fraud on Foreign Direct Investment?

Khalil, M., Ozkanc, A., & Yildiz, Y. (2019). Foreign institutional ownership and demand for accounting
conservatism: Evidence from an emerging market. Review of Quantitative Finance and Accounting, 1–27.
Khanna, T., & Palepu, K. (2000). Emerging market business groups, foreign intermediaries, and corpo-
rate governance. Concentrated corporate ownership. University of Chicago Press.
Kim, I. J., Eppler-Kim, J., Kim, W. S., & Byun, S. J. (2010). Foreign investors and corporate governance
in Korea. Pacific-Basin Finance Journal, 18(4), 390–402. doi:10.1016/j.pacfin.2010.04.002
Klein, B., & Leffler, K. B. (1981). The role of market forces in assuring contractual performance. Journal
of Political Economy, 89(4), 615–641. doi:10.1086/260996
Kong, D., Xiang, J., Zhang, J., & Lu, Y. (2019). Politically connected independent directors and corporate
fraud in China. Accounting and Finance, 58(5), 1347–1383. doi:10.1111/acfi.12449
Larcker, D. F., & Rusticus, T. O. (2010). On the use of instrumental variables in accounting research.
Journal of Accounting and Economics, 49(3), 186–205. doi:10.1016/j.jacceco.2009.11.004
Liao, J., Smith, D., & Liu, X. (2019). Female CFOs and accounting fraud: Evidence from China. Pacific-
Basin Finance Journal, 53, 449–463. doi:10.1016/j.pacfin.2019.01.003
Lin, C., Song, F., & Sun, Z. (2013). Corporate fraud, external debt and corporate cash policy. Chinese
University of Hong Kong. doi:10.2139srn.2255410
Mangena, M., & Tauringana, V. (2007). Disclosure, corporate governance and foreign share ownership
on the Zimbabwe stock exchange. Journal of International Financial Management & Accounting, 18(2),
53–85. doi:10.1111/j.1467-646X.2007.01008.x
Meng, Y., Clements, M. P., & Padgett, C. (2018). Independent directors, information costs and foreign
ownership in Chinese companies. Journal of International Financial Markets, Institutions and Money,
53, 139–157. doi:10.1016/j.intfin.2017.09.016
Niu, G., Yu, L., Fan, G.-Z., & Zhang, D. (2019). Corporate fraud, risk avoidance, and housing investment
in China. Emerging Markets Review, 39, 18–33. doi:10.1016/j.ememar.2019.03.003
Palmrose, Z.-V., Richardson, V. J., & Scholz, S. (2004). Determinants of market reactions to restatement
announcements. Journal of Accounting and Economics, 37(1), 59–89. doi:10.1016/j.jacceco.2003.06.003
Persons, O. S. (2012). Stock option and cash compensation of independent directors and likelihood of
fraudulent financial reporting. The Journal of Business and Economic Studies, 18, 54.
Robertson, C. J., & Watson, A. (2004). Corruption and change: The impact of foreign direct investment.
Strategic Management Journal, 25(4), 385–396. doi:10.1002mj.382
Schuchter, A., & Levi, M. (2016). The fraud triangle revisited. Security Journal, 29(2), 107–121.
doi:10.1057j.2013.1
Shipman, J. E., Swanquist, Q. T., & Whited, R. L. (2016). Propensity score matching in accounting
research. The Accounting Review, 92(1), 213–244. doi:10.2308/accr-51449

160

Impact of Corporate Fraud on Foreign Direct Investment?

Tsang, A., Xie, F., & Xin, X. (2019). Foreign institutional investors and corporate voluntary disclosure
around the World. The Accounting Review, 94(5), 319–348. doi:10.2308/accr-52353
Vo, X. V. (2016). Foreign investors and corporate risk taking behavior in an emerging market. Finance
Research Letters, 18, 273–277. doi:10.1016/j.frl.2016.04.027
Wang, Z., Chen, M.-H., Chin, C. L., & Zheng, Q. (2017). Managerial ability, political connections,
and fraudulent financial reporting in China. Journal of Accounting and Public Policy, 36(2), 141–162.
doi:10.1016/j.jaccpubpol.2017.02.004
Wu, P., Gao, L., Chen, Z., & Li, X. (2016). Managing reputation loss in China: In-depth analyses of
financial restatements. Chinese Management Studies, 10(2), 312–345. doi:10.1108/CMS-12-2015-0275
Wu, X., & Wang, J. (2018). Management’s Materiality Criteria of Internal Control Weaknesses and Cor-
porate Fraud: Evidence from China. The International Journal of Accounting, 53(1), 1–19. doi:10.1016/j.
intacc.2018.02.001
Xin, Q., Zhou, J., & Hu, F. (2018). The economic consequences of financial fraud: Evidence from the
product market in China. China Journal of Accounting Studies, 6(1), 1–23. doi:10.1080/21697213.20
18.1480005
Xu, L. (2004). Types of large shareholders, corporate governance, and firm performance: evidence from
China’s listed companies. Hong Kong Polytechnic University.
Yoshikawa, T., Rasheed, A. A., & Del Brio, E. B. (2010). The impact of firm strategy and foreign
ownership on executive bonus compensation in Japanese firms. Journal of Business Research, 63(11),
1254–1260. doi:10.1016/j.jbusres.2010.06.012
Zahra, S. A., Priem, R. L., & Rasheed, A. A. (2005). The antecedents and consequences of top manage-
ment fraud. Journal of Management, 31(6), 803–828. doi:10.1177/0149206305279598
ZhangY. 2004. Law, corporate governance, and corporate scandal in an emerging economy: Insights
from China. Available at SSRN 957549. doi:10.2139srn.957549

161
Impact of Corporate Fraud on Foreign Direct Investment?

APPENDIX: TABLES

Table 1. Sample selection

Total observations 34518

Less: Observations from 2000-2008 (9668)
Less: The data with missing variables (6803)
Final sample 18048

Table 2. Definition of variables

Variable Definition
ForeignOwnership Indicator variable equal a proportion of foreign shareholders in a firm (i) at the end of the year (t).
Fraud An indicator factor equals 1 if the firm committed fraud in the year (t), otherwise zero.
Board_ind The proportion of independent directors on the board of firm (i) in year t.
Board_size The number of directors on the firm’s board in year (t)
CEO duality An indicator variable equals 1 if the CEO is chairman in firm (i) in year (t).
Number of meeting The number of board’s meeting in firm (i) in year (t).
BTM The ratio of book value of assets to the firm’s market value.
Leverage The ratio of total debts to total assets in firm (i) in year (t)
Firm_size The logarithm of total assets of firm (i) in year (t).
InternalControlW An indicator variable equal 1 if there is a deficiency in internal control system, otherwise zero.
Big4 An indicator variable equals to 1 if the firm has been audited by one of big four audit firms.
SOE An indicator variable equals to 1 if the firm is affiliated with central or local government, 0 otherwise.

162
Impact of Corporate Fraud on Foreign Direct Investment?

Table 3. Descriptive Statistics

Variable Obs Mean Std.Dev. Min Max

Fraud 18048 .12 .335 0 1
FDI 18048 .0192 .759 0 0.341
Board_ind 18048 .372 .054 .091 .75
Board_size 18048 8.703 1.706 4 19
CEO duality 18048 .261 .439 0 1
No of meeting 18048 3.256 1.788 1 33
BTM 18048 .84 .912 0 12.1
ROA 18048 .044 .911 -51.947 108.366
Leverage 18048 .453 1.193 -.195 138.378
Firm_size 18048 21.927 1.285 11.348 28.036
InternalControlW 18048 .187 .39 0 1
Big4 18048 .045 .208 0 1
SOE 18048 .391 .488 0 1
All variable are defined in table 2.

Table 4. Pairwise correlations

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

FDI 1.000

Fraud -0.016* 1.000

Board_ind 0.014* 0.004 1.000

Board_size 0.031* -0.012 -0.447* 1.000

CEO duality 0.011 -0.003 0.105* -0.170* 1.000

Number of
-0.035* 0.094* 0.036* -0.027* 0.033* 1.000
meeting

BTM -0.013 0.003 -0.012 0.183* -0.144* 0.129* 1.000

ROA 0.005 -0.010 0.006 -0.001 0.019* -0.009 -0.018* 1.000

Leverage -0.007 0.014 -0.002 0.015* -0.032* 0.036* 0.084* -0.373* 1.000

Firm_size 0.123* -0.022* 0.040* 0.124* -0.039* 0.032* 0.070* 0.008 0.006 1.000

InternalControlW -0.010 0.095* 0.010 0.053* -0.082* 0.039* 0.134* -0.011 0.021* 0.076* 1.000

Big4 0.065* -0.037* 0.004 0.122* -0.063* -0.039* 0.161* 0.002 0.013 0.246* 0.053* 1.000

SOE 0.017* -0.025* -0.072* 0.272* -0.293* -0.135* 0.320* -0.013 0.049* 0.105* 0.177* 0.121* 1.000

All variable are defined in Table 2. * shows significance at the .05 level

163
Impact of Corporate Fraud on Foreign Direct Investment?

Table 5. Result of OLS, logit regression

Model 1 Model 2
Variable
FDI Fraud
Fraud -0.011**(-2.30) ----------
Foreign Ownership ------------ -0.031***(-2.91)
Board_ind 0.773*(1.68) -0.089(-0.18)
Board_size 0.049***(2.72) 0.010(0.58)
CEO duality 0.039(0.57) -0.050(-0.91)
Number of meeting 0.066***(3.71) 0.122***(10.00)
BTM 0.125***(3.36) -0.023(-0.73)
ROA 0.006 (0.23) -0.02 (-0.38)
Leverage -0.519***(-3.20) 0.022(1.64)
Firm_size 0.001***(12.50) 0.000***(-3.49)
InternalControlW -0.085*(-1.73) 0.506***(9.07)
Big4 0.466***(4.31) -0.486***(-3.32)
SOE 0.432***(6.31) -0.127***(-2.23)
Constant -2.962***(-6.22) -2.206***(-5.59)
Year and Industry Controlled Controlled
R2 / Pseudo R2 6.9 4.6
Observation 18048 18048
This Table provides the results of OLS regression the association between corporate fraud and foreign direct investment (model 1), as
well as the association between foreign shareholders and the likelihood of corporate fraud (model 2). The coefficients and adjusted are
calculated cross years and industry. T-statistics reported in parentheses. All variable described in Table 3.
*** p<0.01, ** p<0.05, * p<0.1

164
Impact of Corporate Fraud on Foreign Direct Investment?

Table 6. Results of 2SLS and PSM estimates (first stage)

Model 1
Model 2 Model 3
Variables 2SLS First Stage
(2SLS) H1 PSM First Stage
Fraud
Lag_Fraud 0.068***(8.67) - -
Fraud - -0.010*(-1.76) -
Board_ind -0.025(-0.46) 0.084(1.48) -0.025 (-0.100)
Board_size -0.002(-1.06) 0.006***(3.16) 0.003(0.380)
CEO duality -0.005(-0.83) 0.005(0.68) -0.030(-1.020)
No of meeting 0.16***(10) -0.002(-0.54) 0.067***(9.950)
BTM -0.004(-1.23) 0.001(0.11) -0.015(-0.890)
ROA -0.002(-0.68) -0.002(-0.63) -0.012 (-0.04)
Leverage -0.001(-0.11) -0.001(-0.57) 0.014*(1.810)
Firm_size -0.10***(-3.57) -0.012***(4.11) -0.001***(3.680)
InternalControlW 0.084***(11.28) 0.001(0.05) 0.28***(9.020)
Big4 -0.028***(-2.10) 0.091***(5.54) -0.276***(3.740)
SOE -0.16***(-2.48) 0.030***(4.35) -0.073***(2.410)
Constant 0.299***(4.53) 0.044(1.26) -1.275***(5.940)
Year&Industry effect Controlled Controlled Controlled
R square 12.5 16 14.5
Observations 14790 14790 18048

Table 7. Foreign ownership and corporate fraud- average treatment effect

Variable Sample Treatment Control Difference S.E. T-stat

Foreign Ownership Unmatched 0.010 0.015 -0.005 0.004 -3.60
ATT
2,318 0.010 0.019 -0.009 0.006 -2.06
Matched
The dependent variable is FDI. First stage is a probit equation including all covariates listed in Table model 4 of Table 6 to estimate the
propensity score, ATT is the average treatment effect.

165
166

Chapter 12
Outsourcing of Internal Audit
Services Instead of Traditional
Internal Audit Units:
A Literature Review on Transition
From In-House to Outsourcing

Yasemin Acar Uğurlu

Istanbul Arel University, Turkey

Çağla Demir Pali

TYH Textile, Turkey

ABSTRACT
The internal audit function traditionally establishes and continues its activities within the company, but
it can also be provided by professionals outside the organization. Therefore, internal audit activities can
be provided in three ways: the internal audit department established within the organization (in-house),
the internal audit service provided by an audit firm (outsourcing), the joint operation of the internal
audit department and the audit firm (co-sourcing). To choose the better approach for a company, the
scale of the organization, the attitude and understanding of the management, and industry in which the
company operates in must be taken into consideration. This study is a literature review that classifies
the studies carried out on these methods that are used in performing internal audit activities.

INTRODUCTION

The Institute of Internal Auditors (IIA) describes internal audit as an objective assurance and advisory
activity designed to improve the operations of an organization and to add value. The internal audit
function, traditionally, is established and continues its activities within the company, but it can also be
provided by professionals outside the organization. The outside party is the person or organization that
is specialized in the field of internal audit that provides the internal audit activities from outside the
DOI: 10.4018/978-1-7998-4805-9.ch012

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

company. Today, internal audit activities can be provided in three ways: the internal audit department
established within the organization (in-house), the internal audit service provided by professionals outside
the company (outsourcing), the joint operation of the internal audit department and professionals outside
the company (co-sourcing). These structures, which appear as different resource uses in internal audit,
emerge as alternatives to companies when planning and establishing their internal audit activities. To
choose the better approach for a company the scale of the organization, the attitude and understanding
of the management, and industry in which the company operates in must be taken into consideration. By
using internal and external resources or both, an effective and value-added internal audit activity in the
organization can be provided economically and efficiently with the enough competence. It also ensures
the independent and impartial assurance and advisory function as stated in the definition of internal
audit activity. The purpose of this study is to classify the studies carried out on these methods that are
used in performing internal audit activities.

BACKGROUND

When the history of internal audit is discussed, financial and compliance audits are the first issues put
forward. Then, at the beginning of the 20th century, with the growth of companies and increasing transac-
tion complexity, the need for competent managers and the necessity of effective and efficient operation of
the business activities have been brought to the agenda. Thus, internal audit, which is added to financial
audit and compliance audit, as well as managerial activities, has been accepted as an auxiliary tool for
equipped managers. (Spraakman, 2001, p.19) Internal audit was initially described as an “evaluation
function”. Today, when the services provided by internal audit are examined, it is seen that this defini-
tion is insufficient. Internal audit continuously adds value to operational activities through prevention
of problems and identification of potential risks. Internal audit helps to achieve the objectives of the
company with a systematic and disciplined approach to evaluate the risk management process, control
and governance processes of a company and to improve the disruptions. From this definition of internal
audit, it is possible to deduce that internal audit is an assurance service. (Ahlawat & Lowe, 2004, p.148)
Competition between audit firms and mergers in the 1980s and 1990s caused decrease in audit revenues.
For this reason, audit firms have begun to seek alternative resources by offering various professional
services, including internal audit, risk management, and various assurance and consulting services in
order to protect growth and profitability. (Swanger and Chewning, 2001, p.115)
Between 1982 and 1988, revenue from services other than independent audit services increased by
3.8% on average to 53% of total revenues in 1988 (Inua and Abianga, 2015, p.38). In the early 1980s,
companies tended to provide some of the business activities outside of their main activities and internal
audit activities carried out within the business so far from outside the company (Papageorgiou, Yasseen &
Padia, 2012, p.11828). In the early 1990s, independent auditing organizations began to consider internal
audit activities as a service area for both existing and new customers. Many of them have established
units within themselves to market and provide internal audit services. (Geiger, Lowe & Pany, 2002, p.21)

167

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

INTERNAL AUDIT

The IIA definition of internal audit activity is as follows: “Internal audit is an objective assurance and
advisory activity designed to improve the activities of an organization and to add value to the activities
of the organization.” Internal audit helps companies achieve their goals by bringing a disciplined and
systematic understanding to evaluate and improve the effectiveness of risk management, control processes
and governance processes (IIA, 2019).
Internal audit is generally seen as one of the four cornerstones of corporate governance. Based on IIA
the internal auditor is like one of the legs of a four-legged table. The other three are audit committee/
board of directors, senior management and independent auditor. Committee of Sponsoring Organizations
of the Treadway Commission (COSO) and Sarbanes-Oxley Act (SOX) emphasized the need for internal
audit services. In line with SOX regulations, improvements have been made to ensure the effective and
efficient internal audit unit in companies (Davidson, Desai & Gerard, 2013, p.43). Article 404 of the
SOX Act increased the responsibilities of the internal auditors. This article states that the entity’s annual
financial reports should include information on internal controls. It is also stated that management is
responsible for the establishment, maintenance and effectiveness of internal controls in financial report-
ing. (Inua & Abianga, 2015, p.37)
While the internal audit service can be provided from the internal audit unit within the company, from
outside the company or from the joint work of the internal audit unit and outside provider, the way in
which the internal audit service will be provided occupies the agenda of the companies. It is suggested
that for the internal audit unit to maintain its independence, it should be functionally linked to the audit
committee and administratively to the board of directors. The IIA recommends that the internal audit
manager must be present within the company, regardless of how the internal audit service is provided.
In addition, the IIA considers that it is objectionable to provide internal audit service from an indepen-
dent audit firm due to conflict of interest. American Institute of Certified Public Accountants (AICPA)
finds it useful to get the internal audit service from the organization that the independent audit service
is provided. According to AICPA’s approach, it is the opinion that the organization that performs the
independent audit of the company knows the company better and thus can provide the internal audit
services more effectively. However, AICPA considers the same firm to be both in the management of
the company and an employee of the company as a conflicting issue. SEC is also considering that it is
inconvenient for companies to receive internal audit services from the company that provides independent
audit. In 2000, the SEC imposed restrictions on the services that independent audit firms could provide
to their clients. Restrictions are increasingly imposed on these services, including SOX.

1. DIFFERENT SOURCE USES IN INTERNAL AUDIT

It has been demonstrated that high quality internal audit function of the company will have a positive
effect on the business activities. Internal audit services, unlike the independent audit service, which are
mandatory for some companies, are not obligatory to a large extent with legal regulations. Accordingly,
investing in the internal audit function is an option for business managements who prefer to develop their
business activities. (Bartlett & Others, 2016, p.145) The importance of internal audit activities increases
day by day, necessitating the existence of internal audit activities in companies. The reasons such as
inexperience, expert need and high cost during internal audit activities are required to be provided from

168

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

outside the company. In summary, inferences regarding the use of sources in internal audit are as follows
(Seetharaman, Moorthy & Saravanan, 2008, p.48):

• Internal audit activities can be sustained through an internal audit unit to be established within
the company or internal audit activities can be carried out with professional support from outside
the company.
• When the internal audit service is provided from outside the company, options arise in identifying
the service provider. A company may obtain internal audit service from the service provider from
which it receives independent audit service. In this case, the issue of whether the service provider
is the same auditor as the independent auditor, or the auditor is different. The company may ob-
tain internal audit service from an independent audit firm other than the company from which it
receives independent audit service. The choice of service provider has been the subject of many
studies on the “independence and objectivity” of the independent auditor.

In internal audit activities, the decision to use in-house, outsourcing or co-sourcing methods should
be taken with consideration of the drawbacks and benefits.

1.1. In-house Internal Audit

The audit team which carries out internal audit activities in-house comprises permanent employees of
the companies (IIA). There are four main reasons why internal audit should be established within the
company with operating personnel (Chadwick, 2000, p.88):

• Internal auditors ensure that confidential information about business activities, a critical factor in
providing high-quality audit services, remains within the business.
• The internal audit unit can provide immediate management sources against a possible crisis.
• Internal auditors are experienced and well-equipped because they are close to the daily activities
of the company in terms of investigating fraud and helping to prevent fraud.
• Independence and objectivity are maintained through internal audit.

The decision to carry out internal audit activities within the company is affected by the facts that the
opinion that there is more harmony between the company and the internal auditor of the company, com-
munication and coordination between different units, access to the internal auditor whenever needed in
more flexible times, improved corporate performance and the desire to keep the company information
confidential. (Sharma & Subramaniam, 2005, p.47)

1.2. Outsourcing of Internal Audit

Outsourcing the internal audit activities refer to internal audit services carried out by service provid-
ers outside of the companies (Al-Rassas & Kamardin, 2015, p.461). Some companies transfer all their
internal audit activities out of the company, while others prefer to use partly outsourcing. The purpose
of using information systems by obtaining information systems from the external service provider of
the audit is an example of partial outsourcing. (Yiannakas, 2000, pp.115-116)

169

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

It is common opinion that it is difficult for the company’s own personnel to act independent from
the management. Therefore, it is considered that the service provider outside the company will act more
independently. (Al-Rassas & Kamardin, 2015, p.461)
Outsourcing the internal audit provides quality assurance as well as personnel flexibility (Martin &
Lavine, 2000, p.58). Internal audit companies are generally large international organizations. Businesses
benefit from these companies in terms of culture, economics and prestige. (Bartlett & Others, 2016,
p.146) Although the hourly wages of the external service providers are higher than the hourly wages of
the internal audit employees, it is seen that outsourcing may be beneficial for the companies considering
the benefits provided and the investment costs required for internal audit. In order to benefit from this,
it is necessary to monitor the long-term use of outsourcing. Businesses need to analyze their situation
well before deciding to outsource the internal audit. (Bostwick & Byington, 1997, p.90)

1.3. Co-sourcing of Internal Audit

Co-sourcing means internal audit activities are carried out in cooperation with the internal audit unit of
the company and the external service provider. (Desai & Others, 2008, p.5) With the use of co-sources,
internal audit activities are carried out within the company while the expert skills of the outside service
provider are also utilized. The help of the outside service provider contribute to the works of the internal
audit department by the understanding of the requirements of the company, the solution of problems
encountered and the operation of the system. (Mumby & Clarke, 2000, pp.31-32) Especially in the
companies that are work on projects with time limits, it is possible to apply for co-source use when
the project needs to be grown on time. It is not always possible to follow technological developments
in companies that require technological infrastructure. In this case, it is beneficial to get professional
support by peer sources. In addition, the interaction between the companies’ personnel and the outside
service provider working in the same environment with the co-sourcing of the internal audit service is
beneficial. Company personnel can make professional development by benefiting from the experience
and competence of the outside service provider. Co-source use also increases the reliability of the result-
ing work. (Goller & Sleezer, 2012, p.6)

2. ADVANTAGES AND DISADVANTAGES OF USING

DIFFERENT SOURCES IN INTERNAL AUDIT

It is generally considered useful to provide business activities from outside service providers. It is believed
that these services, which are planned to be obtained from the service provider outside the company,
should be used for the activities outside the main activity area of the company. One method can provide
advantages for one business, but it may offer disadvantages for other businesses. In internal audit, there
are advantages and disadvantages of in-house, outsourcing and co-sourcing in the areas such as company
recognition, costs and objectivity. (Desai & Others, 2008, p.5)
Outside service providers and internal auditors of the companies cannot agree on the costs and
benefits of outsourcing. Both parties claim to serve at more affordable costs. Many studies on the area
show that outside service providers and internal auditors of the company have similar experience and
technical equipment. Although both auditors have similar experience and technical equipment, two cases
have been identified that indicate that outsourcing is more beneficial. Firstly, the companies’ internal

170

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

auditors’ responsibility for an audit failure is limited since they work in the companies’ working bodies.
On the other hand, the outside service providers can compensate the damage they caused. Secondly, the
outside service provider has a third-party attestation services license, which is an important issue for
their customers, so charges may be excessive. With increasing awareness of the competition between
outside service providers and the importance of the internal audit function, the wage gap between the
outside service provider and the internal auditor of the entity tends to decrease. (Caplan & Kirschen-
heiter, 2010, pp.392-397)
In the literature, advantages and disadvantages related to the use of different sources in internal audit
are classified in two groups as in-house and outsourcing. In addition, there are opinions about the dis-
advantages of in-house and outsourcing can be eliminated by co-sourcing. It is considered that it would
be beneficial to provide strategic cooperation with the outside service provider instead of providing
internal audit activities completely within or outside the company. Some advantages and disadvantages
are listed below:

• Cost: In literature, the same concept is sometimes referred to as advantage or disadvantage.

According to many studies, while outsourcing in internal audit provides a cost advantage, some
other studies suggest that outsourcing in internal audit is more costly than the internal audit unit
established within the company. Based on the research that claims this, the outside service provid-
er keeps the wage low at the contract stage, but then make additions to the bill during the internal
audit activity is held. In other words, there are ideas that outsourcing, which appears to be low-
cost at the beginning, reaches high costs with the additional costs during the process of service.
(Selim & Yiannakas, 2000, p.216) In internal audit, the cost of the service should be taken into
consideration when deciding on the use of in-house, outsourcing or co-sourcing. It is often costly
to employ a specialist for the internal audit unit to be established within the company. On the other
hand, when the internal audit service is fully procured from an outside provider, the terms of the
contract need to be well evaluated and alternatives must be compared carefully. The fact that the
internal audit activities are carried out by co-sourcing, that is, joint work of the company’s own
personnel and the outside service provider, may allow the management of the company to control
the costs to be incurred. With the use of co-sourcing, labor costs can be managed, and company
will benefit both from the knowledge of the outside experts and from the personnel who know the
company and company’s procedures well. As much as the costs incurred in providing the internal
audit service is important effectiveness and efficiency of the internal audit activities must be con-
sidered. A cost-benefit analysis should be carried out to determine which source should be used in
internal audit to get more benefit with lower cost.
• Quality: Competency and experience of the personnel must be considered carefully for all the op-
tions like in-house, outsourcing or co-sourcing. The expert knowledge of the outside service pro-
vider will contribute to the quality of internal audit activities. On the other hand, a better under-
standing of the company and its dominance in the activities will also affect the quality of internal
audit activities if it is performed by the company’s own personnel. In the meantime, co-sourcing
can provide the opportunity to combine the use of peer sources in the internal audit activities with
the expert knowledge required by the internal audit team and the control over the activities.
• Competitiveness: It is possible for firms to keep up with the competition conditions with a broad
perspective of management. This is often difficult to achieve this only with the inside teams and
efforts. Thus, it is possible to gain a broad perspective that will increase the competitiveness of

171

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

the company through the synergy created by the service provider outside the company. (Peursem
& Jiang, 2008, p.223).
• Specialists: If the internal audit services are provided from outside the company, internal audit
activities can be carried out with a technology more advanced than the technology owned by the
company. By using the support and help of the outside service providers training costs to be taken
for each new technology that needs to be adapted can be eliminated. (Yiannakas, 2000, p.75) The
decision to conduct internal audit activities inside or outside the company is affected by the need
for labor to be employed.
• Risk Sharing: Businesses are taking high risks with their investments. With the support of the
outside service provider for the internal audit service, companies aim to reduce the error rate and
thus reduce the risks. With the service received from an outside service provider, the ability to
move more dynamic and flexible is obtained. (Yiannakas, 2000, p.75)
• Confidentiality: Violation of the confidentiality principle is a problem that may arise in cases
where the company prefers to remain confidential but get help from outside service providers.
(Yiannakas, 2000, pp.109-110). It may be risky for businesses to share their long-term strategic
plans with the outside service provider while outsourcing their internal audit services. These
and similar situations may limit the maneuverability of the company. For this reason, businesses
should introduce definitions and restrictions in their agreement with the outside service provider
when they prefer outsourcing or co-sourcing of the internal audit activities.

3. LITERATURE REVIEW

The internal audit function is designed to help in providing reliable accounting information and protect
company assets. Today, it has developed to include internal audit, operational audit, risk assessment,
information technologies (IT) assurance services and more. This expanding role of internal audit has
increased the importance of internal audit as part of the entity’s management control structure or risk
management system. This development in the profession has also changed the demands for internal au-
ditors. The new role of internal auditors requires different skills and competencies. With this change in
companies’ perceptions against internal audit, companies are faced with the decision to provide internal
audit activities internally or externally. (Spekle & Others, 2007, pp.102-103) Developments in commercial
life have taken place in the literature with various researches. The advantages and disadvantages of pro-
viding internal audit activities from different sources have been the subject of studies in various aspects.
A literature review was conducted in order to form a conclusion about the different aspects of the
internal audit activity in the literature. Studies in the literature are examined under four headings. These
are studies on the effects of using different sources on internal audit on fraud and reliability of financial
statements, studies aiming to investigate perceptions about the independence and objectivity of the
internal auditor and reliability of the financial statements based on the source of internal audit service,
studies aiming to determine the independent auditors’ perceptions of internal auditors and their career
plans in the case of using different resources in internal audit and studies aiming to determine the fac-
tors affecting the decision of outsourcing in internal audit. Search engines and databases were used for
literature review. Accessible articles written in English were scanned.

172

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

3.1. Studies on the Effects of Using Different Sources on Internal

Audit on Fraud and Reliability of Financial Statements

Studies aimed at evaluating the use of different sources in internal audit in terms of preventing, reveal-
ing and reporting the fraud act have taken place in the literature. In addition, the effects of the different
structures encountered in internal audit on accounting risk have been the subject of research. The studies
in the literature on these subjects are summarized below:

• Prawitt, Sharp and Wood (2012): The study is aimed to examine whether the use of sources in
internal audit has an impact on financial reporting fraud. According to the results of the study, it
was stated that outsourcing in internal audit prior to SOX has less accounting risk when compared
to internal audit activity provided within the company. The findings of this study include the
findings that internal audit activities performed by independent auditors improve the quality of
internal audit activities. As a result of that, evidence has been found that accounting risk is lower
when internal audit activities are of good quality.
• Salameh and Others (2011): The purpose of this study was to investigate the effectiveness of
the internal audit unit in Jordan’s banking sector in fraud prevention. 45 senior managers partici-
pated in the study. According to the main results of the study, the internal audit unit is effective in
preventing fraud. Addition to that when internal audit service is provided internally, it is seen that
internal audit is more effective in preventing fraud compared to outsourcing.
• Coram, Ferguson and Moroney (2008): It is aimed to investigate whether the companies with
internal audit unit are more likely to reveal and report employee fraud than the companies without
internal audit unit. The data of the study was obtained from KPMG 2004 fraud questionnaire. 491
private and public sector firms from Australia and New Zealand participated in the study. It has
been concluded that the companies with internal audit unit are more likely to reveal and report
fraud. In addition, it is found that fraud detection and reporting are less likely in companies that
prefer outsourcing than in companies that prefer co-sourcing. According to the results, it is seen
that the internal audit function adds value to the company in revealing and reporting fraud. In ad-
dition, finding and reporting the fraud is more common in the companies that have internal audit
units than the companies that prefer outsourcing.
• James (2003): In this study the effect of different source use in internal audit activities on pre-
venting financial statement fraud is examined. A total of 98 bankers working in the lending units
of the banks participated. According to the results of the study, when the internal audit activities
are provided within the company if the results of the internal audit activities are presented to the
senior management, it is found that the probability of preventing fraud of the financial statements
is lower than that of the audit committee. If internal audit activities are presented to the audit com-
mittee, whether internal audit activities are held in-house or outsourced, there is no difference in
the prevention of fraud.

173

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

3.2. Studies Aiming to Investigate Perceptions About the Independence

and Objectivity of the Internal Auditor and Reliability of the Financial
Statements Based on the Source of Internal Audit Service

It has been researched whether which source is used in internal audit activities affects the reliability of
the financial data of the companies. In addition, whether the independence and impartiality of the internal
auditor could be affected due to the use of different sources in the audit has been the subject of research.

• Inua and Abianga (2015): In this study the independence of the internal audit activities and the
use of outsourcing in internal audit are discussed. 15 financial analysts, 19 accounting students,
23 accountants and 6 independent auditors were consulted for the study. The research focuses on
the benefits and disadvantages of outsourcing in internal audit. According to the results, it was
found that there were differences in the perception of independence when the internal audit ser-
vice was completely outsourced, partially outsourced, when the independent audit company was
taken from another department and received from different audit institutions. When the internal
audit service is also received from the organization that provides independent audit service to the
company, it is concluded that the internal audit activities cannot be independent.
• Swanger and Chewning (2011): A two-stage study was designed to measure the perception of
financial analysts about whether providing internal audit from the firm who also performs the
independent audit would impair the independence of the independent auditor (both when provid-
ing independent audit and internal audit). 153 responses were used for the first stage and 117
responses for the second stage. According to the results of the first stage, when the internal audit
service is provided from an internal audit department in the company or outsourced from a com-
pany other than the one which also provides independent audit service, financial analysts thought
the independence is protected. According to the results of the second stage, if the internal audit
service is provided by different personnel of the independent audit firm is another way to ensure
the independence according to financial analysts. In this case, the separation of the personnel
providing the internal audit service and the personnel providing the independent audit service
provides more independence.
• Seetharaman, Moorthy and Saravanan (2008): In this study various aspects of the internal
audit process, independence of the independent auditor, and the effect of the independent auditor
in internal audit is examined. For this purpose, inferences were made from two previous stud-
ies. The first study was the 2002 work of Marshall A. Geiger, D. Jordan Lowe and Kurt J. Pany
in the United States, “Appearances Are Important: Outsourced Internal Audit Services and the
Perception of Auditor Independence”. The second study is Sunita S. Ahlawat and D Jordan Lowe’s
“An Examination of Internal Auditor Objectivity: In-House versus Outsourcing” in Australia in
2004.
• Ahlawat and Lowe (2004): Questionnaires are prepared to ask to internal auditors working in
companies and working in independent audit firms in order to compare the objectivity and inde-
pendence of the internal auditors in the event that internal audit service is outsourced and provided
within the company. 35 internal auditors working in the internal audit department and 31 internal
auditors from four major audit firms participated in the survey. In this study, it is investigated that
which one (internal auditor of the company or internal auditor who works for an outside firm)
is more sensitive to the protection of the business. According to the results of the research, both

174

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

internal auditors and internal auditors from outside the company have the instinct to protect the
company, while the internal auditors from outside the company have less.
• Geiger, Lowe and Pany (2002): A questionnaire was applied to 145 credit officers who were
among the users of financial statements to get their opinions on the reliability of the financial state-
ments and the independence of the auditor in the case of internal audit is outsourced. According
to the results, outsourcing of internal audit service is perceived as negative in terms of auditor
independence and financial statement reliability. The status of the internal audit service provided
by the independent audit firm is examined in two cases as the same employee who also works for
independent audit and different personnel of the independent audit firm (who are not working in
independent audit process). In this case, credit officers have responded positively to the fact that
the internal audit service is provided by different personnel instead of the same personnel provid-
ing independent audit.
• Lowe, Geiger and Pany (1999): In the event that internal audit activities are provided by the
independent auditor of the company through outsourcing, the independence of the auditor, the
reliability of the financial statements and whether it affects the perceptions of the users of the
financial statements are investigated in this study. According to the results, the internal audit
service provided by the independent auditor of the company was perceived as negative in terms
of independence and reliability of financial statement users. This negative perception causes the
possibility of approval of the credit demands of companies is low. If the independent auditors of
financial statements and the independent auditor providing internal audit services are different
people, it is perceived positively by the users of the financial statements in terms of independence
and reliability of the financial statements. This positive perception increases the likelihood of ap-
proval of credit demands of companies. In this study, it is suggested that the independent audit
firm should use different personnel while providing internal audit service to the customers that
provide financial statement audit service, and a solution suggestion is proposed to minimize the
independence problem.
• Rittenberg (1999): Study of Lowe et al (The Effects of Internal Audit Outsourcing on Perceived
External Audit Independence) is examined and comments are made about it. While examining the
research, Rittenberg sought answers to the following questions:
◦◦ Is outsourcing of internal audit an important area of research?
◦◦ Is the research methodology used by researchers suitable for answering research questions?
◦◦ Are the results of the research and the conclusions put forward by the authors significant?
◦◦ What are the research results regarding the future of outsourcing of internal audit or other
services can be outsourced?

At the end of the research, it was emphasized that outsourcing the internal audit and independence
issues should be addressed in the future.

3.3. Studies Aiming to Determine the Independent Auditors’

Perceptions of Internal Auditors and Their Career Plans in the
Case of Using Different Resources in Internal Audit

Independent auditors conduct the independent audit activities by evaluating the internal control environ-
ments and internal audit activities of the companies. Therefore, the reliability of the information produced

175

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

by the internal audit activities of the companies is important for the independent auditors. Therefore, it
is investigated whether the independent auditors’ trust in the internal auditing activities of the internal
auditors is related to how the internal audit activities are provided. There is also a study in the literature on
the positions of independent auditors and their career objectives related to internal audit. The researches
in the literature related to the studies in which independent auditors’ opinions are summarized below:

• Barlett and Others (2016): It is stated that the internal audit function is very important for com-
panies, but it is difficult for the them to fill the professional internal auditor position to perform
this function. In this study, it was aimed to investigate the willingness of independent auditors to
become internal auditors in order to provide internal audit services. Therefore, questionnaires are
applied to independent auditors. According to the results of the study, independent auditors prefer
to apply the accounting positions more than internal auditors or external internal audit positions.
The results also show that the perceptions of independent auditors are negative against the work-
ing environment and internal audit profession. According to the research, this negative perception
reduces the pool of internal audit personnel to be employed and negatively affects the quality of
the personnel to be employed. In addition, it has been observed that graduates applying for internal
audit positions are mediocre students rather than good students. By using the answers given by the
experienced independent auditors suggestions to make the profession more attractive are made.
In addition, it was stated that there were hiring difficulties for internal audit positions and sugges-
tions about how to alleviate these difficulties were included. Participating independent auditors
consider the independent auditors superior to the internal auditors employed in the companies in
terms of competence, objectivity and business characteristics. Nevertheless, independent auditors
prefer internal auditor positions rather than outsourcing the internal audit activities.
• Davidson, Desai and Gerard (2013): A questionnaire was applied to 140 independent auditors
in order to investigate the reliability perceived by independent auditors for in-house or outsourced
internal audit activities. According to the results, if internal audit activities are carried out periodi-
cally, outsourcing is perceived as more reassuring by independent auditors. However, if internal
audit activities are carried out continuously, it is not different in terms of reliability that internal
audit is provided in-house or by outsourcing according to independent auditors’ view.
• Munro and Stewart (2010): Factors that may affect the independent auditors’ confidence in
internal audit activities in the current management environment are examined. According to the
study, the selection of sources to be used in the application of internal audit activities is one of
the factors affecting the trust of independent auditors. According to the results of the study, when
internal audit activity is provided in-house, independent auditors prefer to use internal auditors to
assist their work. In general, independent auditors use internal audit function of the companies in
control and evaluation tasks. 66 independent auditors from 4 major audit firms and two medium-
sized firms from 5 major cities of Australia participated in the study. Of the participants, 17 were
joint chief auditors, 29 were managers and 20 were senior auditors.
• Brandon (2010): A questionnaire was applied to 89 experienced independent auditors in order
to evaluate their perception on providing additional services to the customers when internal audit
services are outsourced from them. According to the results of the study, the services provided
outside the internal audit are perceived as negative in terms of objectivity. To maintain the objec-
tivity, use of separate personnel for internal audit (other than the team members of independent

176

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

audit team) and other services are suggested. In addition, the independent auditors’ trust in inter-
nal audit is affected by the audit fee.
• Desai, Gerard and Triphaty (2008): In the study the independent auditors’ confidence in the
internal audit function is evaluated by the types of source use (in-house, outsourcing and co-sourc-
ing) in internal audit. Also, it is aimed to evaluate the independent auditors’ trust on the internal
audit services if the independent audit firm providing co-sourcing or outsourcing internal audit
service to the company also provides additional services. For these purposes the opinions of 150
independent auditors, 36 of whom were working in 4 senior adults, was used to conduct the study.
Finally, regulations related to source use and company managers perceptions on different source
in internal audit are evaluated. According to the results of the study, outsourcing and co-sourcing
in internal audit is perceived as more objective, competent, proficient and independent than in-
house. In internal audit, the use of co-sourcing is seen as a superior alternative to outsourcing.
• Glover, Prawitt and Wood (2008): In the light of Article 404 of SOX Law and Public Company
Accounting Oversight Board (PCAOB) Auditing Standard 2, surveys applied to 127 independent
auditors from four senior auditors in order to investigate the decision of independent auditors to
rely on the work of internal auditors in terms of natural risk and task subjectivity when internal
audit service was outsourced. If the natural risk of the company is low whether internal audit is
provided in-house or outsourced do not make any difference on the independent auditor’s confi-
dence. However, if the natural risk is high, independent auditors rely more on the work of internal
auditors who outsourced the internal audit activities. In addition, when natural risk is high, in-
dependent auditors trust objective tasks more than subjective tasks, but the situation is different
when the risk is low.

3.4. Studies Aiming to Determine the Factors Affecting

the Decision of Outsourcing in Internal Audit

In the literature, there are studies investigating the factors that affect the decision of in-house, outsourcing
or co-sourcing in internal audit. There are many different reasons that affect this decision. Therefore,
companies should evaluate which source they will use in internal audit activities by making cost-benefit
analysis and make the right decision. The studies about this decision in the literature are summarized
below:

• Plant (2014): In this study the use of outsourcing in internal audit in the public sector in South
Africa was investigated. The scope of outsourcing in internal audit, the rate of outsourcing and the
decision of the outsourcing service provider were examined. 32 internal audit managers, 30 audit
committee chairmen and 31 accounting officers participated a survey. According to the results of
the study, participants prefer to provide internal audit function in-house. However, due to techni-
cal insufficiency and lack of competent internal auditors, it is stated that outsourcing is used in
internal audit.
• Suleiman and Dandago (2014): The scope of the outsourcing in internal audit activities of de-
posit banks in Nigeria is examined. For this purpose, a questionnaire was applied to the senior and
middle level managers of 22 banks in order to access information on outsourcing for each of the
15 functions connected to the internal audit unit. The results of the research show the usage rate of
outsourcing in 15 internal audit functions. In addition, it is seen that in 6 internal audit functions

177

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

outsourcing of internal services are preferred when in other 9 functions in-house internal audit is
preferred.
• Abdolmohammadi (2013): In order to measure the relationship between internal audit activi-
ties using outsourcing and variables such as audit committee, firm size and company location, a
questionnaire was applied to 1,059 chief auditors from six countries. It is concluded that there is
a positive relationship between the presence of the audit committee in the company and outsourc-
ing in internal audit activities. It was found that medium and large-scale companies with audit
committees outsource their internal audit activities more than medium and large-scale companies
without audit committees. In addition, it was seen that there was a negative relationship between
the internal audit service provided by outsourcing and the increase in the added value of internal
audit activities, and there was a positive correlation between the internal audit service provided
by outsourcing and the closing of competent personnel gap. There was no significant relationship
between the variables of age, education, experience, professional certificates, and regular inter-
views with the audit committee of the chief auditor who answered the questionnaire, and the use
of outsourcing in internal audit. Likewise, there are no relations that vary from country to country.
Although there is no significant relationship between the size of companies and outsourcing the
internal audit, the national or international status of companies has different results. International
companies receive more internal audit services than domestic companies. Finally, it was deter-
mined that nonprofit organizations used more outsourcing in internal audit than non-profit public
institutions.
• Papageorgiou, Yasseen and Padia (2012): In this study, the similarities and differences in the
internal audit practices in private and public companies in South Africa are discussed. The per-
ception of outsourcing in internal audit function in private and public companies were examined.
According to the results of the study, outsourcing in internal audit did not show significant differ-
ences in private or public companies. In addition, according to the results, the private sector com-
panies accept the internal audit activities as an important function of the companies while public
sector companies do not. The aim of the research is to contribute to the literature by combining
the current situation and theory. For this purpose, a questionnaire was applied to the internal audit
executives and internal audit managers from 72 private and public companies.
• Caplan and Kirschenheiter (2010): Agency theory was used to examine outsourcing in internal
audit. According to the results of the research, external service providers provide service with
more advanced test techniques than the internal audit personnel of the companies. However, ex-
ternal service providers charge a higher fee for this service. Two cases indicating that outsourc-
ing is more beneficial have been identified. First, the company’s internal auditor’s liability for an
audit failure is limited. The external service provider can compensate for the damage. Secondly,
the external service provider has a third-party approval services license that is important to the
customer business, so charges may be excessive. It is observed that the wage gap between the ex-
ternal service provider and the internal auditor of the company tends to decrease with increasing
awareness of the competition and the importance of the internal audit function among the external
service providers.
• Van Peursem and Jiang (2008): In this study, the rate of outsourcing in internal auditing in New
Zealand, implementation of it and the reasons for using this method are discussed. The purpose of
this study is to evaluate whether the outsourcing practices in internal audit meet the expectations
of Small and Medium Sized Companies (SMEs). The senior financial managers of 165 companies

178

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

that are listed in New Zealand Stock Exchange participated in the study. It is found that inter-
national companies are more engaged in internal audit activities. Of the 65 available responses,
11 of them have just begun outsourcing in internal auditing. They prefer big four audit firms for
outsourcing. 82% participation is aware of the phenomenon of independence.
• Abbott and Others (2007): A questionnaire was applied to 219 head auditors in order to evalu-
ate the effect of outsourcing in internal audit and audit committee on audit quality in terms of
SOX. Continuous or non-continuous internal audit activities are considered to have the same
impact on auditor independence and audit quality. In this study, it is emphasized that continuous
internal audit service damages the independency rule due to the economic link between auditor
and customer. On the other hand, it is accepted that non-continuous outsourcing services can be
useful because of the low probability of creating economic bonds. According to the results of the
research, companies that have expert employees and audit committees do not prefer to outsource
the continuous internal audit services.
• Spekle, Elten and Kruis (2007): A previous study was repeated using different samples. The first
study was conducted in 1999 by Sally K. Widener and Frank H. Selto. In this study, Transaction
Cost Economics is used to determine the source usage decision in internal audit. The new sample
was 66 companies based in the Netherlands. The findings of the study support the findings of
Widener and Selto. As in Widener and Selto’s study, it is stated that the most important factor af-
fecting the decision to choose sources in the internal audit of companies is significantly related to
the characteristics of the company assets and frequency of the audit activities.
• Carey, Subramaniam and Ching (2006): A survey is applied to 99 companies listed in the
Australian Stock Exchange to yield information on source use preferences in internal auditing. In
54.5% of 99 companies internal audit activities are carry out in the internal audit units established
within the companies. In remaining 45.5% of the companies internal audit activities are carry out
by outsourcing or co-sourcing. According to the results of the research, cost saving, and techni-
cal equipment of the external service provider are effective in choosing outsourcing. According
to the results, large companies prefer outsourcing more than small companies. In addition, 75%
of the companies that outsource their internal audit activities receive internal audit services from
companies that perform their independent audits. It is stated that this situation will be a problem
on the independence of the auditors.
• Sharma and Subramaniam (2005): According to the transaction cost economics, the decision of
the companies to provide internal audit service from inside or outside the company is examined.
The study also examines the involvement of the financial statement in the internal audit process
and the level of the relationship between the external service provider and the audit committee.
According to the results of the study, there is a relationship between environmental uncertainty
and the rate of outsourcing in internal audit. As environmental uncertainty increases, companies
prefer to keep at least some of the internal audit services within the company. In this study, it is
stated that cost pressure does not significantly affect the outsourcing decision. In determining the
level of outsourcing in internal audit, qualitative reasons affecting management’s decision are put
forward as lack of technical knowledge, quality of service, compliance with business objectives,
communication and coordination issues at the departmental level. Additional analysis shows that
the outsourcing decision has been significantly influenced by reasons such as overall cost reduc-
tions, protection of company information, easier management of environmental uncertainty and
improvement of organizational performance. 87 companies participated in the research. 37 of

179

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

them do not have internal audit departments, 20 companies have internal audit departments, 12
companies provide internal audit services completely by outsourcing, and 18 companies use both
internal and external sources for internal audit activities.
• Selim and Yiannakas (2000): In addition to examining the reasons that lead to outsourcing in in-
ternal audit, how the internal audit service is perceived when external audit service is outsourced,
the effects of outsourcing on the quality of internal audit and the independence of the auditors are
investigated in this study. This is an article derived from Yiannakas’ doctoral thesis. According
to the results, access to expert internal audit personnel is the most important reason affecting the
decision to outsource internal audit. It is found that when outsourcing is used in internal audit, the
quality of internal audit is satisfying. One third of the participants plan to provide at least a part of
the internal audit service from outside the company. Although the idea of outsourcing in internal
audit was welcomed, 160 out of 165 participants provided their internal audit activities from the
internal audit departments within the companies.
• Widener and Selto (1999): By using the transaction cost economics, the extent to which internal
audit activities are conducted externally in the management control system of companies is inves-
tigated. The results of the research show that companies are struggling with economic pressures
and outsourcing their activities, including a part of the management control system.

4. SOLUTIONS AND RECOMMENDATIONS

Independent auditing organizations also assist businesses with services other than independent audit
services. One of these services is the internal audit. As included in the definition of internal audit ac-
tivities, internal audit is an important structure that adds value to business and increases the efficiency
of business activities. The presence of internal audit activities gives the impression that the financial
statements are prepared correctly and honestly. There have been many studies in which internal audit
activities have a major impact on the reliability of financial reporting. However, it is also stated in the
Association of Certified Fraud Examiners (ACFE) fraud reports that internal audit activities have an im-
pact on the fraud action. Today, internal audit activities can be provided traditionally within the company
by the company’s own personnel. Outsourcing and co-sourcing appear as different sources for internal
audit, emerge as alternatives to companies when planning internal audit activities. Whether the use of
different sources is effective in providing reliable information to internal audit activities has been the
subject of research in various aspects. The evaluation of the internal audit activities by the independent
auditors and the determination of the scope of the independent audit according to the evaluation results
reveal the relationship between the internal audit activities and the independent audit activities. In this
respect, independent auditors trust the work of internal auditors is an important issue. Whether or not
the use of different sources affected the trust in question, and in what direction, was one of the study
topics. In addition, whether the internal auditor differs than the auditor who perform the internal audit
by outsourcing and co-sourcing in terms of independence and objectivity and the factors that affect the
decision to use different sources in internal audit are other research topics. The effect of outsourcing on
independent auditors’ confidence in internal audit activities has been included in the literature. In ad-
dition, there are studies in the literature regarding whether the status of whether independent audit and
internal audit services are obtained from the same or different organizations will affect the independence
of the auditors.

180

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

5. FUTURE RESEARCH DIRECTIONS

The existing studies listed above can be adapted to different groups in different geographies to detect
differences in perception between the study groups. In addition, studies comparing the similar and dif-
ferent aspects of companies that prefer to use the same resource in internal audit can be done.

6. CONCLUSION

The general purpose of this study is to inform the companies about the alternative use of resources by
revealing the studies and results related to the different structures in conducting internal audit activi-
ties. According to the studies reasons of internal audit activities obtained from external sources are cost
advantage, need for expert knowledge and lack of technical knowledge have been determined as factors
affecting resource utilization decision. In the literature, there are studies that apply to the perceptions
of independent auditors about the ways in which internal audit activities are provided. According to the
independent auditors in these studies, the internal audit service provided by outsourcing or co-sourcing
is found to be more objective and reliable than the internal audit activities carried out in-house. How-
ever, if other services are also received from an organization that receives internal audit service, it is
stated that this situation has an effect that will disrupt the independence. For example, if a company’s
internal audit service is provided by the independent audit firm that audits the financial statements of
the company, it is considered that the independent auditor cannot ensure its independence. Perceptions
of users of other financial statements about the use of different sources in internal audit have also been
included in the literature. The effect of different structures encountered in internal audit in preventing,
revealing and reporting fraud of financial statements has been the subject of discussion.
Consequently, even if they do not hesitate that internal audit activities will add value to business
activities, they should consider how they will ensure internal audit activities. In order to make the best
decision for the company, cost-benefit analysis should be done.

REFERENCES

Abbott, L. J., Parker, S., Peters, G. F., & Rama, D. V. (2007). Susan Parker, Gary F. Peters, Dasaratha
V. Rama. “Corporate Governance, Audit Quality, and the Sarbanes-Oxley Act: Evidence from Internal
Audit Outsourcing. The Accounting Review, 82(4), 803–835. doi:10.2308/accr.2007.82.4.803
Abdolmohammadi, M. (2013). Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities.
Auditing, 32(3), 69–85. doi:10.2308/ajpt-50453
Ahlawat, S. S. D., & Lowe, D. J. (2004). Jordan Lowe. “An Examination of Internal AuditorObjectivity:
In-House versus Outsourcing. Auditing, 23(2), 147–158. doi:10.2308/aud.2004.23.2.147
Bartlett, G. D., Kremin, J., Saunders, K. K., & Wood, D. A. (2016). Attracting Applicants for In-House
and Outsourced Internal Audit Positions: Views from External Auditors. American Accounting Associa-
tion, 30(1), 143–156. doi:10.2308/acch-51309

181

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

Brandon, D. M. (2010). ExternalAuditor Evaluations of Outsourced Internal Auditors. Auditing: A

Journal of Practice &Theory American Accounting Association, 29(2), 15-173.
Caplan, D. H., & Kirschenheiter, M. (2000). Outsourcing and Audit Risk for Internal Audit Services.
Contemporary Accounting Research, 17(3), 387–428. doi:10.1506/8CP5-XAYG-7U37-H7VR
Carey, P., Subramaniam, N., & Karin, C. W. C. (2006). Internal audit outsourcing in Australia. Account-
ing and Finance, 46(1), 11–30. doi:10.1111/j.1467-629X.2006.00159.x
Chadwick, W. E. (2000). Keeping Internal Auditing In-house. Internal Auditor, (June), 88.
Coram, P., Ferguson, C., & Moroney, R. (2008). Internal Audit, Alternative Internal Audit Structures and
The Level of Misappropriation of Assets Fraud. Accounting and Finance, 48(0), 543–559. doi:10.1111/
j.1467-629X.2007.00247.x
Davidson, B. I., Desai, N. K., & Gerard, G. J. (2013). The Effect of Continuous Auditing on the Relation-
ship between Internal Audit Sourcing and the External Auditor’s Reliance on the Internal Audit Function.
Journal of Information System. American Accounting Association, 27(1), 41–59. doi:10.2308/isys-50430
Desai, N. K., Gerard, G. J., & Tripathy, A. (2008). Co-sourcing and External Auditors’ Reliance on the
Internal Audit Function. The Institute of Internal Auditors Research Foundation.
Geiger, M. A., Lowe, D. J., & Pany, K. J. (2002). Appearences Are Important: Outsourced Internal Audit
Services and the Perception of Auditor Independence. The CPA Journal, 72(4), 20–25.
Glover, S. M., Prawitt, D. F., & Wood, D. A. (2008). Internal Audit Sourcing Arrangement and the Ex-
temal Auditor’s Reliance Decision. Contemporary Accounting Research, 25(1), 193–213. doi:10.1506/
car.25.1.7
Inua, O. I., & Abianga, E. U. (2015). The Effect of the Internal Audit Outsourcing on Auditor Indepen-
dence: The Nigerian Experience. Research Journal of Finance and Accounting, 6(10), 36–45.
James, K. L. (2003). The Effects of Internal Audit Structure on Perceived Financial Statement Fraud
Prevention. Accounting Horizons, 17(4), 315–327. doi:10.2308/acch.2003.17.4.315
Lowe, D. J., Geiger, M. A., & Pany, K. (1999). The Effects of Internal Audit Outsourcing on Perceived
External Auditor Independence. Auditing, 18(Supplement), 7–26. doi:10.2308/aud.1999.18.supplement.7
Martin, C. L., & Lavine, M. K. (2000). Outsourcing The Internal Audit Function. The CPA Journal.
Mumby, K., & Clarke, A. (2000). Co-Sourcing vs Contracting Internal Audit. Management.
Munro, L., & Stewart, J. (2010). External auditors’ reliance on internal audit: The impact of sourcing
arrangements and consulting activities. Accounting and Finance, 50(2), 371–387. doi:10.1111/j.1467-
629X.2009.00322.x
Papageorgiou, E., Yasseen, Y., & Padia, N. (2012). Internal audit function: Current status and perception
of outsourcing. African Journal of Business Management, 6(49), 11828–11838.
Peursem, K. V., & Jiang, L. (2008). Internal audit outsourcing practice and rationales: SME evidence
from New Zealand. Asian Review of Accounting, 16(3), 219–245. doi:10.1108/13217340810906681

182

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

Plant, K. (2014). Internal audit outsourcing practices in the South African public sector. African Journal
of Public Affairs, 7(3), 73–87.
Prawitt, D. F., Sharp, N. Y., & Wood, D. A. (2012). Internal Audit Outsourcing and the Risk of Mislead-
ing or Fraudulent Financial Reporting: Did Sarbanes-Oxley Get It Wrong? Contemporary Accounting
Research, 29(4), 1109–1136. doi:10.1111/j.1911-3846.2012.01141.x
Rittenberg, L. E. (1999). Discussion of The Effects of Internal Audit Outsourcing on Perceived External
Audit Independence. Auditing: A Journal of Practice & Theory, 18, 27-35.
Salameh. (2011). Alternative Internal Audit Structures and Perceived Effectiveness of Internal Audit in
Fraud Prevention: Evidence from Jordanian Banking Industry. Canadian Social Science, 7(3), 40-50.
Seetharaman, A., Krishna Moorthy, M., & Saravanan, A. S. (2008). Outsourcing of Internal Audit and
Independence of Auditors. Corporate Board: Role, Duties &Composition, 4(2), 40-49.
Selim, G., & Yiannakas, A. (2000). Outsourcing the Internal Audit Function: A Survey of the UK Public
and Private Sectors. International Journal of Auditing, 4(3), 213–226. doi:10.1111/1099-1123.00314
Sharma, D. S., & Subramaniam, N. (2005). Outsourcing Of Internal Audit Services in Australian Firms:
Some Preliminary Evidence. Asian Academy of Management Journal of Accounting, 1, 33–52.
Spekl’e, R. F., van Elten, H. J., & Kruis, A.-M. (2007). Sourcing of Internal Auditing: An Empirical
Study. Management Accounting Research, 18(1), 102–124. doi:10.1016/j.mar.2006.10.001
Spraakman, G. (2001). Internal Audit At The Historical Hudson’s Bay Company: A Challenge To Ac-
cepted History. The Accounting Historians Journal, 28(1), 19–41. doi:10.2308/0148-4184.28.1.19
Suleiman, D. M., & Dandago, K. I. (2014). The extent of internal audit functions outsourcing by Ni-
gerian deposit money banks. Procedia: Social and Behavioral Sciences, 164, 222–229. doi:10.1016/j.
sbspro.2014.11.070
Swanger, S. L., & Chewning, E. G. Jr. (2001). The Effect of Internal Audit Outsourcing on Financial
Analysts’ Perceptions of External Auditor Independence. Auditing, 20(2), 115–129. doi:10.2308/
aud.2001.20.2.115
Widener, S. K., & Selto, F. H. (1999). Management Control Systems and Botmdaries of the Firm: Why
do Firms Outsource Internal Auditing Activities? JMAR: Journal of Management Accounting Research,
11, 45–73.
Yiannakas, A. (n.d.). Outsourcing the Internal Audit Function With Special Reference to the UK Public
and Private Sectors (Doktora Tezi). City University Business School, Department of Accounting and
Finance.

183

Outsourcing of Internal Audit Services Instead of Traditional Internal Audit Units

ADDITIONAL READING

Barr-Pulliam, D. (2016). Engaging Third Parties for Internal Audit Activities: Strategies for Successful
Relationships. The Institute of Internal Auditors Research Foundation.
Bostwick, W. J., & Byington, J. R. (1997). Outsourcing of Internal Audit: Concerns and Opportunities.
Journal of Corporate Accounting & Finance, 8(Summer), 85–93. doi:10.1002/jcaf.3970080408
Farkas, M. J., & Hirsch, R. M. (2016). The Effect of Frequency and Automation of Internal Control
Testing on External Auditor Reliance on the Internal Audit Function. Journal of Information Systems,
30(1), 21–40. doi:10.2308/isys-51266
Goller, L., & Sleezer, J. (2012). Increase Internal Audit Value through Co-sourced and Outsourced
Models. Collage & University: Auditor, 54(1), 4–7.
Hamzo, D. (2012). Get It Outsourcing Under Control. Internal Auditor.
Pyzık, K. (2012). “The Pros and Cons Of Outsourcing”, Internal Auditor. IT Audit.

KEY TERMS AND DEFINITIONS

Assurance Services: They include the internal auditor’s objective evaluation of the findings of the
internal audit activities and the formation of an independent opinion.
Co-Sourcing: Internal audit activities are carried out with the internal audit department established
within the company and the professional person or institution outside the company.
Consultancy Services: Providing the reliable advice to management in order to add value to busi-
ness activities.
Financial Statement User: Persons in need of financial information such as business partners, lend-
ing institutions, investors, users of public financial information.
Fraud: It is general term that explains intentional actions like deception, bribery, forgery, extortion,
corruption, theft, conspiracy, embezzlement, abuse, and concealing important facts to mislead other parties.
In-House: Internal audit activities are carried out by the internal audit department within the company.
Independent Auditor: An expert who carries out audit activities, has professional knowledge and
experience, can act independently and has high moral qualifications.
Internal Audit: It is an objective assurance and consultancy activity designed to improve and to add
value to the activities of the organization.
Internal Auditor: The person who monitors and evaluates whether the risk management and internal
functioning processes of private companies or public institutions work effectively.
Outsourcing: Obtaining the internal audit service from a professional person or organization from
outside the company.

184
185

Chapter 13
Machine Learning Techniques
and Risk Management:
Application to the Banking
Sector During Crisis

Christos Floros
Hellenic Mediterranean University, Greece

Panagiotis Ballas
https://orcid.org/0000-0003-3553-6270
Hellenic Mediterranean University, Greece

ABSTRACT
Crises around the world reveal a generally unstable environment in the last decades within which
banks and financial institutions operate. Risk is an inherent characteristic of financial institutions and
is a multifaceted phenomenon. Everyday business practice involves decisions, which requires the use
of information regarding various types of threats involved together with an evaluation of their impact
on future performance, concluding to combinations of types of risks and projected returns for decision
makers to choose from. Moreover, financial institutions process a massive amount of data, collected
either internally or externally, in an effort to continuously analyse trends of the economy they operate
in and decode global economic conditions. Even though research has been performed in the field of ac-
counting and finance, the authors explore the application of machine learning techniques to facilitate
decision making by top management of contemporary financial institutions improving the quality of
their accounting disclosure.

DOI: 10.4018/978-1-7998-4805-9.ch013

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Machine Learning Techniques and Risk Management

INTRODUCTION

Financial crises around the world in the last decades reveal a generally instability of the banking system.
Risk is an inherent characteristic of financial institutions and is multifaceted phenomenon. Everyday
business practice involves decisions, which requires the use of information regarding various types of
risk involved together with an evaluation of their impact on future performance, concluding to combina-
tions of risks and projected outcomes for decision-makers to choose from.
Scenarios of different levels of constructing a number of scenarios involve a level of risk. This chapter
focuses on various types of risk that financial institutions face, presents the various ways to measure
them and discusses how these risks are managed.
Accounting scandals and financial crisis of 2008-2009 highlighted the need for advanced analysis
and improvement to methods of risk identification and risk management applicable to various types of
organizations and especially to financial institutions due to the role they play in the contemporary global
trading environment. In line with the above, business entities should adopt risk-reporting practices aiming
to the improvement of the quality of financial reporting. Interestingly enough, Singleton-Green (2012)
pointed the ineffectiveness of financial reporting practices to provide a signal on risks having a potential
amplifying effect on financial crisis. The Financial Stability Institute (2015) identified inappropriate
implementation of corporate governance and risk management practices adopted by financial institu-
tions. Bank of England raised concerns about potential negative implications of consumer credit growth
on financial stability as ratio of debt to income for the private sector reached historical highs (Glover,
2017). Thus, there is increased need for additional research on real-life cases to explore and understand
risk management practices by financial institutions has been acknowledged too (Van der Stede, 2011).
Numerous accounting and corporate governance scandals and the subsequent financial crisis of 2008-
2009 highlighted the need for advanced analysis and improvement to methods of risk identification and
risk management applicable to assorted types of organizations, especially to financial institutions, due
to the role they play in the contemporary global trading environment. In line with the above, business
entities should adopt risk-reporting practices aiming to the improvement of the quality of their financial
reports. Furthermore, effective risk management techniques should be depicted to the published financial
statements an annual reports improving the quality of information provided to their numerous stakehold-
ers highlighting the actions taken to prevent from the severity of risks with the subsequent amplifying
effects on the burst of global financial crisis. Under such circumstances, the Financial Stability Institute
identified the inappropriate implementation of corporate governance and risk management practices
adopted by financial institutions, whereas Bank of England raised concerns about potential negative
implications of consumer credit growth on financial stability as ratio of debt to income for the private
sector had reached historical highs.
Machine Learning Techniques (MLT’s) have been extensively utilized in business to facilitate deci-
sion making from various stakeholders. In the aftermath of global crisis, MLT’s have attracted more
attention by research community as a potentially effective tool towards the identification of alternative
sources of risk and gaps for fraudulent actions. Never ending socioeconomic changes influence both
internal and external business environment, within which financial institutions operate. Taking advantage
of contemporary technological advancements in software and hardware, MLT’s sound promising to the
development of more reliable and accurate risk assessment models with considerably higher predictive
power. In an era of increased business complexity, it is stimulating to explore if these techniques could
contribute to accurate forecasting. Even though research has been performed in the field of accounting

186

Machine Learning Techniques and Risk Management

and finance, there is still a promising area for further studies in order to explore how the application
of MLT’s could facilitate decision making by top management of contemporary financial institutions
improving the quality of their accounting disclosure.
Risk is a multifaceted concept with financial and non-financial dimensions of it co-existing. Consid-
ering the potentially severe impact of default on business performance and entrepreneurship within an
economy and the positive correlation between business performance and soundness of monetary system
of an economy, it becomes evident why financial institutions have attracted global research interest. The
numerous stakeholders of such organizations with their usually conflicting aims (agency theory), pose
significant obstacles in designing the optimum business strategy. Concluding on the balance between
risk and return for strategic alternatives is always a challenge, which is amplified during a crisis period
especially when it affects markets globally.
In a turbulent business environment, the fundamental question remains; whether there are mechanisms
and techniques to reliably and accurately forecast the impact on performance of future socioeconomic
developments and conditions. Combining developments in computer science, statistics and auditing,
machine learning seems a promising advancement as a risk management technique. Taking advantage
of theories on handling big data, MLT’s enable the extraction of meaningful details in available business
records transforming them into useful information to the hands of decision-makers. The advantage of
such systems is that they have the ability to “learn and adapt” to changes making their use in complex
environments a promising complementary tool.
This chapter focuses on identification and management of various types of risk, specifically relevant to
financial institutions. Within this scope, we explore how MLT’s could facilitate the field of risk manage-
ment in financial sector, pointing at the advantages if such decision, identifying potentially problematic
areas and suggesting avenues for further research.

IMPORTANCE OF FINANCIAL INSTITUTIONS IN CONTEMPORARY ECONOMIES

The endless search for investing opportunities and profits maximization increases the need for effec-
tive risk management practices from the side of suppliers of capital. Financial institutions facilitate the
matching between supply of and demand for cash. The most common types of such institutions include
central banks, retail and commercial banks, credit unions, savings and loan associations, investment banks,
brokerage firms, insurance companies, and mortgage companies. These institutions act as intermediaries
offering services to various stakeholders at a low cost (compared to the cost that each individual would
entail outside this financial system) taking advantage of economies of scale (agency costs, collection
of information on the company). Additionally, financial institutions act as asset transformers offering
more appealing investing opportunities based on the profile of individuals instead of allowing the latter
alone to decide among investment alternatives. According to this process, institutions buy primary and
sell secondary securities to individual investors. Further to the above, these entities offer diversity in
their investment alternatives eliminating clients’ risk exposure. The importance of such institutions is
enforced by the fact that in many economies they are the sole source for funds. Ineffective operation of
financial institutions leads to major problems to day-to-day transactions, in commerce and investments
leading to stagnation and to the creation of negative externalities. Thus, regulations relevant to the op-
eration of financial institutions have emerged and undergo frequent reviews to abide with contemporary
needs eliminating the impact of emerging risks. Major global financial crises in 2000 and in 2008 had

187

Machine Learning Techniques and Risk Management

important impact on the specific regulation and led to the increase in the need for additional control and
audit practices with an aim for effective governance worldwide. Discussing the situation in U.S., White-
house (2017) inferred that banks in 2017 were not healthier compared to the years of the global financial
crisis even though there are regulations to forbid speculative trading on securities and derivatives, which
was a major initiator for this crisis. This contradicts to the results from conventional measures of risk
(combined value at risk), which presents eliminated amounts of money at risk in case of an unforeseen
event for the year 2009-2018 (figure 1). Whitehouse (2017) infers that even if we adjust for the change
in the one year trailing average of the Chicago Board Options Exchange volatility index, banks’ trading
operations were 25% less risky compared to 2009 (figure 2).

Figure 1. Combined value at risk (average for trailing three months) for the top six U.S. banks, millions
of dollars
[source: Bloomberg]

This chapter builds on Kaplan’s (2011) proposal that accounting research should shed light on risks,
its drivers and how entities could manage them.

TYPES OF RISKS

Providing a general definition on risk, it is the possibility of danger, loss, or other adverse consequence.
Uncertainty avoidance determines decision making in business and people are triggered to a smaller or

Figure 2. Adjusted value at risk for the top six U.S. banks, millions of dollars
[source: Bloomberg]

188

Machine Learning Techniques and Risk Management

greater extent to avoid it (Hofstede 1980, 2001). Investments entail risk to hopefully get an expected
return. Desired future outcomes, especially in the form of cash flows, together with the risk profile of
an investor dictate the overall investing strategy. Existing literature on financial institutions has identi-
fied various types of risks.
Interest rate risk is initiated by the fluctuations in interest rates over a period of time with either
positive or negative impact on the value of an entity’s assets and liabilities. Building on this risk, the
mismatch to the day of maturity between assets and liabilities as well as the decision from the side of a
financial institution to withhold its assets compared to the liabilities in the long run increases the possi-
bility of reinvestment risk, which may require additional investments to cover the returns to its investors.
Prepayment risk is another relevant form of risk and depicts borrowers’ propensity to make advance
payments to older loans (with higher interest rate) and refund them with loans with lower interest rate.
Credit risk results from the possibility a loan or bond that a financial institution withholds not be paid
off. Institutions achieve maximum profitability when borrowers pay both the capital borrowed together
with the interest on it. Traders on loans or bonds with extended maturity are more exposed to this type of
risk compared to the ones with shorter maturity periods. During crisis period the possibility of borrow-
ers to default and declare inability to meet their liabilities increases leading to a generalized systematic
credit risk that applies to all economic units (individual investors, organizations).
Another type of risk is liquidity risk, which depicts the danger when the owners of an institution’s
liabilities (e.g. depositors) postulate the withdrawal of their deposits in cash. This may happen for vari-
ous reasons the most common being a negative announcement regarding the viability of an institution
or, even worse, for the whole financial system. This risk increases the cost of borrowing the amount of
money for an institution and may even require the liquidation part of its assets.
In globalized economies and in worldwide transactions that a financial institution participates either
as an intermediary or an investor itself, it faces the foreign exchange risk. This is the result of fluctua-
tions in exchange rates, which affect the value of its assets and liabilities, which are expressed in foreign
currency. International exposure bears also the country sovereign risk. This depicts the risk of an insti-
tution that has granted loans to foreign countries and the borrowers default avoiding or being unable to
pay back for these loans taking advantage of favorable decisions from the side of foreign governments.
An additional source of risk for financial institutions is market risk, which relates to interest rate
risk, credit risk, and foreign exchange risk, but cannot be easily eliminated; thus, is called systemic risk.
A contemporary risk for financial institutions is the off-balance sheet risk, which may entail huge
losses. Typical example of such risk are the letters of credit and the credit default swaps.
Finally, operational risk embodies any malfunctions in the day-to-day running of a financial institu-
tion and may relate to its back-office operations, the information systems utilized or even mistakes from
the side of employees when offering services.
In a study of around 200 banks from 21 OECD countries for the years 2002 to 2008 (before and during
crisis), Klomp and De Haan (2012) found that capital and asset risk together with liquidity and market
risk are the more influential to capture bank overall risk. They also found that the effectiveness of bank
regulation and supervision depends on the ownership structure of the institution and its size. A potential
source of risk originates from the propensity of managers to proceed to management of earnings either
through the management of accruals or on real transactions (e.g. inventory, marketing, R&D), which
is associated with suboptimal decision making. McNichols and Stubben (2008) found that earnings
management and restatement of financial statements leads to unfavorable allocation of resources in an
organization and over-investment. Irrespective of which approach to earnings management is selected,

189

Machine Learning Techniques and Risk Management

particular practice is a signal of risk to the auditor since it is associated with a distorted view of earn-
ings. Pointing that the manipulation of earnings via real transactions is performed during the fiscal year,
whereas accruals management after the year-end, Zang (2012) found a negative relationship between
the aforementioned types of earnings management and suggests that managers are inclined to proceed
to a trade-off between these two decisions.
Analyzing the multifaceted phenomenon or risk in financial sector, it is worth mentioning the dimension
of risk that stems from the client. Kadous et al. (2008) suggest that tax and audit professionals’ opinion
may be influenced by what they call ‘confirmation bias’, according to which auditors are prone to search
for information to confirm clients’ perceptions. Transferring this attitude to accounting decisions, the
willingness to satisfy a valued customer makes an auditor willing to accept a rather aggressive investing
position taken by the financial institution even though such decision may not be well justified. Hence,
these scholars discriminate between high- versus low-practice-risk clients suggesting that auditors in
the first category of clients search for objective information proceeding to balanced recommendations,
whereas for the latter type of clients they try to find supportive information to justify clients’ decisions.
Boyd and De Nicolo (2005) explored the impact of business environment, competitiveness and the
market in evaluating the risk confronted by a bank. Specifically, they found that as market concentra-
tion increases, the same happens to the bank risk. The rationale is that as competition reduces, banks
increase their rates in their loan market received since they could charge higher loan rates increasing at
the same time the borrowers’ bankruptcy risk and default. Similarly, increased competition in the bank-
ing industry increases the possibility of making an individual bank prone to take additional risk. Even
though one would expect to achieve a trade-off between the level of competition and financial stability,
it requires significant regulatory initiatives (e.g. minimum capital requirements) for both of them to
co-exist (Allen and Gale, 2004). In a more recent study, Martinez-Miera and Repullo (2010) justify the
view that as competition increases, loan rates decrease and so does the probability of default. However,
they suggested that lower rates decrease bank revenues, which may stagger the stability and the viability
of a financial institution. Focusing on commercial and savings banks, Jiménez et al. (2013) inferred that
bank failure risk is reduced as competition increases.
Finally, focusing on Islamic banks, operational risk seems to be more important compared to other
types of risks due to the complexity of the products offered (Archer and Haron, 2007). Performing an
investigation on the risks that commercial banks in United Arab Emirates faced, Al-Tamimi and Al-
Mazrooei (2007) inferred that the most relevant were foreign exchange risk, credit risk and operating risk.

RISK MEASUREMENT BY FINANCIAL INSTITUTIONS

The process through which financial institutions could manage risks involve the following stages:

1. Risk identification; namely, to identify which variables lead to risky situations. In this initial stage,
risks are grouped into the risk categories identified in the previous part.
2. Risk measurement, which is associated with the use of statistical approaches to quantify risk and
its impact on a financial institution. At this stage, risks are categorized based on their severity to
the viability of an entity.
3. Risk mitigation through which an entity eliminates, if not extinguish, unexpected or negative im-
pacts of the above identified risks.

190

Machine Learning Techniques and Risk Management

4. Risk monitoring and reporting; namely, risk mitigation techniques should undergo continuous
evaluations to test and certify the effectiveness of the relevant controls adopted. In a negative sce-
nario, auditors should report on the above ineffectiveness, which initiates the process to update the
relevant control. Also, environmental scanning should be performed on a regular basis to identify
as soon as possible potential types of risk.

As mentioned earlier, one of the most common types of risk is interest rate risk. Numerous factors
could be put forward regarding its origins with the policy adopted by central banks and the interrela-
tion among globalized financial markets being of the most significant ones. One way of measuring the
particular type of risk is by estimating the gap between the interest earned from assets and the interest
paid for the liabilities of an entity concluding to a rate of sensitive assets or liabilities. Banks’ effort is to
continuously evaluate their sensitivity to changes to interest rates making proper adjustments to elimi-
nate the gap avoiding the risk to find additional amounts of money to finance this gap. For example, an
increase to the short-term interest rates would reduce short-term earnings from interest rates increasing
short-term interest rate expenses. This approach is called repricing gap model and the financial entity
should account for any gaps due to the difference between the market and the book value of assets and
liabilities. Also, potential implications to the cash flows from off-balance sheet activities due to the in-
terest rate risk should also be taken into consideration. Another option to estimate the interest rate risk
would be to take the weighted duration gap, which takes into consideration the sensitivity of interest
earned on assets versus the interest paid on liabilities towards their maturity.
Moving on to measurement of credit risk, it requires information on debtors’ credibility irrespec-
tive of the type of credit (e.g. bond, loan). In retail banking, the particular information could be found
either from external bodies that collect such type of details or internally (i.e. the bank could develop
an information system internally to update with information about its customer base). Information on
performance of a listed organization could be found from its published financial statements too. Thus,
one would expect that developing a system to evaluate credit risk could be proved to be more accurate
for corporate compared to retail customers. The measurement of credit risk involves the use of both
quantitative and qualitative data. Qualitative data capture details on the specific customer (e.g. customer’s
reputation, factors affecting leverage, seasonality of revenues/profits, quality of collateral) and the market
(e.g. business cycle, level of interest rates). On the other side, quantitative models include credit scoring
(linear probability models, logit models, linear discriminant analysis models). Other credit risk models
are based on the evaluation of performance of an entity awarding a relevant score (e.g. S&P score),
mortality rate models that use historical data on default risk, and risk-adjusted return on capital model.
Another approach for banks is to set a limit either to the amount of money in loans or to the portfolio of
loans given to specific companies or group (concentration limits). Instead of focusing on individual loans
to companies, they could proceed to an evaluation of credit risk of the whole portfolio of loans/bonds.
This is performed by using migration analysis and the design of a loan migration matrix, through which
financial institutions decide on the attractiveness of various business sectors to target their loan policy.
Basel III (2017) promotes the selection between two approaches on calculating credit risk; namely, the
standardized approach that assigns weights to risks utilizing data by external credit assessment institutions
and internal ratings-based approach that allows banks to use an internal credit risk assessment scheme.
Focusing on liquidity risk of a financial institution, it stems either from the assets or the liabilities
side of the balance sheet. Products offered by banks to customers with specific risk profile could either
a positive or negative impact on revenues and profitability. Cash management involves techniques to

191

Machine Learning Techniques and Risk Management

anticipate deposits and withdrawals to control for net deposit drain. Bank run is a major reason that leads
to this type of risk; thus, management of a financial institution should measure and control sources and
uses of liquidity on a daily basis concluding to a net liquidity statement. Also, a financial institution could
compare its liquidity ratios with competitors’ similar ratios (benchmarking). Another way to measure
liquidity risk is by evaluating its financing gap; namely, the difference between the average amount of
loans and the average amount of deposits. Basel III (2013) supported the applicability of liquidity cover-
age ratio, and a year later enriched it with the inclusion of net stable funding ratio too (Basel III, 2014)
for the effective calculation of the particular type of risk by banks. Both of them could provide a better
picture on the entity’s risk exposure providing at the same time a tool for effective decision making. The
former of these two ratios indicates that the financial institution could maintain high quality of easily
liquidated assets in case of an immediate need for cash either due to a temporary problem faced solely
by the particular institution or due to the systematic risk. Adopting a long-term perspective on liquidity,
a financial institution could measure its net stable funding ratio, which motivates the detection of stable
sources of funding with a maturity greater than a year. In addition to the above measures, institutions
could group their liabilities based on their maturity concluding to the calculation of contractual maturity
mismatches. Analyzing its customer base, a bank should identify key depositors, who could cause seri-
ous implications to liquidity if they asked for their money. Thus, the large concentration of funds offered
by a small number of customers/depositors would be alarming for financial institutions and should be
avoided. Another measure for liquidity risk could be the unencumbered assets available, which could
potentially be utilized as warrants for additional funding from secondary markets (sources of funds).
Finally, the establishment of an information system to monitor global trends in markets could provide an
alarm regarding to liquidity risks around the world, which could impact a specific sector/market/country.
Assessing liquidity risk exposure improves quality of information provided to the balance sheet, which
in turn enables managers take informed strategic decisions.
Globalization of financial markets and trade transactions has made financial institutions vulnerable
to foreign exchange risk. Depending on the maturity (short- and long-term) of its liabilities, a financial
institution takes long or short positions on foreign currencies. In this way, the level of risk is evaluated
and then hedged either by making proper changes to its balance sheet to maintain profitability or via
off-balance sheet transactions (via futures and forwards).
Relevant to the previous risk is the country sovereign risk, according to which financial institutions
should evaluate the possibility a particular country to renunciate its total debt or even ask for restructuring
in the terms of an agreement (e.g. duration, interest, installments). Calculating this risk, entities could
use information offered by external assessment bodies such as Euromoney Country Risk index and the
Economist Intelligence unit. Utilizing information available to statistical services in many countries,
banks could proceed to the calculation of ratios that denote high country risk such as the debt service
ratio, import ratio, investment ratio, variance of export revenue, and domestic money supply growth.
What institutions should also include to their measurements is the political risk derived from measures
of corruption and transparency by incorporating readily available indexes on them into their statistical
models.
Market risk stems from changes to market conditions, which may affect revenues and profits of a
financial institution. Calculating the level of exposure to market risk, an institution could follow various
methods, one of which is riskmetrics approach that is based on the calculation of the daily value at risk
of a portfolio that the particular institution holds. Another method would be to utilize historic simulation
to compute value at risk, which values the portfolio based on the real (historic) market prices of the past

192

Machine Learning Techniques and Risk Management

(e.g. previous day). The disadvantage of the latter approach is the confidence interval, which is usually
based on the last 500 observations. Going back in past to include more observations would incorporate
the risk of adding observations with low predicting ability. The solution to the above is the use of Monte
Carlo simulation. In a recent study on US financial institutions, Kleinow et al. (2017) proposed the
use of four measures of systematic risk; namely marginal expected shortfall, codependence risk, delta
conditional value at risk, and lower tail dependence. However, they concluded to the limited ability of
a single metric to capture the severity of the specific dimension of risk.
Following proposals made by Anderson and Fraser (2000) the total risk of a bank for every fiscal
year is calculated as the standard deviation of its daily stock returns. The rationale is that the total risk
of a bank should capture the overall variability in stock returns, which incorporates information on risk
relative to assets and liabilities as well as off-balance sheet risks.
Applying an enterprise risk management approach to financial institutions classifying risks into
market, credit and operations could be a fruitful way forward (Sabato, 2010). The same scholar advo-
cates that risk measurement should involve the grouping of risks into two categories; namely, hazard
and speculative risks. The former category of risks is associated with a loss, whereas the latter includes
an inherent possibility of a gain. Measuring risks through an integrated enterprise risk management
system requires the financial institution to detect the types of risks it is vulnerable to, to evaluate their
importance and to estimate potential implications to the assets and liabilities. Needless to say that in
contemporary organizations this approach requires the adoption of an integrated information system,
which is regularly updated with details from both the internal and external environment.
Focusing on Islamic Banking, Sundararajan (2007) realized the inappropriateness of existing mea-
surement techniques to be applied to Islamic Banks and proposed the need for finding new techniques
to measure risks in these institutions.
Kanagaretnam et al. (2013) explored the impact of national culture on accounting conservatism and
risk taking in banking and corroborated the negative relationship between individualism and conser-
vatism and the positive relationship between uncertainty avoidance and conservatism as expressed in
reporting of earnings. They also found that financial reporting and decisions made even by experienced
managers are to a significant extent affected by culture. Thus, countries that encourage risk taking and
have incorporated a risk-loving culture were prone to experience bank failures during the period of
global financial crisis. Isolating one dimension of culture, McGuire et al. (2012) focused on religion
and its impact on financial reporting. They inferred that companies in religious areas are less likely to
follow unethical business practices, but managers are willing to accept real earnings management over
accruals manipulation.
Investigating risk in reporting accounting figures as perceived by investors, Nelson and Rupar (2015)
found evidence to support the assignment of higher risk to figures that are expressed in monetary (dollar)
form in contrast to percentage form.
IMF (2000) explored various types of risk indicators relevant to financial institutions and developed
two sets of indicators to measure health and stability of a financial institution. One set of them captured
macroeconomic variables, whereas the second institution specific ones to capture risks on:

Capital adequacy to protect their balance sheets due to foreign exchange risk, credit risk, interest rate
risk, off-balance sheet risk.
Asset quality to avoid impairment of assets and solvency paying special attention to credit risk, various
types of guarantees (off-balance sheet risk), and derivatives.

193

Machine Learning Techniques and Risk Management

Management soundness to capture managers’ deficiencies through their decision making.

Earnings and profitability measures that could reveal a well-hidden risk for the viability of the institution.
Liquidity measures to prevent solvency risk.
Sensitivity to market risk with the more common being interest rate and foreign exchange risks.

In addition to the CAMELS framework (acronym of the above-mentioned risk areas), IMF (2000)
suggested the inclusion of market-based indicators too such as excess yields offered by a financial in-
stitution compared to its competitors.

RISK MANAGEMENT IN FINANCIAL INSTITUTIONS

Managing risks is a challenging process, especially in banks that operate in a complex environment
with risks stemming from both their internal and external environment. Global financial crisis of 2007-
2008 indicated that risk management in financial institutions was far from being effective. Even though
there was extensive regulatory pressure initiated by the above-mentioned crisis, quality of governance
in banking sector was marginally improved (Mongiardino and Plath, 2010).
The adoption of enterprise risk management solutions gradually becomes insufficient in risk pre-
vention especially in dealing with credit, market and operational types of risk (Sabato, 2010). This is
because such systems are usually isolated from other enterprise resource planning systems and do not
communicate effectively with all business functions. Hence, members of the board do not always have
the necessary information to proceed to effective risk management decisions. A typical example may
be with the off-balance sheet risk of a bank.
The stance a financial institution adopts towards risk is influenced by many internal or external fac-
tors such as regulation, creditor rights, ownership structure. Regulatory regimes as well as corporate
governance and internal audit standards dictate that risk management system should be independent of
revenue generating functions (Lim et al., 2017).
A movement to the establishment of generally accepted and applied regulations to eliminate risk in
financial institutions was made with Basel I (Basel, 1988), which focused on ensuring that these entities
should proceed to certain practices to maintain their capital adequacy. After a number of serious scan-
dals with global impact in 90’s (e.g. Barings bank in 1995), the Basel Committee was forced to update
regulations to improve the quality of internal control within financial institutions, promoting the central
role of the internal audit function (Basel, 1998). The importance of internal audit and its inclusion to the
Three Lines of Defense ideally present within an organization, was postulated by subsequent regulations
on banking supervision published by the Basel Committee (Basel, 2012).
Existing literature associates management of risks with the level of accounting conservatism too;
namely, conservative financial institutions would require higher verification standards to adopt positive
news in their reports compared to bad ones (Nichols et al., 2009).
Research has acknowledged the importance for an organization to design a system so as relevant
information on risks to reach both the responsible business function as well as to be shared among its
senior managers to help them in their decision making (Stein, 2002). Ellul and Yerramilli (2013) inves-
tigated the above to a number of US-based financial institutions and inferred that the independence of
risk management function was not important at a pre-crisis period, whereas this relationship strengthened

194

Machine Learning Techniques and Risk Management

during crisis. In line with the above, default rates on mortgage loans was lower in banks with increased
risk manager’s power (Keys et al., 2009).
Another stream of research related the propensity to absorb risky news and take decisions based on
them with national culture. A number of studies have focused on quality of reporting investigating the
determinant role of national culture on earnings management (e.g. Doupnik, 2008; Han et al., 2010).
Even during the period that the global financial crisis began, the Institute of International Finance (2008)
warned about potential negative implications to risk management, if organizations did not cater for the
development of a risk culture within their departments. Kanagaretnam et al. (2011) collected data before
and during global financial crisis and inferred that cultural factors affected quality of earnings and finan-
cial reporting before crisis and consequently financial institutions proceeded to large loan loss provisions
during crisis period to compensate for such risky decision making. Kanagaretnam et al. (2013) used data
from a sample of 70 banks to conclude that in high uncertainty avoidance societies, banks reported their
earnings more conservatively showing lower levels of risk-taking activities.
Moreover, literature has associated risk taking activity by banks with corporate governance charac-
teristics. Kirkpatrick (2009) supports the importance of effective corporate governance practices as a
stability factor for banks during crisis period since they positively lead to effective risk management.
One aspect of the above relates to the negative relationship between board independency and risk-taking
behavior (Aebi et al., 2012). Adams and Mehran (2003) suggested that complexity theory should be
applied when performing research in banking sector and, building on it, Grove et al. (2011) found as-
sociation between risk taking and the frequency of board meetings and the size of the board. In a study
on performance of a sample of US banks before the crisis, Pathan (2009) found that small size of the
board positively affected risk-taking decisions due to pressure from the side of shareholders for improved
performance, which in the majority of cases links to risky decision-making. In case corporate gover-
nance was inclined to satisfy shareholders’ subjective desires, this resulted to higher risk for the bank
(Anginer et al., 2018). However, they point that this was particularly true for large banks compared to
smaller ones since the former benefitted from too-big-to-fail guarantees as a result of generous financial
safety nets. Hiring competent members of the board with financial expertise could potentially contribute
to the negative impacts of the above mentioned complexity. However, financially competent members
of the board were more prone to take risky positions for a financial institution and this behavior was
negatively associated with performance during crisis (Minton et al., 2010). Dong et al. (2017) found that
the presence of female board of directors for the years between 2003 and 2011 was positively related to
the profitability and cost efficiency and negatively to the traditional banking risk and also that the bank
liquidity ratio was significant to the increase of risk. Besides, the mediating effect of gender diversity on
reducing risk taking behavior had been identified by Qian et al. (2015) too. Chaigneau (2013) inferred
that there is a positive relationship between CEO compensation and risk-taking decisions. In a study on
determinants of default, Berger et al. (2016) verified the importance of capital ratio, return on assets,
and the proportion of non-performing loans together with the ownership structure.
In banking sector, financial institutions under different ownership regimes coexist ranging from
privately-owned to state/government controlled entities. Literature has already identified that the con-
flict of interest between owners and managers, which is a major source of risky decisions taken by the
latter. Performing a research on European banking sector for the years 1999-2004 before the burst of
last global financial crisis, Iannota et al. (2007) found that public banks had low loans quality together
with high insolvency risk; hence, public banks were riskier and underperformed (lower profitability)
compared to entities from private sector. In line with the above, Beltratti and Stulz (2012) support that

195

Machine Learning Techniques and Risk Management

banks with boards that were significantly influenced by their shareholders’ desire for increased return
on their investments and took decisions that involved more risk to satisfy them, underperformed dur-
ing the crisis period (i.e. 2007 and 2008). Concentrating on a sample of European banks, Barry et al.
(2009) found that changes in ownership structure did not affect risk taking initiatives and there were not
significant differences between public and private banks. They also inferred that the participation of
financial institutions in public banks reduced exposure to credit and default risks. Focusing on the Chi-
nese market, Qian et al. (2015) explored the determinant role of ownership to their prudential behavior,
which is pivotal to safeguard financial and economic stability. They concluded that the employment of
government officials reduces prudential behavior since they are more inclined to abide with governmental
decisions in their decision making (e.g. by offering loans to specific sectors or business entities, which
would not have qualified otherwise).
From the above discussion, it is implied that state laws and regulations may have a mediating role to the
level of risk for a financial institution. Moving a step further, risk may be affected by shareholders’ power
to the governance of a bank. Laeven and Levine (2009) supported the importance of acknowledging the
power of ownership structure when evaluating risk management practices of a bank since equity holders
usually put pressure on the board of directors for increased capital gains and performance, which induces
risky decisions. Within the above conditions, financial institutions should develop information systems

CONCLUDING REMARKS

This chapter discussed the types of risks that financial institutions could potentially face in their day-to-
day operation in a globalized business environment. In the second part we presented methods on how
to measure the exposure to them. The third part discussed how financial institutions manage these risks
during a crisis period. It is encouraging that here are indications about the soundness and stability of the
global financial system with the Financial Stability Board declaring the elimination of toxic instruments
(El-Erian, 2017). To this end, banks focused their efforts on liquidity, transparency of operations and
investment activities, improving the quality of their balance sheets. Further, regulators impose restric-
tions to financial institutions to maintain capital within certain boundaries influencing the amount of
credit offered to the economy.
However, there is a need for future research to be directed to the analysis of systematic risk with the
development of frameworks to assess its impact of systemic risk to financial institutions. In line with
the above, a framework to capture the overall risk faced by a financial institution should be developed,
especially in turbulent times with high systemic stress, in order to protect not only investors and generally
all its stakeholders in their decision making, but also governments when deciding about the national fis-
cal policy and its implications to the viability of financial institutions. Furthermore, comparative studies
should be performed in order to explore and highlight differences among different countries and financial
markets. The above will build on stability measures to reduce regulatory arbitrage risk among different
countries and financial regimes. Moreover, case study approach could be applied to compare risk-taking
activity in private versus state-owned financial institutions. In line with it, this analysis should investigate
the magnitude of risk in cases of banks that have bestowed part of their activities to non-banks, because
the latter operate under different regulatory regimes (El-Erian, 2017). Acknowledging the important
and emergent role of corporate governance in the contemporary management of financial institutions,
further research could be directed to capture the impact of ownership structure to risk management too.

196

Machine Learning Techniques and Risk Management

Within the above conditions, these entities should develop information systems to provide an integrated
view of performance providing data on the implications of regulatory compliance and risk exposure
facilitating at the same time decision making and control.

REFERENCES

Adams, R., & Mehran, H. (2003). Is corporate governance different for bank holding companies? Eco-
nomic Policy Review, (April), 123–142. doi:10.2139srn.387561
Aebi, V., Sabato, G., & Markus, S. (2012). Risk management, corporate governance, and bank per-
formance in the financial crisis. Journal of Banking & Finance, 36(12), 3213–3226. doi:10.1016/j.
jbankfin.2011.10.020
Al-Tamimi, H., & Al-Mazrooei, M. (2007). Banks’ Risk Management: A Comparison Study of UAE Na-
tional and Foreign Banks. The Journal of Risk Finance, 8(4), 394–409. doi:10.1108/15265940710777333
Allen, F., & Gale, D. (2004). Competition and financial stability. Journal of Money, Credit and Banking,
36(3b), 453–480. doi:10.1353/mcb.2004.0038
Anderson, R. C., & Fraser, D. R. (2000). Corporate control, bank risk-taking, and the health of the bank-
ing industry. Journal of Banking & Finance, 24(8), 1383–1398. doi:10.1016/S0378-4266(99)00088-6
Anginer, D., Demirguc-Kunt, A., Huizinga, H., & Ma, K. (2018). Corporate governance of banks and
financial stability. Journal of Financial Economics, 130(2), 327–346. doi:10.1016/j.jfineco.2018.06.011
Archer, S., & Haron, A. (2007). Operational Risk Exposures of Islamic Banks. In Islamic Finance: The
Regulatory Challenge. John Wiley & Son (Asia) Pte Ltd.
Barry, T. A., Lepetit, L., & Tarazi, A. (2011). Ownership structure and risk in publicly held and privately
owned banks. Journal of Banking & Finance, 35(5), 1327–1340. doi:10.1016/j.jbankfin.2010.10.004
Basel Committee on Banking Supervision. (1988). International convergence of capital measurement
and capital standards. Basel Committee on Banking Supervision.
Basel Committee on Banking Supervision. (1998). Framework for internal control in banking organiza-
tions. Basel Committee on Banking Supervision.
Basel Committee on Banking Supervision. (2012). The internal audit function in banks. Basel Com-
mittee on Banking Supervision.
Basel Committee on Banking Supervision. (2013). Basel III: The liquidity coverage ratio and liquidity
risk monitoring tools. Basel Committee on Banking Supervision.
Basel Committee on Banking Supervision. (2014). Basel III: The net stable funding ratio. Basel Com-
mittee on Banking Supervision.
Basel Committee on Banking Supervision. (2017). Basel III: Finalising post-crisis reforms. Basel Com-
mittee on Banking Supervision.

197

Machine Learning Techniques and Risk Management

Beltratti, A., & Stulz, R. M. (2012). The credit crisis around the globe: Why did some banks perform
better? Journal of Financial Economics, 105(1), 1–17. doi:10.1016/j.jfineco.2011.12.005
Berger, A. N., Imbierowicz, B., & Rauch, C. (2016). The roles of corporate governance in bank failures
during the recent financial crisis. Journal of Money, Credit and Banking, 48(4), 729–770. doi:10.1111/
jmcb.12316
Boyd, J. H., & De Nicolo, G. (2005). The theory of bank risk taking and competition revisited. The
Journal of Finance, 60(3), 1329–1343. doi:10.1111/j.1540-6261.2005.00763.x
Chaigneau, P. (2013). Risk-shifting and the regulation of bank CEOs’ compensation. Journal of Financial
Stability, 9(4), 778–789. doi:10.1016/j.jfs.2012.08.003
Dong, Y., Girardone, C., & Kuo, J. M. (2017). Governance, efficiency and risk taking in Chinese bank-
ing. The British Accounting Review, 49(2), 211–229. doi:10.1016/j.bar.2016.08.001
Doupnik, T. S. (2008). Influence of culture on earnings management: A note. Abacus, 44(3), 317–340.
doi:10.1111/j.1467-6281.2008.00265.x
El-Erian, M. (2017). How healthy is the global financial system. The Guardian. https://www.theguard-
ian.com/business/2017/jul/10/how-healthy-global-financial-system-mohamed-el-erian
Ellul, A., & Yerramilli, V. (2013). Stronger risk controls, lower risk: Evidence from US bank holding
companies. The Journal of Finance, 68(5), 1757–1803. doi:10.1111/jofi.12057
Financial Stability Institute (FSI). (2015). The “four lines of defense model” for financial institutions.
Occasional Paper No. 11.
Glover, J. (2017). Bank of England focuses on consumer-credit risk to stability. Bloomberg. https://www.
bloomberg.com/news/articles/2017-04-04/bank-of-england-focuses-on-consumer-credit-risk-to-stability
Grove, H., Patelli, L., Victoravich, L., & Xu, P. (2011). Corporate governance and performance in
the wake of the financial crisis: Evidence from US commercial banks. Corporate Governance, 19(5),
418–436. doi:10.1111/j.1467-8683.2011.00882.x
Han, S., Kang, T., Salter, S., & Yoo, Y. K. (2010). A cross-country study on the effects of national cul-
ture on earnings management. Journal of International Business Studies, 41(1), 123–141. doi:10.1057/
jibs.2008.78
Hofstede, G. (1980). Culture’s consequences: International differences in work related values. Sage
Publications.
Hofstede, G. (2001). Culture’s consequences: Comparing values, behaviors, institutions, and organiza-
tions across nations. Sage Publications.
Iannotta, G., Nocera, G., & Sironi, A. (2007). Ownership structure, risk and performance in the European
banking industry. Journal of Banking & Finance, 31(7), 2127–2149. doi:10.1016/j.jbankfin.2006.07.013
Institute of International Finance (IFF). (2008). Interim report of the IIF committee on market best
practices. April. IIF.

198

Machine Learning Techniques and Risk Management

International Monetary Fund (IMF). (2000). Macroprudential indicators of financial system soundness.
Occasional Paper 192, Washington, DC: IMF.
Jiménez, G., Lopez, J. A., & Saurina, J. (2013). How does competition affect bank risk-taking? Journal
of Financial Stability, 9(2), 185–195. doi:10.1016/j.jfs.2013.02.004
Kadous, K., Magro, A. M., & Spilker, B. C. (2008). Do effects of client preference on accounting profes-
sionals’ information search and subsequent judgments persist with high practice risk? The Accounting
Review, 83(1), 133–156. doi:10.2308/accr.2008.83.1.133
Kanagaretnam, K., Lim, C. Y., & Lobo, G. J. (2011). Effects of national culture on earnings management
in banks. Journal of International Business Studies, 42(6), 853–874. doi:10.1057/jibs.2011.26
Kanagaretnam, K., Lim, C. Y., & Lobo, G. J. (2013). Influence of national culture on accounting conser-
vatism and risk-taking in the banking industry. The Accounting Review, 89(3), 1115–1149. doi:10.2308/
accr-50682
Kaplan, R. S. (2011). Accounting scholarship that advances professional knowledge and practice. The
Accounting Review, 86(2), 367–383. doi:10.2308/accr.00000031
Keys, B. J., Mukherjee, T., Seru, A., & Vig, V. (2009). Financial regulation and securitization: Evidence
from subprime loans. Journal of Monetary Economics, 56(5), 700–720. doi:10.1016/j.jmoneco.2009.04.005
Kirkpatrick, G. (2009). The corporate governance lessons from the financial crisis. OECD Journal:
Financial Market Trends, 2009(1), 61–87. doi:10.1787/fmt-v2009-art3-en
Kleinow, J., Moreira, F., Strobl, S., & Vähämaa, S. (2017). Measuring systemic risk: A comparison of
alternative market-based approaches. Finance Research Letters, 21, 40–46. doi:10.1016/j.frl.2017.01.003
Klomp, J., & De Haan, J. (2012). Banking risk and regulation: Does one size fit all? Journal of Banking
& Finance, 36(12), 3197–3212. doi:10.1016/j.jbankfin.2011.10.006
Laeven, L., & Levine, R. (2009). Bank governance, regulation and risk taking. Journal of Financial
Economics, 93(2), 259–275. doi:10.1016/j.jfineco.2008.09.003
Lim, C. Y., Woods, M., Humphrey, C., & Seow, J. L. (2017). The paradoxes of risk management in the
banking sector. The British Accounting Review, 49(1), 75–90. doi:10.1016/j.bar.2016.09.002
Martinez-Miera, D., & Repullo, R. (2010). Does competition reduce the risk of bank failure? Review of
Financial Studies, 23(10), 3638–3664. doi:10.1093/rfs/hhq057
McGuire, S. T., Omer, T. C., & Sharp, N. Y. (2011). The impact of religion on financial reporting ir-
regularities. The Accounting Review, 87(2), 645–673. doi:10.2308/accr-10206
McNichols, M. F., & Stubben, S. R. (2008). Does earnings management affect firms’ investment deci-
sions? The Accounting Review, 83(6), 1571–1603. doi:10.2308/accr.2008.83.6.1571
Minton, B., Taillard, J. P. A., & Williamson, R. (2010). Do independence and financial expertise of the
board matter for risk taking and performance? Working Paper, Ohio State University.

199

Machine Learning Techniques and Risk Management

Mongiardino, A., & Plath, C. (2010). Risk governance at large banks: Have any lessons been learned?
Journal of Risk Management in Financial Institutions, 3, 116–123.
Nelson, M. W., & Rupar, K. K. (2014). Numerical formats within risk disclosures and the moderating
effect of investors’ concerns about management discretion. The Accounting Review, 90(3), 1149–1168.
doi:10.2308/accr-50916
Nichols, C., Wahlen, J., & Wieland, M. (2009). Publicly traded versus privately held: Implications
for conditional conservatism in banking accounting. Review of Accounting Studies, 14(1), 88–122.
doi:10.100711142-008-9082-3
Pathan, S. (2009). Strong boards, CEO power and bank risk-taking. Journal of Banking & Finance,
33(7), 1340–1350. doi:10.1016/j.jbankfin.2009.02.001
Qian, X., Zhang, G., & Liu, H. (2015). Officials on boards and the prudential behaviour of banks:
Evidence from China’s city commercial banks. China Economic Review, 32, 84–96. doi:10.1016/j.
chieco.2014.11.010
Sabato, G. (2010). Financial crisis: Where did risk management fail? International Review of Applied
Financial Issues and Economics, 2(2), 315.
Singleton-Green, B. (2012). Commentary: Financial reporting and financial stability: Causes and effects.
Australian Accounting Review, 22(1), 15–17. doi:10.1111/j.1835-2561.2011.00161.x
Stein, J. C. (2002). Information production and capital allocation: Decentralized versus hierarchical
firms. The Journal of Finance, 57(5), 1891–1921. doi:10.1111/0022-1082.00483
Sundarajan, V. (2007). Risk Characteristics of Islamic Products: Implications for Risk Measurement and
Supervision. In Islamic Finance: The Regulatory Challenge. John Wiley & Son (Asia) Pte Ltd.
Van der Stede, W. A. (2011). Management accounting research in the wake of the crisis: Some reflec-
tions. European Accounting Review, 20(4), 605–623. doi:10.1080/09638180.2011.627678
Whitehouse, M. (2017). How much have banks really cut their risks? Bloomberg. https://www.bloomberg.
com/view/articles/2017-09-11/how-much-have-banks-really-cut-their-risks
Zang, A. Y. (2011). Evidence on the trade-off between real activities manipulation and accrual-based
earnings management. The Accounting Review, 87(2), 675–703. doi:10.2308/accr-10196

200
201

Chapter 14
Application of Adaptive
Neurofuzzy Control in the
Field of Credit Insurance
Konstantina K. Ainatzoglou
School of Production Engineering and Management, Technical University of Crete, Greece

Georgios K. Tairidis
https://orcid.org/0000-0002-3857-4996
School of Production Engineering and Management, Technical University of Crete, Greece

Georgios E. Stavroulakis
https://orcid.org/0000-0001-9199-2110
School of Production Engineering and Management, Technical University of Crete, Greece

Constantin K. Zopounidis
School of Production Engineering and Management, Technical University of Crete, Greece &
Audencia Business School, France

ABSTRACT
Credit insurance is of vital importance for the trade sector and almost every related business. Moreover,
every policy in credit insurance is tailor-made in order to suit in the best available way the unique
needs and demands of the insured business. Thus, pricing of such service can be tricky for an insurance
company. In the present chapter, this pricing problem in the field of credit insurance will be addressed
through the use of intelligent control mechanisms. More specifically, a way of calculating the price of
insurance policies that has to be paid by a prospective client of an insurance company will be suggested.
The model will be created and implemented with the use of fuzzy logic, and more specifically, through
the implementation of an adaptive neurofuzzy inference system. The training data that will be used for
the tuning of the system will be derived from real anonymous insurance policies of the Greek insurance
market.

DOI: 10.4018/978-1-7998-4805-9.ch014

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

INTRODUCTION AND THEORETICAL BACKGROUND

The current paper is an attempt to research the application of a tool offered by the adaptive neurofuzzy
inference system on the domain of credit insurance. The purpose of this paper is to explore the effec-
tiveness of this alternative approach in order to automate the process of calculating prices of insurance
credit policies.
There are many papers in literature which have previously addressed some applications of fuzzy
logic in the field of insurance (Calibo et al. 2017), (Shapiro, 2005), (Sokolovska, 2017), (Yazdani and
Kwasnicka, 2012). The first article that has made use of fuzzy logic in insurance was the one of DeWit
(1982). One of the scopes of the formerly mentioned paper was to quantify fuzziness in the field of
underwriting. Since then, there have been numerous other attempts that examine how fuzzy logic can
be involved in the field of insurance. There are papers which examine the theoretical dimension of how
fuzzy inference systems could be used in order to improve the processes of risk assessment and risk
decision making (Shapiro, 2007). There have been efforts of evaluating credit risk using neurofuzzy
logic (Sreekantha and Kulkarni, 2010) and attempts to develop fuzzy logic distribution for soft data and
variables used for the corporate client credit risk assessment (Brkic et al., 2017).
The purpose of this paper is to address topics of credit insurance from the perspective of the credit
insurance brokerage. Using anonymous credit insurance policies as an input in an adaptive neurofuzzy
inference system, rules and results will be produced for the calculation of prices in credit insurance policies.
In order to facilitate the comprehension of the current investigation, an initial analysis regarding the
basic concepts and definitions that govern the tools which are used in this chapter will be provided.
More specifically, concepts stemming from different fields of professional activity will be combined.
Definitions regarding the field of credit insurance as well as the field of intelligent control systems will
be examined.
Trade credit insurance: “Trade credit insurance protects manufacturers, traders and service provid-
ers against losses from non-payment of a commercial trade debt. If a buyer does not pay (often due to
bankruptcy or insolvency) or pays very late, the trade credit insurance policy will pay out a percentage
of the outstanding debt. The primary function of trade credit insurance is to protect sellers against buyers
that do not or cannot pay”. (Moorcraft, 2018).
Control system: A system is anything that has receives inputs and produces outputs. A system that
has to be controlled called a plant. A control system is a system that can transform the inputs to the plant
in order to produce a desired output. From a more technical perspective, a control system is an inter-
connection of components which form a system configuration that is able to produce a desired system
response. (Dorf and Bishop, 2011).
Fuzzy logic: “The basic idea of fuzzy logic is to associate a number with each object indicating the
degree to which it belongs to a particular class of objects” (Pfeifer, 2013).
Fuzzy inference system (FIS): “A nonlinear mapping that derives its output based on fuzzy reasoning
and a set of fuzzy if-then rules. The domain and range of the mapping could be fuzzy sets or points in
multidimensional spaces.” (Jang and Sun, 1997).
Adaptive neurofuzzy inference system (ANFIS): “There is a class of adaptive networks that are
functionally equivalent to fuzzy inference systems. The architecture of these networks is referred to as
ANFIS, which stands for adaptive network-based fuzzy inference system or semantically equivalently,
adaptive neurofuzzy inference fuzzy inference system.” (Jang and Sun, 1997).

202

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

FUZZY INFERENCE SYSTEMS

The Basic Concepts of Fuzzy Systems

Fuzzy sets were initially introduced by Zadeh (1965) for the representation and management of data that
was not in a precise format, but rather fuzzy. The basic idea of fuzzy logic is to provide a specific infer-
ence format that allows approximate human reasoning skills to be used in a knowledge-based system.
Fuzzy logic can provide a mathematical base in order to capture the uncertainty involved in the human
cognitive process, such as reasoning and decision making. The previous approach to knowledge model-
ling failed to embrace the concept of fuzziness. This was the main reason why techniques such as the
first order logic and the classical probability theory cannot deal with the representation and modelling of
commonsense knowledge. The necessity of addressing problems of uncertainty and verbal imprecision
led to the adoption of the fuzzy logic concepts.

Important Qualities of Fuzzy Logic

Some of the qualities that describe fuzzy logic relate to exact reasoning faced as a limiting case of the
broader approximate reasoning and scaling. Another important parameter is the fact that knowledge is
conceived as a set of elastic variables and that inference is viewed as a function that propagates elastic
constraints. Any logical system can be modelled with fuzzy logic.
There are two characteristics that make fuzzy systems preferable in certain applications. Fuzzy
systems are applicable for uncertain or approximate reasoning, particularly in case that the system has
a mathematical problem that is difficult to construct. Another valuable characteristic of fuzzy logic is
that it enables the process of decision making with estimated values under incomplete or uncertain data.

Fuzzy Sets and Membership Functions

In crisp sets, an element belongs to a set only when it takes the value 1. In any other case, the element takes
the value 0 and is not part of the set. In fuzzy sets each element can take values from a range with some
participation (membership) rate of the element in the set. The higher the value, the greater the participa-
tion of the element within the set. This set is called fuzzy set, while the function is called membership
function. A graphical comparison between a membership function and a crisp set is shown in Figure 1.
A fuzzy set A is referred to as a triangular fuzzy number with peak (or center) a > 0 , left width
α > 0 and right width β > 0 if it has the following form (Fullér, 1995):

A (t ) = 1 − (α − t ) / α ,if a − α ≤ t ≤ α

A (t ) = 1 − (t − α) / β ,if a ≤ t ≤ a + β

A (t ) = 0 otherwise .

203

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 1. A fuzzy membership function in comparison to a crisp set

A fuzzy set is referred to as a trapezoidal fuzzy number with tolerance interval a, b  , left width α
and right width β if it has the following form:

A (t ) = 1 − (α − t ) / α ,if a − α ≤ t ≤ α

A (t ) = 1,if a ≤ t ≤ b

A (t ) = 1 − (t − α) / β ,if a ≤ t ≤ b + β

A (t ) = 0 otherwise

and the notation A = (a, b, α, β ) is used in order to describe this pattern.

A fuzzy subset A of a set X can be considered as a set of pairs in a certain order, each with the first
element coming from X and the second element coming from the interval [0,1], with exactly one ordered
pair present for each element that belongs to X. This process creates a mapping μΑ between the elements
of X and the values that derive from the interval [0,1]. A zero value denotes complete non-membership,

Figure 2. Triangular fuzzy number

(Robert Fullér 1995)

204

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 3. Trapezoidal fuzzy number

(Robert Fullér 1995)

a value of one denotes complete membership and the values in between denote intermediate percentages
of membership. The set X can be described as the universe of discourse for the fuzzy subset A. The
mapping μΑ represents as function called “the membership function of A”. Consequently, the definitions
“membership function” and “fuzzy subset” can be used interchangeably. The following definitions will
provide clarifications regarding the previously analysed terms (Fullér, 1995).
Assuming that X is a nonempty set, a fuzzy set A in X is characterized by the membership function:

µA : X → 0, 1

and μA(x) is interpreted as the percentage of membership x in fuzzy set A for each given x that belongs
to X.
The percentage of fuzziness that characterizes a fuzzy set is represented with the use of its member-
ship functions. These functions can be depicted either in a numeric or in a graphical way. There are
numerous forms in which a membership function can be graphically described. The most popular ones
are the following (Tairidis, 2016):

• Triangular membership functions

• Trapezoidal membership functions
• Bell membership functions
• Gaussian membership functions
• Sigmoid membership functions
• Polynomial membership functions

Operations on Fuzzy Sets

The classical operations from the theory of ordinary sets can also be applied to fuzzy sets. The same
symbols used in the ordinary set theory will be used when operations are extended to fuzzy sets. Let a
nonempty crisp X set (a crisp set is part of the distinct set theory that employs bi-valued logic) with its
fuzzy subsets A and B:
The intersection of A and B is described as:

205

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 4. Intersection of two triangular fuzzy numbers

(Robert Fullér, 1995)

(A ∩ B )(t ) = min {A (t ), B (t )}, ∀t ∈ X

The union of A and B is described as:

(A ∪ B ) = max {A (t ), B (t )}, ∀t ∈ X

The complement of a fuzzy set A is described as:

(−A)(t ) = 1 − A (t )

The Extension Principle

In order to make use of fuzzy concepts and relations in an intelligent system, arithmetic operations with
these fuzzy quantities should be applied. More specifically, the operations of addition, subtraction, multi-
plication and division with fuzzy quantities should be performed. In this chapter, the first two operations
will be mathematically defined. The extension principle is an essential concept from fuzzy set theory
that needs to be analyzed before proceeding to the examination of arithmetic operations. This principle
enables the extension of any point operation to operations between fuzzy sets.
The extension principle can be explained as follows:

Figure 5. Union of two triangular fuzzy numbers

(Robert Fullér, 1995)

206

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

If X and Y are nonempty crisp sets and f is a mapping from X and g is a mapping from X to Y:

g : X →Y

such that for each x ∈ X , g (x ) = y ∈ Y . Let that A is a fuzzy subset of X, with the use of the extension
principle, g(A) can be defined as a fuzzy subset of Y such that:

g (A)(y ) = supx ∈g −1 y A (x ), if g −1 (y ) ≠ 0
()

g (A)(y ) = 0 otherwise

where

{
g −1 (y ) = x ∈ X | f (x ) = y }
and

( ) {
sup A (x ) = x ∈ X A (x ) 0 }
After the mathematical definition of the extension principle, the operations of extended addition and
extended subtraction can be analyzed.
The operation of extended addition can be described as:
Let g : X × X → X be defined as g (x 1, x 2 ) = x 1 + x 2 . If A1 and A2 are fuzzy subsets belonging to
X, then according to the extension principle:

{( )}
g (A1, A2)(y ) = supx −x =y min A1 (x 1 ), A2 (x 2 ) or g (A1, A2 ) = A1 + A2
1 2

The operation of extended subtraction can be described as:

Figure 6. Addition of triangular fuzzy numbers

(Robert Fullér, 1995)

207

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Let g: X × X → X be defined as g (x 1, x 2 ) = x 1 −x 2 . . If A1 and A2 are fuzzy subsets belonging to X,

then according to the extension principle:

{ ( )}
g (A1, A2 )(y ) = supx −x =y min A1 (x 1 ), A2 (x 2 ) or g (A1, A2 ) = A1 − A2
1 2

Linguistic Variables

Figure 7. Subtraction of triangular fuzzy numbers (A-A)

(Robert Fullér, 1995)

The use of fuzzy sets enables a systematic and organized management of vague and imprecise concepts.
More specifically, linguistic variables can be represented by fuzzy sets. A linguistic variable is a variable
whose value is a fuzzy number or a variable which is described in lexical terms.
( )
A linguistic variable can be denoted as z ,T (z ),U ,G, M , where z is the variable, T(z) is the term
set of z or alternatively, the set of names of lexical values of z with each value being a fuzzy number
defined on the universe U.G is a rule that generates the names of the values of z, and M is a rule that
associates each value to its meaning.
For example, if price is interpreted as a linguistic variable, z=price, then its term set T (price) can
be described as:

T={very low, low, medium, high, very high,....}

where each term in T(price) is described by a fuzzy set in a universe of interval U=[0,100].
Then the following lexical variables could denote the following arithmetic intervals:

• Very low = “a price below 20”

• Low = “a price between 20 and 40”
• Medium= “a price between 40 and 60”
• High = “a price between 60 and 80”
• Very high = “a price between 80 and 100”

These descriptions can be described as fuzzy sets whose membership functions (in this example
triangular) are shown in Figure 8.

208

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 8. Values of linguistic variable “price”

Fuzzification

Fuzzification is one of the most essential parts of fuzzy theory. It is the process of transforming a crisp
quantity into a fuzzy one, which is depicted through membership functions. From a practical point of
view, application errors might occur. These errors might have an impact on the reduction of data ac-
curacy. This reduction can be also depicted through the membership functions. For the process of fine
tuning of the membership functions various techniques can be used. Some methods that could be used
for fine tuning are the following:

• Intuition
• Inference
• Optimization (e.g. Genetic Algorithms)
• Deep learning (e.g. Neural Networks)

Defuzzification

The process of defuzzification enables the translation of the fuzzy output set produced by the fuzzy logic
rule-based system. There is a great number of methods used in order to defuzzify the fuzzy output set.
The most common techniques are presented below:

• Maximum membership principle

• Centroid
• Bisector

209

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

• Middle or mean of maximum (MOM)

• Smallest of maximum (SOM)
• Largest of maximum (LOM)
• Centre of sums
• Centre of largest area
• Weighted average (WTAVER)

The choice of the most suitable defuzzification method depends on the requirements of the researcher
and the parameters of the problem. It is possible that two methods give identical or completely different
results.

The Theory of Approximate Reasoning

Figure 9. Illustration of defuzzification methods

(https://www.mathworks.com/help/fuzzy/defuzzification-methods.html)

The theory of approximate reasoning enables modelling a reasoning that involves imprecision and un-
certainty of information. This theory describes premises as statements assigning fuzzy sets as values to
variables. Let two interactive variables x∈ X and y∈ Y with their causal relationship defined

y = f (x )

An obvious example of inference that can be made is:

210

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Assumption [ y = f (x ) ] +Fact [ x = x ’ ] → Consequence: [ y = f (x ’) ]

Zadeh (1965) has created a group of translation rules that enable the representation of a number of
commonly used lexical statements that refer to propositions in a certain language. Some of these transla-
tion rules are analysed in this chapter.

• Entailment rule:
◦◦ {z is A} and {A ⊂ B}→ x is B
◦◦ {George is very smart} + {very smart ⊂ smart} → George is smart
• Conjunction rule:
◦◦ {z is A} and {z is B} → z is A∩B
◦◦ {temperature is not very high} + {temperature is not very low} → {temperature is not very
high and not very low}
• Disjunction rule:
◦◦ {x is A} or {x is B} → {x is A ∪ B}
◦◦ {temperature is high} or {temperature is low} →{temperature is high or low}
• Negation:
◦◦ not{x is A} →{ x is !A}
◦◦ not{x is high}→{x is not high}
• The Modus Ponens inference rule:
◦◦ Statement {if a then b} and Fact {a} → consequence {b}
• Basic property:
◦◦ {if x is A then y is B} + {x is A} → {y is B}
◦◦ {if speed is high then price is high} + {speed is high} →{price is high}
• Total indeterminance:
◦◦ {if x is A then y is B} + {x is not A}→y is unknown
◦◦ {if speed is high then price is high} + {speed is not high} → {price is unknown}

ADAPTIVE NEUROFUZZY INFERENCE SYSTEMS

The Basic Concepts of Neurofuzzy Systems

The basic idea of a fuzzy inference system is the construction of membership functions that represent
the inputs and outputs of the system based on a set of verbal rules in order to support a decision making
process. The choice of membership functions is either arbitrary or based on experience. The structure
of rules should be predefined and based on the knowledge of an expert (Tairidis 2016).
Fuzzy inference systems produce satisfactory solutions when applied to control. However there are
some limitations, such as the absence of systematic framework or the method of transforming the hu-
man cognitive experience into a set of if-then rules, which hinder the total efficacy of the system and
may be responsible for deviations between the results produced and the expected results. It is a common
phenomenon that when the control mechanism is built, the system designer cannot make a decision
about the form and other qualities of membership functions or the structure of the rules of the system

211

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

taking into consideration just the available data that derives from the expert (Tairidis 2016), (Tairidis
and Stavroulakis 2019).

How Adaptive Neurofuzzy Systems Work

Adaptive Neurofuzzy Inference Systems (ANFIS) belong to the most commonly used adaptive fuzzy
systems. The structure of ANFIS is based on a fuzzy inference system which is implemented inside the
framework of adaptive neural networks.
ANFIS consists of a set of fuzzy rules which in contrast to conventional fuzzy systems, are local
mappings instead of global ones (Jang and Sun, 1995). These mappings enable the minimal disturbance
principle, according to which the adaptation should diminish the output error for the current training
pattern but also reduce as much as possible the disturbance to response already learned. (Widrow and
Lehr, 1990).
During the construction of a fuzzy inference system, one of the most basic processes followed was
fuzzy modelling. Neurofuzzy modelling is the process of applying learning methods, developed using
the neural network theory, to fuzzy inference systems. Back-propagation neural networks are commonly
used for the definition of parameters of an adaptive fuzzy inference system.
In the case of a hybrid learning procedure, the control model could create an input and output mapping
depending on both human knowledge, just like in fuzzy systems and input-output data combinations.
However, there is also the option to construct a control model with input-output mapping even when the
human knowledge is not available. In this case, the initial parameters are given intuitively and the fuzzy
rules could be constructed using a learning process to estimate the expected performance. Consequently,
instead of selecting the parameters of the controller (membership functions, rules, etc.) arbitrarily, an
automated process can produce membership functions for the fuzzy variables based on the available
training dataset. A set of rules or other parameters can also be included and the controller can be trained
in order to function under different circumstances.

ANFIS in MATLAB Environment

An ANFIS can be created with the use of the fuzzy logic toolbox in MATLAB. It is a training routine
for the creation of adaptive Sugeno-type neurofuzzy inference systems.
With ANFIS, a fuzzy inference system can be structured through the use of an input-output training
dataset. One way of setting up the parameters of the system is the use of the back-propagation algorithm,
either alone or combined with the least squares algorithm (hybrid method). This tuning technique enables
fuzzy systems to learn from the data they are modelling. The learning method is similar to the one used
in neural networks.
The modelling process begins with the introduction of a parameterized model and the collection and
application of a training dataset. This data is used by the fuzzy system for automatic approximation of
its parameters until an error criterion is fulfilled.
The training dataset should be carefully selected. As far as simple models are concerned, the more
training data available for the learning process, the more accurate the approximation of parameters. For
systems that contain noise, model validation is an essential process.
Model validation can be accomplished by using a second dataset, the so called testing data. During
the process of model validation, new inputs coming from the testing data and were not included in the

212

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

training phase, are introduced to the system in order to check whether the system produces accurate
results in terms of output prediction. This is an essential step in order to ensure that the model does not
overfit the training data. Apart from this function, testing data enables the process of checking whether
the constructed fuzzy inference system is robust and produces proper results in different conditions.

Training of ANFIS Through MATLAB

At the beginning of the process lies the collection of training data with input and output data that refers
to the system to be modelled. This dataset must be in the form of arrays organized as column vectors with
the output data in the last column. The training dataset could be loaded from a file or from MATLAB
workspace. The initial fuzzy inference system variables should be parameterized arbitrarily or, in case
human expertise cannot define their form, automatically by clustering on the data. More specifically, the
structure of the model can be either loaded by a pre-existing Sugeno fuzzy inference system structure or
produced through a partitioning technique, such as grid partitioning or subtractive clustering.
The first method produces a single-output Sugeno fuzzy inference system through applying grid
partitioning on the data. The second method generates an initial form of model for ANFIS training after
applying subtractive clustering on the training dataset.
A typical grid partition in a two dimensional input space can produce satisfactory results when a
small number of membership functions describes each input. For larger numbers of inputs, the grid
partition method may produce unexpected results. For instance, a fuzzy model with seven inputs and
three membership functions for each input would create a set of 2187 if-then rules, which is admittedly
large. This issue is called the curse of dimensionality and can be partially solved with the use of other
partition techniques.
Subtractive clustering on the contrary is the appropriate partition technique in case that the number
of clusters there should be at each input is unknown. This algorithm is fast in terms of estimating the
number of clusters and the cluster centres in the training dataset. These approximations can enable the
initialization of optimization-based clustering methods and model identification methods like ANFIS.

The Training Process Through ANFIS

After loading the training dataset and creating the initial FIS structure, the system is ready for the training
process. As previously stated, the back-propagation and the hybrid method are the two methods used as
far optimization is concerned. Both methods are used for enabling the training of the membership func-
tion parameters. These parameters are formed in a way that approximates the training dataset.
The back-propagation method belongs to the gradient descend methods. It calculates the derivative of
the function of error, taking into consideration all the neural network weights. The derivative calculated
by the process is used as input to the optimization method which uses it in order to update the values of
weights and minimize the produced error. The method of least squares calculates an approximate solution
in overdetermined systems. According to this process, the overall solution produced should minimize
the sum of errors computed for every equation.
The hybrid method uses back propagation to calculate the parameters that refer to membership functions
and least squares method to approximate the parameters that refer to the output membership functions.

213

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Fuzzy and Neurofuzzy Logic Controllers

A feedback controller within a neurofuzzy system checks if the response of the output deriving from
the adaptive neurofuzzy system is the expected one (Figure 10). The process of maintaining the value
of the real output close to the value of the reference input (desired output) despite any deviances and
noise that the system parameters may create, is referred to as regulation. The output that derives from
the controller, which is used as input for the system, is called control action.

Figure 10. Basic feedback control system

The structure of a control system which is based on the principles of fuzzy logic as described above,
is depicted in Figure 11. More information about fuzzy and neurofuzzy control can be found in the recent
chapter of Tairidis and Stavroulakis (2019).

CREDIT INSURANCE SYSTEMS AND PRODUCTS

What Is Credit Insurance?

All over the world, businesses produce and trade products and services. The way these businesses sell
their goods is either in cash or on trade credit. If the transactions of businesses depended solely on sales
in cash, the turnover would be much more limited. Sales on trade credit maximize the transactions vol-
ume and the size of every company as well as the size of total economy.
All businesses worldwide sell their products on credit either solely to local buyers within the borders
of their country or to buyers in other nations to promote exports of their country.
The sum of transactions made by businesses depends on the credibility between transacting members,
supplier and buyer. The promise of payment is transferred to a date after the date of sale. This can be
30, 60 up to 180 days after the date of sale. In some cases, there are transactions that can be completed
even up to 12 or 18 months depending on the nature of the product.
The trading behaviour and financial status of buyers is of vital importance as buyers conduct the
promise of payment and they are responsible for fulfilling it after a certain period of time.

Credit Insurance Companies

In order to fill this gap of trading credibility, to promote commerce between transacting companies and
to increase exports worldwide, in other words in order to boost the economy, financial organisations and
credit insurance companies have been established. These companies are responsible for providing insur-

214

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 11. Fuzzy and Neurofuzzy Logic Controller

ance coverage of this credibility gap. These credit insurance companies have agencies worldwide. Credit
insurance organisations are robust businesses and their main functions are referring to three parameters:

• Financial underwriting for each and every buyer at an international level.

• Conduction of insurance policies with tailor-made special terms.
• Undertaking of legal actions against the insolvent buyer, after compensating a claim.

Financial Underwriting

Insurance companies execute corporate investigation depending on financial data collected by their local
agencies, specialized credit rating agencies like ICAP Group and Teiresias SA in the respective nations,
banks and already existing credit insurance policies that refer to risk coverage. In corporate investiga-
tion potential negative characteristics and indicators for the credibility of buyers should be thoroughly
examined.
Private individuals who buy on credit, i.e. a family which buys an air-conditioner and decides to pay
in instalments, cannot be characterized as buyer. Buyers should be characterized by commercial status,

215

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

registered office, organization and structure. They should be companies which operate according to the
rules of the country where they are established.
This could be a general partnership family business, a limited company of medium size or a multi-
national company. During the corporate investigation process, the total transaction risk, the moral risk
and the country risk of the buyer-company should be examined. Companies in Venezuela, for instance,
cannot be covered in terms of credit insurance due to the political risk (foreign exchange prohibition
risk). The buyer company receives a unique identification code in the insurance company’s underwriting
system. The amount of credit insurance coverage a buyer-company will receive depends on the request
of the insured supplier company, the sector and the size of the buyer, the liabilities and other factors.
Credit limits can vary greatly depending on all these factors mentioned.
Credit limits depend on the turnover of the buyer company, its liabilities and claims, its equity, the
sector in which the company operates and the period of time the request is submitted. In some cases, ex-
ternal unexpected factors may influence the final credit limits approved. For instance, there is a difference
between credit limits approved before and after the Covid-19 crisis, which destabilized global economy.
Credit limits may transform depending on the financial behaviour of the buyer-company, i.e. if the
buyer shows punctuality in payments, respective credit limits could increase. Credit limits also depend
on the financial status of the buyer-company, i.e. the image presented in balance sheets regarding the
last three years. Newly established companies might receive a credit limit which will be relatively low
due to their lack of payment history.
Companies whose shareholders have declared bankruptcy in the past cannot receive credit limits
due to moral risk.
The most interesting part of credit insurance limits is that they are dynamic and they depend on a
great number of factors that equals the number of risks within a business.

Insurance Terms and Regulations

The basis of credit insurance is the feeling of trust between the insurance company and the company that
receives the insurance. This trust is essential prerequisite for the establishment of a long lasting relation-
ship between the two parts in the scope of protecting the interests of the insured company.
The insured company should present all issues it faces concerning its buyers in order for these issues
to be thoroughly examined and resolved through coverage of non-payment risks. The insured company
may wish to share its plans regarding new exports, including the target countries, the product the com-
pany wants to promote and potential competitors it would like to hinder.
There should be thorough recording of the needs of the insured company and the desirable credit limits
regarding buyer companies which could be operating in other nations like Brazil, Angola or South Africa.
Every credit insurance policy is tailor made to suit the unique demands of the insured business.
The general steps for the conduction of a credit insurance policy are the following:

• Statement of the turnover to be insured.

• Statement of the countries in which the buyer companies operate.
• Definition of the credit period given to buyer companies.
• Approximation of the price of the insurance policy - overall clearance usually takes place at the
end of insurance period.
• Statement of the maximum yearly compensation by the insurance company.

216

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

• Definition of the coverage percentage, in other words the amount of compensation to be provided
by an insurance company in case that a buyer becomes disloyal and insolvent. This percentage is
usually 90%.
• Other tailor made rules depending on the characteristics of the company to be insured.

Insurance Compensation and Claim Assertion

A case of non payment can occur due to a variety of factors. The buyer company might not have properly
managed its finance, it might not have been paid by a client or it might be operating under unfavourable
financial conditions, i.e. the financial instability due to Covid-19.
In this case, the insured company declares a claim for unpaid insured receivables and calls the insur-
ance company to compensate for the non payment of the buyer.
The insurance company compensates and legally substitutes the insured supplier company. Conse-
quently, the credit insurance company, which has its own legal department, has the right to be posed
legally against the debtor and assert the amount due. The cost of all legal proceedings is included in the
price of a credit insurance policy. This legal claim of the amount due, might last for years depending
on the case. The resolution of this claim is no longer an issue that should be addressed by the insured
supplier company, since the client has already received the compensation. The insured supplier com-
pany has the right to record the incident of non payment and the compensation received in its financial
reports accounts.
Considering the case that the debtor company might be operating in Brazil, the legal assistance
provided by the insurance company might prove a very helpful parameter. The credit insurance branch
operating in the country of the insured supplier can grant the credit insurance subsidiary in Brazil,
which has expertise on the legal system of the particular country a mandate to legally proceed with the
assertion of the amount due.
Moreover, in case of total recovery of the amount due, the insured supplier company is entitled to 10%
of this amount, since the insured company has previously received coverage of 90% of the amount due.

Credit Insurance Benefits

The insured company can safely sell products to every buyer company the insurance company has
approved a credit limit to. The supplier does not need “to be familiar” with the buyer. This promotes
the total image of an insured company in terms of marketing. The evolution of the insured company is
guaranteed, as the credit insurance policy can be used as a valuable tool for corporate investigation in
the scope of increasing sales.
The department of financial management within the insured company can focus on other aspects of
financial development of the company, since it is guaranteed that risks are limited and manageable. The
department can organize the use of budget available on a completely different basis. Financial security
and avoidance of unexpected financial incidents regarding clients are remarkably reduced.
Banking institutions lend to an insured company at lower interest rates, since a financially healthy
company is more likely to be punctual in terms of payments. A credit insurance policy can be submitted
to a bank or factoring company for extra provision of funding to the insured company.
Accurate and early information regarding buyers facing difficulties in payments protects the insured
supplier company and enables it to take steps in order to cease further sales to this particular buyer.

217

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

The total benefits of credit insurance lie in a more efficient function of the insured supplier company
in terms of marketing and financial management as well as the decisions taken by the chief executive
manager.

RESULTS AND DISCUSSION

Adaptive Neurofuzzy Inference System Modelling

During the process of evaluating the price of a certain insurance policy, the insurance broker needs to
take into consideration, among others, three basic criteria that are recorded on the balance sheets of every
company. The first criterion regards the claims of the insured company. As previously mentioned, claims
are defined as the amount of money that other companies owe to the insured company or, alternatively,
the amount of money the insured company expects to receive from other companies. The second criterion
that determines the pricing of an insurance policy regards the liabilities of the insured company. Liabili-
ties are defined as the amount of money the insured company owes to other companies or, alternatively,
the cash outflow of the insured company. The third criterion that is taken into consideration during the
pricing process is the total turnover of the insured client.
The first step during the process of pricing is the definition of the inputs and outputs of the problem. In
our case, the problem has three inputs, that is the claims, the liabilities and the turnover of the customer,
and one output, that is, the rate to turnover, which will in turn determine the final insurance policy price.
Each of these four variables is described by a set of membership functions that represents the differ-
ent categories which are included in each variable.
As previously analyzed, an adaptive neurofuzzy inference system addresses the same problem that
fuzzy inference systems targets to solve. The most important difference between the two systems lies
on their basic principles.
A fuzzy inference system is based on a number of rules that simulate the human cognitive process
of decision making. This system simulates the way in which a decision should theoretically or ideally
be reached and this is the reason why fuzzy inference systems are expected to produce results that do
not precisely approximate actual values of pricing factors that are used in real life. When constructed
properly, a fuzzy inference system indicates how pricing factors should ideally be attributed based on
the theoretical pricing criteria of an insurance expert. On the contrary, an adaptive neurofuzzy infer-
ence system receives actual input values -in our case triplets of claims, liabilities and turnover of the
insured company- as well as the output attributed by the credit insurance company, from a large dataset
of anonymous registrations.
After processing a large number of these quadruplets coming from the anonymous dataset provided,
the adaptive neurofuzzy inference system divides the dataset, namely the group of clients with their
unique characteristics, into an optimal number of clusters. From a more technical perspective, the
adaptive neurofuzzy inference system, given the anonymous registrations of the dataset, creates its own
complex rules and membership functions whose form cannot be initially perceived by the human brain.
Before creating and training the adaptive neurofuzzy inference system, the training data has to be
gathered. In our problem, four vectors of the same size are going to be created. These vectors correspond
to the three input variables and the output variable of the system. The size depends on the number of
quadruplet registrations selected as training data. After the creation of four equally sized column vectors,

218

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

a table containing all four column vectors is produced and registered into file which is loaded on the
neurofuzzy system. The anonymous dataset provided by the insurance company contains 150 quadruplets
of three inputs -claims, liabilities and turnover- and one output -pricing factor attributed to each insured
company- corresponding to the 150 companies included in the sample. 140 registrations are used for the
creation of a training set and the remaining 10 will be used for testing the effectiveness of the system.
For the construction of an adaptive neurofuzzy inference system, a Sugeno type fuzzy inference
system has to be created. Then, a number of input and output variables have to be added to the system
depending on the number of inputs and outputs included in the dataset provided. Contrary to the proce-
dure followed during the creation of a Mamdani type fuzzy inference system, the membership functions
added into the Sugeno type fuzzy inference system are not manually tuned.
After the addition of input and output variables, the fuzzy inference system is generated through the
method of subtractive clustering, which creates an optimal number of clusters, based on the training data
provided. For the process of training the fuzzy inference system, hybrid optimization method is selected
with zero error tolerance and ten training epochs. The plot formed by the system depicts the training
data loaded. The clusters for the three input variables, along with the surface which shows the correla-
tion between the input variables and the output variable pricing factor as constructed by the adaptive
neurofuzzy inference system are given in Figure 12.

Numerical Results of the Neurofuzzy Inference System

Based on the registrations provided by the available dataset, the adaptive neurofuzzy inference system
created a number of output pricing factors regarding the ten triplets of inputs -claims, liabilities and
turnover- included in the testing dataset. The precision of approximations produced by the system de-
pends highly on the quality of the dataset as well as on the quantity of instances provided by the expert,
namely the insurance company.
Due to the great confidentiality that governs credit insurance companies, the provision of anonymous
data has been proven a challenging procedure. In the scope of training an adaptive neurofuzzy inference
system properly, thousands of instances may have to be included in the training dataset in order for the
system to approximate actual pricing factors even more accurately. In order to construct all possible rules
that describe the complex relationships between inputs and outputs, the adaptive neurofuzzy inference
system requires a large number of training instances.
Nevertheless, the accuracy of the adaptive neurofuzzy system with the use of 140 anonymous instances
is of relevance to the way in which fuzzy systems function and is therefore examined in this chapter. In
the table presented below, a comparison between the pricing factors produced by the adaptive neurofuzzy
inference system and the actual pricing factors is provided.

CONCLUSION

The neurofuzzy inference system which was modelled and tested in the present chapter produced ac-
curate results for credit insurance pricing compared to the actual values which were provided by real
insurance policies as seen from the results of the previous section. This is suggested from the relatively
small mean square error which occurred. This was expected, since neurofuzzy system can produce ac-
curate predictions if designed and trained properly. However, these results could be improved even more,

219

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Figure 12. Clusters for the input variables “Claims”, “Liabilities”, “Turnover” and the fuzzy surface
which shoes the correlation of “Pricing factor” with “Liabilities” and “Claims”

in order to achieve even smaller error values. This can be done through the use of a larger amount of
data for training and/or optimization techniques for the improvement of the decision-making adaptive
neurofuzzy system characteristics. Regarding the first option, one should have in mind that it is rather
hard to collect a large amount of data from real policies in the field of credit insurance, especially in
a small market as is the Greek insurance market. Regarding the second option several methods can be
used for optimization, such as for example the genetic algorithms; however, this was beyond the scope
of the present chapter.

Table 1. Comparison of ANFIS to actual pricing factor values

Claims Liabilities Turnover ANFIS Actual

0.3000 0.5400 1.00 0.677 0.80
0.1891 0.3361 2.38 0.566 0.55
0.5000 0.6500 4.00 0.596 0.63
0.3126 0.3614 5.95 0.520 0.45
0.1130 0.1087 6.90 0.294 0.30
0.3123 0.6325 8.55 0.462 0.53
0.3570 0.6340 10.00 0.430 0.55
0.5439 0.6326 11.95 0.445 0.45
0.2969 0.3814 14.92 0.337 0.33
0.2713 0.6244 16.00 0.366 0.37
M.S.E. 0.0040575 0

220

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

REFERENCES

Brkic, S., Hodzic, M., & Dzanic, E. (2017). Fuzzy Logic Model of Soft Data Analysis for Corporate
Client Credit Risk Assessment in Commercial Banking. In Fifth Scientific Conference with International
Participation “Economy of Integration” (MPRA Paper No. 83028). ICEI 2017.
Calibo, D.I., & Ballera, M.A. (2017). A Fuzzy Logic Model for Risk Analysis and Recommendation
System of a Government Financial Granting Project. International Journal of Simulation Systems.
DeWit, G. W. (1982). Underwriting and Uncertainty. Insurance, Mathematics & Economics, 1(4),
277–285. doi:10.1016/0167-6687(82)90028-2
Dorf, R. C., & Bishop, R. H. (2017). Modern Control Systems (13th ed.). Pearson.
Fullér. (1995). Neural Fuzzy Systems, Lecture notes, Abo Akademi University.
Jang, J.-S. R., & Sun, C.-T. (1995). Neuro-fuzzy modelling and control. Proceedings of the IEEE, 83(3),
378–406. doi:10.1109/5.364486
Jang, J.-S. R., & Sun, C.-T. (1997). Neuro-Fuzzy and Soft Computing. Prentice Hall.
Moorcraft, B. (2018). What is trade credit insurance? https://www.insurancebusinessmag.com/asia/
news/breaking-news/what-is-trade-credit-insurance-116058.aspx
Pfeifer, R. (2013). Crash course in Fuzzy Logic. In Real-world computing. University of Zurich.
Shapiro, A. F. (2005). Insurance applications of Fuzzy Logic, In Proceedings of the Institute of Actuaries
2005 Biennial Convention. Actuaries Institute
Shapiro, A. F. (2007). An Overview of Insurance Uses of Fuzzy Logic. In S. H. Chen, P. P. Wang, &
T. W. Kuo (Eds.), Computational Intelligence in Economics and Finance. Springer. doi:10.1007/978-
3-540-72821-4_2
Sokolovska, O. (2017). Trade Credit Insurance and Asymmetric Information Problem. Scientific Annals
of Economics and Business, 64(1), 123–137. doi:10.1515aeb-2017-0008
Sreekantha, D. K., & Kulkarni, R. V. (2010). Expert system design for credit risk evaluation using neuro-
fuzzy logic. Expert Systems: International Journal of Knowledge Engineering and Neural Networks,
29(1), 56–69. doi:10.1111/j.1468-0394.2010.00562.x
Tairidis, G. K. (2016). Optimal design of smart structures with intelligent control (Ph.D. Dissertation).
Technical University of Crete.
Tairidis, G. K., & Stavroulakis, G. E. (2019). Fuzzy and neuro-fuzzy control for smart structures. In M.
Khakifirooz, M. Fathi, & P. Pardalos (Eds.), Computational intelligence and optimization methods for
control engineering. Springer. doi:10.1007/978-3-030-25446-9_4
Widrow, B., & Lehr, M. A. (1990). 30 years of adaptive neural networks: Perceptron, madline, and
backpropagation. Proceedings of the IEEE, 78(9), 1415–1442. doi:10.1109/5.58323

221

Application of Adaptive Neurofuzzy Control in the Field of Credit Insurance

Yazdani, H., & Kwasnicka, H. (2012). Fuzzy Classification Method in Credit Risk. In Computational
Collective Intelligence. Technologies and Applications. ICCCI 2012. Lecture Notes in Computer Sci-
ence, (vol 7653). Springer. doi:10.1007/978-3-642-34630-9_51
Zadeh, L. A. (1965). Fuzzy Sets. Information and Control, 8(3), 338–353. doi:10.1016/S0019-
9958(65)90241-X

222
223

Chapter 15
Prediction of Corporate Failures
for Small and Medium-Sized
Enterprises in Europe:
A Comparison of Statistical and
Machine Learning Approaches

Marianna Eskantar
Technical University of Crete, Greece

Michalis Doumpos
Technical University of Crete, Greece

Evangelos Grigoroudis
https://orcid.org/0000-0001-8613-9350
Technical University of Crete, Greece

Constantin Zopounidis
School of Production Engineering and Management, Technical University of Crete, Greece &
Audencia Business School, France

ABSTRACT
The risk of bankruptcy is naturally faced by all corporate organizations, and there are various factors
that may lead an organization to bankruptcy, including microeconomic and macroeconomic ones. Many
researchers have studied the prediction of business bankruptcy risk in recent decades. However, the
research on better tools continues to evolve, utilizing new methodologies from various scientific fields
of management science and computer science. This chapter deals with the development of statistical
and artificial intelligence methodologies for predicting failures for small and medium-sized enterprises,
considering financial and macroeconomic data. Empirical results are presented for a large sample of
European firms.

DOI: 10.4018/978-1-7998-4805-9.ch015

Copyright © 2021, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

1. INTRODUCTION

Predicting corporate bankruptcies is an interesting topic of research with important implications for
professionals working in the areas of management and finance. It is of direct interest to senior banking
executives, businesspeople, and academic researchers dealing with this issue. The risk of bankruptcy
arises when firms cannot cope with macroeconomic and microeconomic challenges that they face. The
bankruptcy process causes many problems for lenders, suppliers, customers, employees, investors,
shareholders, and business creditors.
Various concepts have been attributed to bankruptcy by researchers, such as failure, lack of liquidity,
high insolvency, financial distress, default, and legal bankruptcy. However, in various articles, research-
ers use all of the above concepts, while defining bankruptcy in its legal sense, that is, the declaration
of bankruptcy to be made by a decision of the judicial authorities, following the applicable law of each
country. Therefore, a specific definition for corporate bankruptcy may not be easy to provide. In any
case, a firm faces financial difficulties long before legal bankruptcy occurs. Thus, it is imperative for
managers to be able to identify as early as possible financial problems and take action to avoid financial
distress and ultimately bankruptcy.
While all firms face the risk of bankruptcy, small and medium-sized enterprises (SMEs) are par-
ticularly vulnerable as they often have limited means to overcome external shocks (Berger and Udell,
1998). The particular nature of SMEs and their importance for economic activity have led to various
studies about the investigation and prediction of SMEs’ failure risk. Such studies have conducted for
several countries such as Belgium (Tobback et al., 2017), France (Abid et al., 2018), Italy (Calabrese et
al., 2016; Cultrera and Brédart, 2015; Gordini, 2014), Russia (Lugovskaya, 2010), the United Kingdom
(Altman et al., 2010), and the United States (El Kalak and Hudson, 2016), among others.
In Europe, SMEs play a major role in business activity, employment, and growth. According to data
from the European Commission, SMEs account for 99% of all business in the European Union (EU),
creating around 85% of new jobs, and providing more than 65% of the total private sector employment.1
Therefore, it is no surprise that several studies, such as the ones noted above, on the prediction of bank-
ruptcy for SMEs have used data from European countries. However, although country-specific studies
contribute to the understanding of the factors that affect the risk of failure for SMEs in a country, the
EU is a common market with countries sharing similarities in terms of economic and business policies,
cultural similarities, and trade networks. Therefore, the examination of bankruptcy risk for SMEs in a
cross-border European setting is important. International studies on bankruptcy prediction have been
presented by Altman et al. (2017) and Laitinen and Suvas (2016), whereas Laitinen et al. (2014) focused
on SMEs using a data set from 6 EU countries.
In this study, we follow a similar path and examine the development of bankruptcy prediction models
for SMEs in European countries. Compared to the previous study of Laitinen et al. (2014), in this chapter
a much larger sample is used involving more than 450,000 firm-year observations during the period
2011-2015. Different modeling specifications are considered combining financial data and macroeco-
nomic factors, through statistical and machine learning approaches.
The rest of the paper is organized as follows. Section 2 describes the data used in the analysis. Section
3 outlines the methodologies employed in the study to develop bankruptcy prediction models, whereas
section 4 presents the obtained results. Finally, section 5 concludes the paper and discusses some future
research directions.

224

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

2. DATA

2.1. Sample Selection

The sample used in this study includes data for commercial European SMEs, obtained from the Ama-
deus database, for the period 2011 to 2015. The data of the companies in the sample have the following
characteristics: they employ less than 250 employees, their turnover is less than 50 million euros, or
their assets are less than 43 million euros. Very small firms with less than 10 employees and a turnover
of less than 2 million or assets less than 2 million are excluded from the analysis.
The countries covered in the sample are Italy, Spain, France, Portugal, Germany and Finland. Table 1
shows the characteristics of the sample including the number of distressed (D) and non-distressed (ND)
firm-year observations by country. The country with the most observations is Italy, while the country
with the least observations is Finland. Italy has the highest bankruptcy rate, while Spain and Germany
have the lowest.

Table 1. Sample composition

Finland France Germany Italy Portugal Spain Total

ND D ND D ND D ND D ND D ND D ND D
2011 2243 13 10590 106 4070 31 43841 1321 9560 180 21819 90 92123 1741
2012 2309 23 9230 110 5288 22 44877 1256 9324 111 21034 124 92062 1646
2013 2333 18 9887 94 7614 61 45043 822 9289 102 20513 68 94679 1165
2014 2434 81 11997 280 3805 28 46729 870 9646 110 21293 166 95904 1535
2015 2239 64 11117 268 3375 13 49461 726 10048 103 22032 234 98272 1408
Total 11558 199 52821 858 24152 155 229951 4995 47867 606 106691 682 473040 7495
FR (%) 98,31 1,69 98,40 1,60 99,36 0,64 97,87 2,13 98,75 1,25 99,36 0,64 98,44 1,56

2.2. Predictor Variables

Financial and macroeconomic variables are commonly used to predict bankruptcy. Beaver (1966) was
one of the first researchers to use financial ratios to predict corporate bankruptcy. There are several
difficulties in choosing the right ratios. For example, there are many ratios that can be used as substi-
tutes for the same financial characteristics, whereas the use of many ratios can create problems such
as, increasing data processing time, high cost to collect data, and multicollinearity problems (Gaganis,
Pasiouras, Spathis, & Zopounidis, 2007).
In the present study, the analysis is based on 16 variables (5 financial ratios and 11 macroeconomic
variables) selected based on the literature. The selected variables are presented in Table 2. The mac-
roeconomic variables were collected through the questionnaire survey conducted by the Institute for
Management Development for its annual World Competitiveness Yearbook (Bris, 2017). Most of these
variables measure on a 1-10 scale the opinion of various market participants about the conditions in

225

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 2. Presentation of the 16 variables used

Financial Ratios
ROA: Profit before tax / Assets
EQ/A: Equity / Assets
D/T: Debt / Turnover
C/CL: Cash / Current liabilities
CE/T: Cost of employees / Turnover
Macroeconomic Variables
IN: Investment Risk
UN: Unemployment Rate
CTRP: Corporate Tax Rate on Profit
RCT: Real Corporate Taxes (1-10 scale with 10 indicating that taxes do not discourage entrepreneurial activity)
CL: Competition Legislation (1-10 scale with 10 indicating that legislation is efficient in preventing unfair competition)
EDB: Ease of Doing Business (1-10 scale with 10 indicating that doing business is supported by regulations)
LabR: Labor Regulations (1-10 scale with 10 indicating that labor regulations do not hinder business activities)
SME: Small and Medium size Enterprises (1-10 scale with 10 indicating that SMEs are efficient by international standards)
BFS: Banking Financial Services (1-10 scale with 10 indicating that banking and financial services support business activities efficiently)
Cr: Credit (1-10 scale with 10 indicating that credit is easily available for business)
Bur: Bureaucracy (1-10 scale with 10 indicating that bureaucracy does not hinder business activity)

each country related to the issues covered by each variable, whereas investment risk is Euromoney’s risk
rating for the countries, which is measured on a 0-100 scale (100 indicating the lowest risk).
Table 3 presents the averages of the financial ratios for the two groups of firms (failed, non-failed)
by country. It is evident that the most profitable companies belong to Germany, France, and Finland.
Also, German companies have more liquidity, while the southern countries have higher borrowing and
less equity. Table 4 presents the averages for the macroeconomic variables. In northern countries, there
are more favorable trends in terms of entrepreneurship. They pose a low investment risk, corporate taxes
do not discourage entrepreneurship, and credit is readily available. In contrast, in the countries of the
south, we do not find such good macroeconomic conditions. In general, macroeconomic factors make
entrepreneurship difficult in southern countries.

Table 3. Average of financial ratios by country

Finland France Germany Italy Portugal Spain

ND D ND D ND D ND D ND D ND D
ROA 0.059 -0.056 0.051 -0.075 0.070 -0.017 0.040 -0.163 0.025 -0.120 0.022 -0.140
EQ/A 0.380 0.176 0.412 0.114 0.338 0.215 0.278 -0.163 0.344 -0.075 0.441 0.076
D/T 0.427 0.666 0.406 0.578 0.424 0.554 0.753 1.823 0.749 1.737 0.617 1.330
C/CL 0.491 0.257 0.496 0.174 0.878 0.770 0.274 0.086 0.429 0.159 0.427 0.087
CE/T 0.297 0.337 0.295 0.362 0.259 0.290 0.245 0.360 0.320 0.498 0.306 0.424

226

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 4. Averages of macroeconomic variables

Finland France Germany Italy Portugal Spain

ND D ND D ND D ND D ND D ND D
IN 85.159 84.453 73.559 72.441 81.889 81.978 59.538 60.549 53.237 53.607 58.253 57.960
UN 8.360 8.706 9.808 9.996 5.185 5.209 11.181 10.821 14.143 14.028 23.709 23.443
CTRP 22.972 21.319 33.330 33.330 30.335 30.360 27.500 27.500 24.942 25.202 30.000 30.000
RCT 5.837 6.056 3.562 3.323 6.036 6.001 2.614 2.743 3.963 3.973 3.995 3.878
CL 7.658 7.749 6.250 6.243 7.010 7.038 4.710 4.729 4.779 4.709 5.767 5.633
EDB 6.309 6.173 3.905 3.642 5.289 5.306 2.905 2.987 4.150 4.214 3.781 3.692
LabR 4.787 4.669 2.883 2.651 4.877 4.882 3.234 3.296 4.784 4.645 3.982 4.063
SME 6.834 6.756 5.282 5.268 8.567 8.601 6.449 6.502 4.566 4.546 5.549 5.626
BFS 7.246 7.206 4.828 4.841 6.332 6.362 3.746 3.826 3.815 3.948 3.339 3.413
Cr 7.105 7.001 4.960 5.019 6.837 6.840 3.268 3.365 2.600 2.637 2.387 2.612
Bur 5.735 5.557 2.418 2.285 3.985 3.994 1.201 1.292 3.158 3.168 2.230 2.166

Table 5 presents the correlations of the financial ratios. The results indicate that there are no high
correlations between the ratios. Table 6 presents similar information for the macroeconomic variables.
Here it is observed that there are high correlations between the variables. Focusing on the highest cor-
relations, the following conclusions can be drawn: First, it is evident that low investment risk (high rating
in IN) is associated with easier access to credit (Cr) and better support for businesses from the banking
and finance sector (BFS). Moreover, the adoption of business-friendly taxation policies (RCT) and a
good regulatory framework (CL) are associated with more acceptable bureaucracy levels (Bur), thus
making it easier to do business in a country (EDB).

Table 5. Correlations – Financial ratios

EQ/A D/T C/CL CE/T

ROA 0,379 -0,359 0,213 -0,233
EQ/A -0,425 0,430 -0,092
D/T -0,209 0,182
C/CL 0,059

3. METHODS

This section presents the methods used in the analysis. These statistical approaches, namely logistic
regression, regularized logistic regression, and generalized additive models, as well as two popular
ensemble-based machine learning approaches. All methods were implemented in the R project using
the CARET package.

227

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 6. Correlations – Macroeconomic variables

UN CTRP RCT CL EDB LabR SME BFS Cr Bur

IN -0,530 0,367 0,529 0,679 0,571 0,101 0,475 0,860 0,882 0,494
UN 0,164 0,067 0,028 -0,062 0,170 -0,542 -0,620 -0,691 -0,041
CTRP 0,105 0,431 0,073 -0,282 -0,062 0,052 0,148 -0,012
RCT 0,751 0,892 0,685 0,118 0,557 0,432 0,901
CL 0,791 0,243 0,148 0,625 0,541 0,754
EDB 0,556 0,061 0,663 0,479 0,954
LabR 0,016 0,181 0,112 0,642
SME 0,484 0,572 -0,021
BFS 0,945 0,631
Cr 0,459

3.1 Logistic Regression and Regularized Logistic Regression

Logistic regression (LR) is a well-known approach for building models for classification problems. In
a binary classification setting with a dependent variable Y ∈ {0, 1} (e.g., failed versus non-failed firms),
LR models the probability π = Pr (Y = 1 | x ) that an observation x belongs in category 1, through
the following function:

e
β0 + ∑ i =1βixi
π= n

1 +e
β0 + ∑ i =1βixi

n is the number of variables x = (x 1, …, x n ) and β = (β0, …, βn ) is the vector with the constant
term ( β0 ) and the regression coefficients β1, …, βn , estimated through maximum likelihood techniques.
LR is a linear model, as the above formula can be expressed equivalently as follows:

 π  n

ln   = β0 + ∑βi x i
1 − π  i =1

For the purposes of the analysis we also consider regularized logistic regression (RegLR), a meth-
odology based on the same general idea as LR. The difference in RegLR is that the parameters of the
model are estimated through the solution of the following optimization problem:

min β1 + C ∑ log 1 + e
β
j =1
( −yi β xi
).

228

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

where ⋅ indicates the 1-norm, m is the number of training observations, and C > 0 is a user-defined
1

constant that corresponds to the tradeoff between the regularization term β1 and the errors of the
model for the training cases.

3.2 Generalized Additive Models (GAMs)

Generalized additive models (GAMs; Hastie & Tibshirani, 1990) provide a general framework for
extending typical linear regression models, allowing nonlinear functions to be created for each of the
variables while maintaining additiveness. Under the GAM framework, the linear logistic regression
model is expressed in an additive form as follows:

 π  n

log   = β0 + ∑fi (x i )

1 − π  i =1

where f1, …, fn are spline (smooth) functions of the attributes.

3.3 Random Forest

The random forest algorithm (RF; Breiman, 2001) is a popular machine learning ensemble approach
for developing prediction models for classification and regression. RF is based on the bagging approach
introduced by Breiman (1996), to create a series of decision trees on bootstrapped training sets. When
constructing these decision trees, creating a decision node in a tree is based on examining a random
sample of independent variables from the set of available predictors variables. The random selection of
variables is made for each new node that is created into the tree. In contrast to the bagging process, where
multiple decision trees are constructed using the same set of variables, the variable selection process in
RF enhances the independence of the individual decision trees, so that their combination is more stable
and has a higher predictive capacity.

3.4 Gradient Boosting Machine

The gradient boosting machine (GBM; Friedman, 2001) is a state-of-the-art machine learning algorithm
that creates complex classification models through the idea of boosting. Boosting is an ensemble meth-
odology for developing regression and classification models. Boosting models are developed through
an iterative process, by constructing and combining multiple base (elementary) models, each built con-
sidering the errors from previous iterations.
Gradient boosting is an approach where new models are created that predict previous models’ er-
rors and then are added together to make the final prediction. The gradient descent algorithm is used to
determine the optimal composition of the individual models combined.
An extension of the GBM algorithm is the eXtreme gradient boosting algorithm (XGB; Tianqi &
Guestrin, 2016). There are three main differences between the two algorithms. First, in the XGB algo-
rithm, second order derivatives of the error function are used to optimize the combination of independent

229

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

models. Moreover, XGB controls the complexity of the model to avoid the phenomenon of over-fitting,
and it employs parallel processing techniques reduce training time.

4. RESULTS

This section presents the results of the analysis. The presentation starts with the discussion of the
importance of the variables and then the predictive performance of the models is examined. For the
purposes of the analysis different modeling specifications are tested, including country-specific models
and global models based on data from all countries. The former specifications rely solely on financial
ratios, whereas for the latter specification we consider both the case of financial data as well as models
that combine all variables. All models are fitted on the data from the years 2011-2013 and tested on the
period 2013-2015.

4.1 The Importance of Variables

We start the presentation with the country-specific models, which rely on financial data only. Tables
7-12 present the results by country for all the methods used in the analysis
The tables below show the results of the methodologies used for models that predicted bankruptcy
for each country separately. More specifically, Table 7 presents the LR coefficients and their statistical
significance, Table 8 summarizes the results for the estimated degrees of freedom of the GAM models,
whereas Table 9 presents the estimates for the importance of the variables in the three machine learning
approaches. We should note that no results are presented for RegLR, as this methodology only provides
information about the regression coefficient without direct indications about their statistical significance.
In the LR modes, ROA is the only ratio that is consistently significant at the 1% level across all
countries. The debt/turnover ratio (D/T) is also found significant in five out of the six countries, whereas
the solvency ratio equity/assets (EQ/A) is significant in four countries. The significance of ROA, D/T,
and EQ/A is also confirmed through the results of GAM. In the three machine learning methods, EQ/A
has the highest significance, overall, whereas the importance of other indicators varies significantly
depending on the method and country. The most noticeable difference between the machine learning
models and the estimates of LR and GAM, involves the debt/turnover ratio, which appears to have low
importance, despite being significant in LR and GAM.

Table 7. Importance of ratios for LR

Finland France Germany Italy Portugal Spain

Constant 4.974*** 4.314*** 4.831*** 3.834*** 4.750*** 5.214***
ROA 4.441*** 3.812*** 3.473*** 8.791*** 3.949*** 7.284***
EQ/A 1.048*** 1.234*** 0.412 3.006*** 0.955*** 0.181
D/T 2.105** 1.509*** -0.027 0.384*** 1.143*** 6.179***
C/CL -0.158 0.506*** -0.020 -0.575*** -0.278*** -0.223***
CE/T -1.439* -2.033*** -0.094 1.464*** -0.965*** 0.446
***: p-value ≤ 0.01, **: p-value ≤ 0.05, *: p-value ≤ 0.1

230

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 8. Estimated degrees of freedom of the GAM models

Finland France Germany Italy Portugal Spain

ROA 1.109*** 6.142*** 2.167*** 6.210*** 8.683*** 3.447***
EQ/A 4.235*** 3.030*** 7.482*** 4.693 4.405*** 3.810**
D/T 4.088 2.333*** 2.710** 6.215*** 1.318*** 3.152***
C/CL 3.711** 4.752*** 0.001 6.247*** 5.489*** 3.055***
CE/T 0.852** 2.262*** 0.001 3.481*** 1.221*** 2.158*
***: p-value ≤ 0.01, **: p-value ≤ 0.05, *: p-value ≤ 0.1

Table 10 presents the results for the importance of the ratios in the models constructed using the data
from all countries. In the two statistical models (LR and GAM), all ratios are found highly significant
at the 1% level. For the three machine learning models, the solvency ratio EQ/A appears to be the most
important financial attribute, followed by ROA and the liquidity indicator C/CL. significant in all models.
ROA is also a significant indicator, except for the GBM model where its relative importance is just 27%.
The results obtained after adding the macroeconomic indicators are presented in Table 11. It should
be noted that given that these are country-specific variables and their variability throughout the period
of the analysis is not high, they are modeled in GAM using linear component functions instead of the
spline terms used for the financial ratios. Therefore, the GAM column for these indicators presents their

Table 9. Importance of ratios for GBM

Finland France Germany Italy Portugal Spain

GBM
ROA 100.000 45.894 0.014 31.727 75.498 100.000
EQ/A 85.334 100.000 100.000 100.000 86.825 92.181
D/T 0.000 0.000 0.000 0.000 17.907 0.566
C/CL 45.802 3.990 3.999 15.201 100.000 18.847
CE/T 12.314 11.716 8.305 3.904 0.000 0.000
RF
ROA 31.989 18.636 100.000 92.393 60.715 100.000
EQ/A 100.000 93.956 61.239 100.000 83.710 43.395
D/T 0.000 0.000 0.000 0.000 0.000 0.000
C/CL 65.409 44.550 45.051 21.504 100.000 88.538
CE/T 42.401 100.000 45.307 7.731 27.643 71.071
XgbTree
ROA 31.846 100.000 53.662 100.000 84.481 79.114
EQ/A 100.000 93.247 100.000 63.715 100.000 0.000
D/T 0.000 55.105 36.136 7.210 0.000 100.000
C/CL 33.362 0.000 3.058 37.934 33.246 84.527
CE/T 8.155 23.934 0.000 0.000 1.843 20.048

231

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 10. Importance of the financial ratios in the global models

LR GAM-edf GBM RF XgbTree

ROA 6.936*** 6.954*** 27.080 100.000 94.642
EQ/A 1.641*** 4.736*** 100.000 83.899 100.000
D/T 0.414*** 6.773*** 9.622 0.000 7.501
C/CL -0.485*** 5.243*** 52.676 46.603 29.401
CE/T 1.216*** 1.780*** 0.000 6.541 0.000
***: p-value ≤ 0.01, **: p-value ≤ 0.05, *: p-value ≤ 0.1

regression coefficients as opposed to the estimated degrees of freedom reported for the financial data.
The results from these more comprehensive models, once again confirm the importance of the solvency
indicator EQ/A and ROA. It is worth noting that most of the macroeconomic variables have rather weak
significance compared to the financial ratios. Among them, the countries’ investment risk rating appears
to be the most important predictor.

4.2 Predictive Performance

The predictive performance of the models is tested on the 2013-2015 data using the area under the re-
ceiver operating characteristic curve (AUROC). Table 12 summarizes the results for the country-specific

Table 11. Significance of variables in the global models that combine financial ratios and macroeco-
nomic indicators

LR GAM GBM RF XgbTree

ROA 7.642*** 7.434*** 18.158 90.271 88.313
EQ/A 1.560*** 4.096*** 100 100 100
D/T 0.304*** 5.887*** 0.754 55.822 30.793
C/CL -0.462*** 5.332*** 11.367 70.506 45.447
CE/T 0.658*** 2.734*** 6.329 62.456 20.747
IN 0.573*** 0.578*** 0.877 15.131 16.898
UN 0.152*** 0.141*** 0.073 1.300 4.590
CTRP -0.122** -0.117*** 0.009 0.000 5.593
RCT -0.449*** -0.441** 0.039 7.178 22.210
CL 0.142 0.135*** 0.029 3.894 4.402
EDB 0.157 4.314 0.000 4.053 0.000
LabR -0.346*** 3.812 0.010 0.723 2.781
SME 0.237** 0.288*** 0.023 2.693 1.365
BFS -0.936*** -0.899*** 0.016 0.135 2.333
Cr 0.653*** 0.582*** 0.131 0.419 1.077
Bur 0.396* 0.423*** 0.005 3.827 7.394

232

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Table 12. AUROC results for the country-specific models based on financial ratios

Finland France Germany Italy Portugal Spain Average

LR 0.6379 0.7772 0.7456 0.8625 0.8265 0.8513 0.7835
RegLR 0.5794 0.6854 0.7497 0.8585 0.7809 0.8551 0.7515
GAM 0.6155 0.7811 0.7804 0.8789 0.8389 0.8618 0.7928
RF 0.5795 0.6931 0.7072 0.8419 0.7791 0.7237 0.7208
GBM 0.6007 0.7674 0.6210 0.8813 0.8394 0.8552 0.7608
XgbTree 0.6207 0.7809 0.7178 0.8772 0.8448 0.8641 0.7842
Average 0.6056 0.7475 0.7203 0.8667 0.8182 0.8352 0.7656

models based on financial ratios, whereas Table 13 presents the results for the two specifications used
for the global models. In both tables the best results for each country are marked in bold.
Regarding the country-specific models, the best results are achieved for Italy, Portugal, and Spain,
for which the sample size and the number of distressed firms was larger. On the contrary, the prediction
results for Finland are lower. On average, GAM provides the best results, followed by LR and XgbTree,
whereas RF achieved the worst performance among the considered methods.
Interestingly, the models developed with the data from all countries (global models), in most cases they
outperform the country-specific models. More specifically, the global models developed with financial
ratios (Panel A of Table 13) provide better results, on average, for all countries except for Portugal. In
terms of the performance of the methods used in the analysis XgbTree is the top performer, followed by
GAM, LR and RegLR, whereas RF and GBM provide the worst results.

Table 13. AUROC results for the global models

Finland France Germany Italy Portugal Spain All Countries

Panel A: Models Based Solely on Financial Ratios
LR 0.6203 0.7603 0.7484 0.8582 0.7924 0.8526 0.8117
RegLR 0.6204 0.7604 0.7483 0.8582 0.7924 0.8526 0.8117
GAM 0.6514 0.7809 0.7650 0.8749 0.8244 0.8705 0.8323
RF 0.5981 0.6747 0.7019 0.8220 0.7900 0.7895 0.7739
GBM 0.6247 0.7518 0.7326 0.8318 0.7845 0.8309 0.7968
XgbTree 0.6462 0.7890 0.7855 0.8867 0.8561 0.8792 0.8453
Average 0.6269 0.7529 0.7469 0.8553 0.8066 0.8459
Panel B: Models With Financial Ratios and Macroeconomic Variables
LR 0.6205 0.7620 0.7464 0.8650 0.7774 0.8593 0.7889
RegLR 0.6157 0.7672 0.7347 0.8692 0.8040 0.8640 0.7976
GAM 0.6617 0.7797 0.7596 0.8829 0.8101 0.8781 0.8224
RF 0.6466 0.7601 0.7586 0.8678 0.8428 0.8535 0.8349
GBM 0.6617 0.7773 0.7807 0.8800 0.8276 0.8708 0.8264
XgbTree 0.6336 0.7858 0.7984 0.8838 0.8478 0.8722 0.8517

233

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

5. CONCLUDING REMARKS AND FUTURE DIRECTIONS

Corporate bankruptcy is a multifaceted and complex research topic with important practical implications
for all stakeholders of a corporate entity, as well as policy makers. This study focused on the prediction
of bankruptcy for SMEs, which constitute the vast majority of businesses in Europe. Using a large data
set from six European countries different modeling specifications were considered and various statistical
and machine learning methods have been tested.
The results of the analysis indicate that profitability (return on assets) and solvency (equity/assets)
are strong factors for predicting bankruptcy in European SMEs. Among the macroeconomic factor a
country’s risk rating was found to be the most important factor. Global models developed from the pooled
data set comprising all countries provided good prediction results. The introduction of the macroeco-
nomic variables led to noticeable improvements in the predictive power of machine learning models.
Statistical models, on the other hand, performed better with a smaller, carefully selected set of financial
attributes. Among the statistical models, GAM was found to be superior to LR and RegLR, whereas
XgbTree provided the best results among the machine learning algorithms.
The results and analysis conducted in this study can be extended to examine various other important
issues. First, the data coverage could be extended to consider other European countries and business
sectors (e.g., industry, manufacturing, services, etc.). Moreover, a deeper examination of macroeconomic
factors would provide helpful insights into the external risk that European SMEs face. Finally, other
model building approaches could be tested, such as multicriteria decision analysis approaches (Doumpos
and Zopounidis, 2014).

REFERENCES

Abid, I., Mkaouar, F., & Kaabia, O. (2018). Dynamic analysis of the forecasting bankruptcy under pres-
ence of unobserved heterogeneity. Annals of Operations Research, 262(2), 241–256. doi:10.100710479-
016-2143-2
Altman, E. I., Iwanicz-Drozdowska, M., Laitinen, E. K., & Suvas, A. (2017). Financial distress predic-
tion in an international context: A review and empirical analysis of altman’s Z-score model. Journal of
International Financial Management & Accounting, 28(2), 131–171. doi:10.1111/jifm.12053
Altman, E. I., Sabato, G., & Wilson, N. (2010). The Value of Non-Financial Information in Small
and Medium-Sized Enterprise Risk Management. The Journal of Credit Risk, 6, 1–33. doi:10.21314/
JCR.2010.110
Beaver, W. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4, 71–111.
doi:10.2307/2490171
Berger, A., & Udell, G. F. (1998). The economics of small business finance: The roles of private eq-
uity and debt markets in the financial growth cycle. Journal of Banking & Finance, 22(6–8), 613–673.
doi:10.1016/S0378-4266(98)00038-7
Breiman, L. (1996). Bagging predictors. Machine Learning, 24(2), 123–140. doi:10.1007/BF00058655
Breiman, L. (2001). Random forests. Machine Learning, 45(1), 5–32. doi:10.1023/A:1010933404324

234

Prediction of Corporate Failures for Small and Medium-Sized Enterprises in Europe

Bris, A. (2017). IMD World Competitiveness Center. Retrieved from World Competitiveness Center
website: https://www.imd.org/wcc/world-competitiveness-center/
Calabrese, R., Marra, G., & Osmetti, S. A. (2016). Bankruptcy prediction of small and medium enter-
prises using a flexible binary generalized extreme value model. The Journal of the Operational Research
Society, 67(4), 604–615. doi:10.1057/jors.2015.64
Cultrera, L., & Brédart, X. (2015). Bankruptcy prediction: The case of Belgian SMEs. Review of Ac-
counting and Finance, 15(1), 101–119. doi:10.1108/RAF-06-2014-0059
Doumpos, M., & Zopounidis, C. (2014). Multicriteria Analysis in Finance. Springer. doi:10.1007/978-
3-319-05864-1
El Kalak, I., & Hudson, R. (2016). The effect of size on the failure probabilities of SMEs: An empirical
study on the US market using discrete hazard model. International Review of Financial Analysis, 43,
135–145. doi:10.1016/j.irfa.2015.11.009
Friedman, J. H. (2001). Greedy function approximation: A gradient boosting machine. Annals of Sta-
tistics, 29(5), 1189–1232. doi:10.1214/aos/1013203451
Gaganis, C., Pasiouras, F., Spathis, C., & Zopounidis, C. (2007). A cormarison of nearest neighbours,
disciminant and logit models for auditing decisions. Intelligent Systems in Accounting, Finance & Man-
agement, 15(1-2), 23–40. doi:10.1002/isaf.283
Gordini, N. (2014). A genetic algorithm approach for SMEs bankruptcy prediction: Empirical evidence
from Italy. Expert Systems with Applications, 41(14), 6433–6455. doi:10.1016/j.eswa.2014.04.026
Hastie, T., & Tibshirani, R. (1990). Generalized additive models. Chapman and Hall.
Laitinen, E. K., Lukason, O., & Suvas, A. (2014). Are firm failure processes different? evidence from
seven countries. Investment Management and Financial Innovations, 11(4), 212–222.
Laitinen, E. K., & Suvas, A. (2016). Financial distress prediction in an international context: Moderating
effects of hofstede’s original cultural dimensions. Journal of Behavioral and Experimental Finance, 9,
98–118. doi:10.1016/j.jbef.2015.11.003
Lugovskaya, L. (2010). Predicting default of russian SMEs on the basis of financial and non-financial
variables. Journal of Financial Services Marketing, 14(4), 301–313. doi:10.1057/fsm.2009.28
Tianqi, C., & Guestrin, C. (2016). XGBoost: A Scalable Tree Boosting System. KDD ’16: Proceedings of
the 22nd ACM SIGKDD International Conference on Knowledge Discovery and Data Mining, 785-794.
Tobback, E., Bellotti, T., Moeyersoms, J., Stankova, M., & Martens, D. (2017). Bankruptcy prediction
for SMEs using relational data. Decision Support Systems, 102, 69–81. doi:10.1016/j.dss.2017.07.004

ENDNOTE
1
https://ec.europa.eu/growth/smes_en

235
236

Compilation of References

10 Li, J., Huang, K.-Y., Jin, J., & Shi, J. (2008). A survey on statistical methods for health care fraud detection. Health
Care Management Science, 11(3), 275–287. doi:10.100710729-007-9045-4 PMID:18826005

11Edelstein, H. (1997). Data Mining: Exploiting the Hidden Trends in Your Data. DB2Online Mag., 2, 1.

11Smith, L. M., & Smith, K. T. (Eds.). (n.d.). The Journal of Legal, Ethical and Regulatory Issues, 19(1).

12Akhilomen, J. (2013). Data mining application for cyber credit-card fraud detection system. Lecture Notes in Engi-
neering and Computer Science, 1537–1542.

13Gottlieb, Salisbury, Shek, & Vaidyanathan. (2006). Detecting Corporate Fraud: An Application of Machine Learning.
Academic Press.

13Hung & Cheupg. (1999). Parallel Algorithm for Mining Outliers in Large Database. http: l/citeseer.nj.nec.comihun-
g99parallel.hbnl

14Bolton, R. J., & Hand, D. J. (2001). Unsupervised profiling methods for fraud detection. In Conference of Credit
Scoring and Credit Connol VII, Edinburgh, UK.

15Phua, C., Lee, V., Smith, K., & Gayler, R. (2010). A comprehensive survey of data mining-based fraud detection.
Research, 1-14.

16 Padhy, N., Mishra, P., & Panigrahi, R. (2012). The Survey of Data Mining Applications and Feature Scope. Interna-
tional Journal of Computer Science. Engineering and Information Technology, 2(3), 43–58.

16 Roy, A. (2018). Deep learning detecting fraud in credit card transactions. In 2018 Systems and Information Engineer-
ing Design Symposium (SIEDS). IEEE. 10.1109/SIEDS.2018.8374722

17 Chauhan, A., Mishra, G., & Kumar, G. (2011). Survey on Data mining Techniques in Intrusion Detection. Interna-
tional Journal of Scientific and Engineering Research, 2(7), 1–4.

18 Garcia-Teodoro, P., Diaz-Verdejo, J., Maciá-Fernández, G., & Vázquez, E. (2009). Anomaly-based network intrusion
detection: Techniques, systems and challenges. Computers & Security, 28(1), 18–28. doi:10.1016/j.cose.2008.08.003

19Issa & Vasarhelyi. (2011). Application of Anomaly Detection Techniques to Identify Fraudulent Refunds. Academic Press.

1Business Study Notes. (n.d.). Auditing. https://www.businessstudynotes.com/finance/auditing/fraud-in-business/

1 Saputra, A., & Suharjito. (2019). Fraud Detection using Machine Learning in e-Commerce. International Journal of
Advanced Computer Science and Applications, 10(9). Advance online publication. doi:10.14569/IJACSA.2019.0100943

20Thiprungsri & Vasarhelyi. (2011). Cluster Analysis for Anomaly Detection in Accounting Data: An Audit Approach.
The International Journal of Digital Accounting Research, 11.

Compilation of References

22 Donoho, S. (2004). Early detection of insider trading in option markets. Proceedings of the tenth ACM SIGKDD
international conference on Knowledge discovery and data mining, 420–429. 10.1145/1014052.1014100

23 Jyotindra, N. D., & Ashok, R. P. (2011). A Data Mining with Hybrid Approach Based Transaction Risk Score Gen-
eration Model (TRSGM) for Fraud Detection of Online Financial Transaction. International Journal of Computers and
Applications, 16(1), 18–25. doi:10.5120/1977-2651

24 Le Khac, N. A., & Kechadi, M.-T. (2010). Application of Data Mining for Anti-money Laundering Detection: A Case
Study. IEEE International Conference on Data Mining Workshops. 10.1109/ICDMW.2010.66

25 Panigrahi, S., Kundu, A., Sural, S., & Majumdar, A. (2009). Credit card fraud detection A fusion approach using
Dempster-Shafer theory and Bayesian learning. Information Fusion, 10(4), 354–363. doi:10.1016/j.inffus.2008.04.001

26 Hao, M. C., Dayal, U., Sharma, R. K., Keim, D. A., & Janetzko, H. (2010). Bibliothek der Universität Konstanz. Visual
Analytics of Large Multi-Dimensional Data Using Variable Binned Scatter Plots. Bibliothek der Universität Konstanz.

27Jans, Lybaert, & Vanhoof. (2007). Data Mining for Fraud Detection: Toward an Improvement on Internal Control
Systems. Academic Press.

28 Zhang, Z. M., Salerno, J. J., & Yu, P. S. (2003). Applying data mining in investigating money laundering crimes.
Proceedings of the ninth ACM SIGKDD international conference on Knowledge discovery and data mining, 747–752.
10.1145/956750.956851

29 Wu, J., Xiong, H., & Chen, J. (2010, January). COG: Local decomposition for rare class analysis. Data Mining and
Knowledge Discovery, 20(2), 191–220. doi:10.100710618-009-0146-1

2Ghosh, S., & Reilly, D. L. (1994). Credit Card Fraud Detection with a Neural Network. Information Systems: Decision
Support and Knowledge-Based Systems, 3, 621-630. 10.1109/HICSS.1994.323314

30 Chang, W.-H., & Chang, J.-S. (2010). Using clustering techniques to analyze fraudulent behavior changes in on-
line auctions. 2010 International Conference on Networking and Information Technology (ICNIT), 34-38. 10.1109/
ICNIT.2010.5508564

31Jurek, A., & Zakrzewska, D. (2019). Improving Naïve Bayes models of insurance risk by unsupervised classification.
Computer Science and International Journal of Applied Engineering Research, 14(7), 137–144.

32 Virdhagriswaran, S., & Dakin, G. (2006). Camouflaged fraud detection in domains with complex relationships.
Proceedings of the 12th ACM SIGKDD international conference on Knowledge discovery and data mining, 941–947.
10.1145/1150402.1150532

33 Ghani, R., & Kumar, M. (2011). Interactive learning for efficiently detecting errors in insurance claims. Pro-
ceedings of the 17th ACM SIGKDD international conference on Knowledge discovery and data mining, 325–333.
10.1145/2020408.2020463

34 Deng, Q., & Mei, G. (2009). Combining self-organizing map and K-means clustering for detecting fraudulent financial
statements. IEEE International Conference on Granular Computing, 126-131. 10.1109/GRC.2009.5255148

35Data Flair. (n.d.). https://data-flair.training/blogs/data-mining-tutorial

36Machine Learning Mastery. (n.d.). https://machinelearningmastery.com/supervised-and-unsupervised-machine-

learning-algorithms/

37Shmais & Hani. (2011). Data Mining for Fraud Detection. Academic Press.

38 Russell, S. J., & Norvig, P. (2010). Artificial Intelligence: A Modern Approach (3rd ed.). Prentice Hall.

237
Compilation of References

39 Murphy, K. P. (2012). Machine Learning A Probabilistic Perspective. MIT Press.

3Aleskerov, E., Freisleben, B., & Rao, B. (1997). CARDWATCH: A Neural Network Based Database Mining System
for Credit Card Fraud Detection. Proc. IEEE/IAFE: Computational Intelligence for Financial Engineering, 220-226.
10.1109/CIFER.1997.618940

3Penyelenggara, A. (2019). Jasa Internet Indonesia. Magazine APJI.

40 Forests, R. D. (Ed.). (1995). Proceedings of the Third International Conference on Document Analysis and Recogni-
tion. IEEE Computer Society.

41 Ho, T. K. (1998). The Random Subspace Method for Constructing Decision Forests. IEEE Transactions on Pattern
Analysis and Machine Intelligence, 20(8), 832–844. doi:10.1109/34.709601

42Hastie, T. J. (2001). The Elements Of Statistical Learning. Academic Press.

43 Cortes, C., & Vapnik, V. (1995). Support-Vector Networks. Machine Learning, 20(3), 273–297. doi:10.1007/BF00994018

4 Maes, S., Tuyls, K., & Vanschoenwinkel, B. (2002). Credit Card Fraud Detection Using Bayesian and Neural Networks.
In First International NAISO Congress on Neuro Fuzzy Technologies, Havana, Cuba.

5Kim, M. J., & Kim, T. S. (2002). A Neural Classifier with Fraud Density Map for Effective Credit Card Fraud Detec-
tion. Lecture Notes in Computer Science, 2412, 378-383. 10.1007/3-540-45675-9_56

5 Schnatterly, K. (2003). Increasing firm value through detection and prevention of white- collar crime. Strategic Man-
agement Journal, 24(7), 587–614. doi:10.1002mj.330

6Hajeka & Henriquesb. (n.d.). Mining Corporate Annual Reports for Intelligent Detection of Financial Statement Fraud
– A Comparative Study of Machine Learning Methods. Mining Corporate Annual Reports for Intelligent Detection of
Financial Statement Fraud Ð A Comparative Study of Machine Learning Methods. doi:10.1016/j.knosys.2017.05.001

6 Magalla, A. (2013). Security, Prevention and Detection of Cyber Crimes. Tu-Maini University Iringa University College.

7Belo, O., & Vieira, C. (2011). Applying User Signatures on Fraud Detection in Telecommunications Networks. Aca-
demic Press.

8Behdad, M., Barone, L., Bennamoun, M., & French, T. (2012). Nature-inspired techniques in the context of fraud
detection. IEEE Trans. Syst. Man Cybern. Part C (Appl. Rev.), 42(6), 1273–1290. doi:10.1109/TSMCC.2012.2215851

8Mangala, D., & Kumari, P. (n.d.). Corporate Fraud Prevention and Detection: Revisiting the Literature, Corporate
Fraud Prevention and Detection: Revisiting the Literature. http://cbi.nic.in/fromarchives/satyam/satyam.php

9 Gupta, P. K., & Gupta, S. (2015). Corporate frauds in India –perceptions and emerging issues. Journal of Financial
Crime, 22(1), 79–103. doi:10.1108/JFC-07-2013-0045

9 Tennyson, S. (2001). Claims Auditing in Automobile Insurance. Procedia Technol., 9, 1252–1264.

Abdolmohammadi, M. (2013). Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities. Auditing, 32(3),

69–85. doi:10.2308/ajpt-50453

238
Compilation of References

Abid, I., Mkaouar, F., & Kaabia, O. (2018). Dynamic analysis of the forecasting bankruptcy under presence of unobserved
heterogeneity. Annals of Operations Research, 262(2), 241–256. doi:10.100710479-016-2143-2

Abu Ghunmi, D. N. A. E.-H. (2008). Stock return, risk and asset pricing, Durham theses, Durham University. Available
at Durham E-Theses Online: http://etheses.dur.ac.uk/1921/

Adams, R. B., & Ferreira, D. (2009). Women in the boardroom and their impact on governance and performance. Journal
of Financial Economics, 94(2), 291–309. doi:10.1016/j.jfineco.2008.10.007

Adams, R., & Mehran, H. (2003). Is corporate governance different for bank holding companies? Economic Policy
Review, (April), 123–142. doi:10.2139srn.387561

Aebi, V., Sabato, G., & Markus, S. (2012). Risk management, corporate governance, and bank performance in the fi-
nancial crisis. Journal of Banking & Finance, 36(12), 3213–3226. doi:10.1016/j.jbankfin.2011.10.020

Agrawal, A., & Cooper, T. (2017). Corporate governance consequences of accounting scandals: Evidence from top
management, CFO and auditor turnover. Quarterly Journal of Finance, 1.

Agrawal, A., & Cooper, T. (2017). Corporate governance consequences of accounting scandals: Evidence from top man-
agement, CFO and auditor turnover. The Quarterly Journal of Finance, 7(1), 1650014. doi:10.1142/S2010139216500142

Aguilera, R. V., & Cuervo-Cazurra, A. (2009). Codes of good governance. Corporate Governance, 17(3), 376–387.
doi:10.1111/j.1467-8683.2009.00737.x

Agyei-Ampomah, S., Clare, A., Mason, A., & Stephen Thomas, S. (2015). On luck versus skill when performance
benchmarks are style-consistent. Journal of Banking & Finance, 59(10), 127–145.

Aharony, J., Lee, C.-W. J., & Wong, T. J. (2000). Financial packaging of IPO firms in China. Journal of Accounting
Research, 38(1), 103–126. doi:10.2307/2672924

Ahlawat, S. S. D., & Lowe, D. J. (2004). Jordan Lowe. “An Examination of Internal AuditorObjectivity: In-House versus
Outsourcing. Auditing, 23(2), 147–158. doi:10.2308/aud.2004.23.2.147

AICPA. (2009). Guidance on monitoring Internal Control systems. AICPA.

AICPA. (2017). https://www.aicpa.org/InterestAreas/InformationTechnology/Resources/Privacy/CyberSecurity/Down-

loadableDocuments/Top-5-CyberCrimes.pdf

Al-ahdal, W. M., Alsamhi, M. H., Tabash, M. I., & Farhan, N. H. (2020). The impact of corporate governance on finan-
cial performance of Indian and GCC listed firms: An empirical investigation. Research in International Business and
Finance, 51(101083), 101083. doi:10.1016/j.ribaf.2019.101083

Albrecht, S. (2014, July/August). Iconic Fraud Triangle Endures. Fighting a Culture of Fraud, 4, 46–52.

Albrecht, W. S., Albrecht, C. O., & Zimbelman, M. F. (2011). Fraud examination. Cengage Learning.

Albring, S. M., Huang, S. X., Pereira, R., & Xu, X. (2013). The effects of accounting restatements on firm growth.
Journal of Accounting and Public Policy, 32(5), 357–376. doi:10.1016/j.jaccpubpol.2013.06.005

Aldasoro, I., Gambacorta, L., Giudici, P., & Leach, T. (2020). Operational and cyber risks in the financial sector. Bank
of International Settlements - Monetary and Economic Department. Working Papers No. 840.

239
Compilation of References

Allen, F., & Gale, D. (2004). Competition and financial stability. Journal of Money, Credit and Banking, 36(3b), 453–480.
doi:10.1353/mcb.2004.0038

Al-Tamimi, H., & Al-Mazrooei, M. (2007). Banks’ Risk Management: A Comparison Study of UAE National and Foreign
Banks. The Journal of Risk Finance, 8(4), 394–409. doi:10.1108/15265940710777333

Altman, E. I., Iwanicz-Drozdowska, M., Laitinen, E. K., & Suvas, A. (2017). Financial distress prediction in an interna-
tional context: A review and empirical analysis of altman’s Z-score model. Journal of International Financial Manage-
ment & Accounting, 28(2), 131–171. doi:10.1111/jifm.12053

Altman, E. I., Sabato, G., & Wilson, N. (2010). The Value of Non-Financial Information in Small and Medium-Sized
Enterprise Risk Management. The Journal of Credit Risk, 6, 1–33. doi:10.21314/JCR.2010.110

An, Y. (2015). Does foreign ownership increase financial reporting quality? Asian Academy of Management Journal, 20.

Anderson, R. C., & Fraser, D. R. (2000). Corporate control, bank risk-taking, and the health of the banking industry.
Journal of Banking & Finance, 24(8), 1383–1398. doi:10.1016/S0378-4266(99)00088-6

Anderson, R. C., Reeb, D. M., Upadhyay, A., & Zhao, W. (2011). The Economics of Director Heterogeneity. Financial
Management, 40(1), 5–38. doi:10.1111/j.1755-053X.2010.01133.x

Anderson, U. (2006). Implementing the professional practices framework (2nd ed.). The IIA Research Foundation.

Ang, A., Chen, J., & Xing, Y. (2006). Downside Risk. Review of Financial Studies, 13(4), 1191–1239. doi:10.1093/rfs/
hhj035

Angelidis, T., Giamouridis, D., & Tessaromatis, N. (2013). Revisiting mutual fund performance evaluation. Journal of
Banking & Finance, 37(5), 1759–1776.

Anginer, D., Demirguc-Kunt, A., Huizinga, H., & Ma, K. (2018). Corporate governance of banks and financial stability.
Journal of Financial Economics, 130(2), 327–346. doi:10.1016/j.jfineco.2018.06.011

Anti-Fraud Collaboration – AFC. (2014). The Fraud-Resistant Organization: Tools, Traits, and Techniques to Deter
and Detect Financial Reporting Fraud. Available at: https://www.thecaq.org/wp-content/uploads/2019/03/the-fraud-
resistant-organization.pdf

Archer, S., & Haron, A. (2007). Operational Risk Exposures of Islamic Banks. In Islamic Finance: The Regulatory
Challenge. John Wiley & Son (Asia) Pte Ltd.

Arnes, A. (2018). Introduction. In A. Arnes (Ed.), Digital Forensics (pp. 1–10). John Wiley & Sons, Inc.

Association of Certified Fraud Examiners – ACFE. (2020a). Developing an Integrated Anti-Fraud, Compliance, and
Ethics Program. Creating a Culture of Ethics and Compliance. Available at: https://www.acfe.com/uploadedFiles/
ACFE_Website/Content/review/diafp/02-Creating-a-Culture-of-Ethics-and-Compliance.pdf

Association of Certified Fraud Examiners – ACFE. (2020b). Report to the Nations: 2020 Global Study on Occupational
Fraud and Abuse. Available at: https://www.acfe.com/report-to-the-nations/2020/

Association of Certified Fraud Examiners – ACFE. (n.d.). What Is Fraud? Available at: https://www.acfe.com/fraud-101.
aspx

Association of Certified Fraud Examiners. (2014). Fraud examiners manual

240
Compilation of References

Auditing Standards Board. (1995). Statement of Auditing Standard, SAS 110 fraud and error. Author.

Awolowo, I. F., Garrow, N., Clark, M. C., & Chan, D. (2018). Accounting scandals: Beyond corporate governance. 9th
Conference on Financial Markets and Corporate Governance (FMCG).

Baker, M., Litov, L., Wachter, J. A., & Wurgler, J. (2010). Can mutual fund managers pick stocks? Evidence from their
trades prior to earnings announcements. Journal of Financial and Quantitative Analysis, 45(5), 1111–1131.

Bali, T. G., Brown, S. J., & Caglayan, M. O. (2014). Macroeconomic risk and hedge fund returns. Journal of Financial
Economics, 114(1), 1–19.

Barberis, N., & Shleifer, A. (2003). Style investing. Journal of Financial Economics, 68(2), 61–199.

Barry, T. A., Lepetit, L., & Tarazi, A. (2011). Ownership structure and risk in publicly held and privately owned banks.
Journal of Banking & Finance, 35(5), 1327–1340. doi:10.1016/j.jbankfin.2010.10.004

Bartlett, G. D., Kremin, J., Saunders, K. K., & Wood, D. A. (2016). Attracting Applicants for In-House and Outsourced
Internal Audit Positions: Views from External Auditors. American Accounting Association, 30(1), 143–156. doi:10.2308/
acch-51309

Basel Committee on Banking Supervision – BCBS. (2011). Principles for the Sound Management of Operational Risk.
Bank for International Settlements. Available at: https://www.bis.org/publ/bcbs195.pdf

Basel Committee on Banking Supervision – BCBS. (2017). Basel III: Finalising post-crisis reforms. Bank for Interna-
tional Settlements. Available at: https://www.bis.org/bcbs/publ/d424.pdf

Basel Committee on Banking Supervision. (1988). International convergence of capital measurement and capital stan-
dards. Basel Committee on Banking Supervision.

Basel Committee on Banking Supervision. (1998). Framework for internal control in banking organizations. Basel
Committee on Banking Supervision.

Basel Committee on Banking Supervision. (2012). The internal audit function in banks. Basel Committee on Banking
Supervision.

Basel Committee on Banking Supervision. (2013). Basel III: The liquidity coverage ratio and liquidity risk monitoring
tools. Basel Committee on Banking Supervision.

Basel Committee on Banking Supervision. (2014). Basel III: The net stable funding ratio. Basel Committee on Banking
Supervision.

Basel Committee on Banking Supervision. (2017). Basel III: Finalising post-crisis reforms. Basel Committee on Bank-
ing Supervision.

Baucus, M. S., & Near, J.P. (1991). Can Illegal Corporate Behavior be Predicted? An Event History Analysis. Academy
of Management Journal, 34, 9–36.

Bawa, V., & Lindenberg, E. B. (1977). Capital market equilibrium in a mean-lower partial moment framework. Journal
of Financial Economics, 5(2), 189–200. doi:10.1016/0304-405X(77)90017-4

Beasley, M. S. (1996). An empirical analysis of the relation between the board of director composition and financial
statement fraud. The Accounting Review, 443–465.

241
Compilation of References

Beaver, W. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4, 71–111. doi:10.2307/2490171

Bebchuk, L., & Weisbach, M. (2009). The state of corporate governance research. Review of Financial Studies, 23(3),
939–961. doi:10.1093/rfs/hhp121

Beltratti, A., & Stulz, R. M. (2012). The credit crisis around the globe: Why did some banks perform better? Journal of
Financial Economics, 105(1), 1–17. doi:10.1016/j.jfineco.2011.12.005

Beneish, M. D. (2001). The detection of earnings manipulation. Financ. Anal. J., 24–36.

Bentley, K., Omer, T., & Sharp, N. (2013). Business strategy, financial reporting irregularities, and audit effort. Con-
temporary Accounting Research, 30(2), 780–817. doi:10.1111/j.1911-3846.2012.01174.x

Berger, A. N., Imbierowicz, B., & Rauch, C. (2016). The roles of corporate governance in bank failures during the recent
financial crisis. Journal of Money, Credit and Banking, 48(4), 729–770. doi:10.1111/jmcb.12316

Berger, A., & Udell, G. F. (1998). The economics of small business finance: The roles of private equity and debt markets
in the financial growth cycle. Journal of Banking & Finance, 22(6–8), 613–673. doi:10.1016/S0378-4266(98)00038-7

Berk, J. B., & Tonks, I. (2007). Return persistence and fund flows in the worst performing mutual funds. National Bureau
of Economic Research, Working Paper No. w13042.

Berk, J. B., & Green, R. C. (2004). Mutual fund flows and performance in rational markets. Journal of Political Economy,
112(6), 1269–1295.

Biegelman, M. (2008). Building a World – Class Compliance Program: Best practices and strategies for success. John
Wiley & Sons, Inc.

Birol, B. (2019). Corporate Governance and Fraud Detection: A study from Borsa Instambul. Eurasian Journal of Busi-
ness and Management, 7(1), 44–64. doi:10.15604/ejbm.2019.07.01.005

Black’s Law Dictionary. (1999). (7th ed.). Academic Press.

Black, F. (1972). Capital market equilibrium with restricted borrowing. The Journal of Business, 45(3), 444–455.
doi:10.1086/295472

Bologna, J., Lindquist, R. J., & Wells, J. T. (1993). The Accountant’s Handbook of Fraud and Commercial Crime. Wiley.

Boycko, M., Shleifer, A., & Vishny, R. W. (1996). A theory of privatisation. Economic Journal (London), 106(435),
309–319. doi:10.2307/2235248

Boyd, J. H., & De Nicolo, G. (2005). The theory of bank risk taking and competition revisited. The Journal of Finance,
60(3), 1329–1343. doi:10.1111/j.1540-6261.2005.00763.x

Braiotta, L. (2004). Audit Committee handbook (4th ed.). John Wiley & Sons Inc.

Brandon, D. M. (2010). ExternalAuditor Evaluations of Outsourced Internal Auditors. Auditing: A Journal of Practice
&Theory American Accounting Association, 29(2), 15-173.

Breiman, L. (1996). Bagging predictors. Machine Learning, 24(2), 123–140. doi:10.1007/BF00058655

Breiman, L. (2001). Random forests. Machine Learning, 45(1), 5–32. doi:10.1023/A:1010933404324

Brennan, N. M., & McGrath, M. (2007). Financial statement fraud: Some lessons from US and European case studies.
Australian Accounting Review, 17(42), 49–61. doi:10.1111/j.1835-2561.2007.tb00443.x

242
Compilation of References

Brenner, S. N., & Cochran, P. (1991, July). The stakeholder theory of the firm: Implications for business and society
theory and research. In Proceedings of the international association for business and society (Vol. 2, pp. 897-933).
10.5840/iabsproc1991235

Breton, G., & Taffler, R. J. (2001). Accounting information and analyst stock recommendation decisions: A content
analysis approach. Accounting and Business Research, 31(2), 91–101. doi:10.1080/00014788.2001.9729604

Brickley, J. A., & Zimmerman, J. L. (2010). Corporate governance myths: Comments on Armstrong, Guay, and Weber.
Journal of Accounting and Economics, 50(2–3), 235–245. doi:10.1016/j.jacceco.2010.10.002

Bris, A. (2017). IMD World Competitiveness Center. Retrieved from World Competitiveness Center website: https://
www.imd.org/wcc/world-competitiveness-center/

Britz, M. T. (2013). Computer Forensics and Cyber Crime: An Introduction. Pearson.

Brown, S. J., & Goetzmann, W. N. (1997). Mutual fund styles. Journal of Financial Economics, 4(3), 373–399. doi:10.1016/
S0304-405X(96)00898-7

Brown, S. J., Kang, M., In, F. H., & Lee, G. (2010). Resisting the manipulation of performance metrics: An empirical
analysis of the manipulation-proof performance measure. Finance and Corporate Governance Conference.

Bruner, D., Mckee, M., & Santore, R. (2008). Hand in the cookie jar: An experimental investigation of equity-based
compensation and managerial fraud. Southern Economic Journal, 261–278.

Cadbury, A., & Cadbury, C. A. (2002). Corporate governance and chairmanship: A personal view. Oxford University
Press on Demand. doi:10.1093/acprof:oso/9780199252008.001.0001

Cadbury, S. A. (2000). The Corporate Governance Agenda. Corporate Governance, 8(1), 7–15. doi:10.1111/1467-
8683.00175

Calabrese, R., Marra, G., & Osmetti, S. A. (2016). Bankruptcy prediction of small and medium enterprises using a
flexible binary generalized extreme value model. The Journal of the Operational Research Society, 67(4), 604–615.
doi:10.1057/jors.2015.64

Calibo, D.I., & Ballera, M.A. (2017). A Fuzzy Logic Model for Risk Analysis and Recommendation System of a Gov-
ernment Financial Granting Project. International Journal of Simulation Systems.

Calluzzo, P., & Dong, G. N. (2015). Has the financial system become safer after the crisis? The changing nature of
financial institution risk. Journal of Banking & Finance, 53, 233–248. doi:10.1016/j.jbankfin.2014.10.009

Campbell, K., & Minguez-Vera, A. (2007). Gender Diversity in the Boardroom and Firm Financial Performance. Journal
of Business Ethics, (83), 435–451.

Caplan, D. H., & Kirschenheiter, M. (2000). Outsourcing and Audit Risk for Internal Audit Services. Contemporary
Accounting Research, 17(3), 387–428. doi:10.1506/8CP5-XAYG-7U37-H7VR

Carey, P., Subramaniam, N., & Karin, C. W. C. (2006). Internal audit outsourcing in Australia. Accounting and Finance,
46(1), 11–30. doi:10.1111/j.1467-629X.2006.00159.x

Carhart, M. M. (1997). On persistence in mutual fund performance. The Journal of Finance, 52(1), 57–82.
doi:10.1111/j.1540-6261.1997.tb03808.x

243
Compilation of References

Carozza, D. (2017). Banking on experience. Fraud Magazine. Available at: https://www.fraud-magazine.com/article.

aspx?id=4294998017

Chadwick, W. E. (2000). Keeping Internal Auditing In-house. Internal Auditor, (June), 88.

Chaigneau, P. (2013). Risk-shifting and the regulation of bank CEOs’ compensation. Journal of Financial Stability, 9(4),
778–789. doi:10.1016/j.jfs.2012.08.003

Chan, L. K., Dimmock, S. G., & Lakonishok, J. (2009). Benchmarkingmoney manager performance: Issues and evidence.
Review of Financial Studies, 22(11), 4553–4599.

Chan, W. K. (1977). Merchants, mandarins, and modern enterprise in late Chʻing China. Harvard Univ Pr.

Chartered Institute of Credit Management – CICM. (2019). External Business Fraud in the UK. Graydon Report. Avail-
able at: https://www.cicm.com/wp-content/uploads/2019/10/External-Fraud-report_FINAL.pdf

Chartered Institute of Management Accountants – CIMA. (2008). Fraud risk management: a guide to good practice. Available
at: https://www.cimaglobal.com/Documents/ImportedDocuments/cid_techguide_fraud_risk_management_feb09.pdf.pdf

Chen, T. M. (2010). Identity Theft Through the Web. In Handbook of Research on Computational Forensics, Digital
Crime, and Investigation: Methods and Solutions (pp. 379-395). IGI Global. doi:10.4018/978-1-60566-836-9.ch016

Chen, D., Jiang, D., Liang, S., & Wang, F. (2011). Selective enforcement of regulation. China Journal of Accounting
Research, 4(1-2), 9–27. doi:10.1016/j.cjar.2011.04.002

Chen, G., Firth, M., Gao, D. N., & Rui, O. M. (2005). Is China’s securities regulatory agency a toothless tiger? Evidence
from enforcement actions. Journal of Accounting and Public Policy, 24(6), 451–488. doi:10.1016/j.jaccpubpol.2005.10.002

Chen, J., Cumming, D., Hou, W., & Lee, E. (2016). Does the external monitoring effect of financial analysts deter cor-
porate fraud in China? Journal of Business Ethics, 134(4), 727–742. doi:10.100710551-014-2393-3

Chen, K. C., & Yuan, H. (2004). Earnings management and capital resource allocation: Evidence from China’s accounting-
based regulation of rights issues. The Accounting Review, 79(3), 645–665. doi:10.2308/accr.2004.79.3.645

Chen, Y.-J., Liou, W.-C., Chen, Y.-M., & Wu, J.-H. (2018). Fraud detection for financial statements of business groups.
International Journal of Accounting Information Systems, 32, 1–23. doi:10.1016/j.accinf.2018.11.004

Chernobai, A., Rachev, S., & Fabozzi, F. (2007). Operational Risk: A Guide to Basel II Capital Requirements, Models,
and Analysis. John Wiley & Sons, Inc.

Chuang, Y. C., & Lin, C. M. (1999). Foreign direct investment, R&D and spillover efficiency: Evidence from Taiwan’s
manufacturing firms. The Journal of Development Studies, 35(4), 117–137. doi:10.1080/00220389908422583

Ciftci, I., Tatoglu, E., Wood, G., Demirbag, M., & Zaim, S. (2019). Corporate governance and firm performance in emerg-
ing markets: Evidence from Turkey. International Business Review, 28(1), 90–103. doi:10.1016/j.ibusrev.2018.08.004

Coderre, D. (2009). Computer-Aided Fraud Prevention and Detection: A Step-by-Step Guide. John Wiley & Sons, Inc.

Coenen, T. L. (2009). Expert Fraud Investigation: A Step-by-Step Guide. John Wiley & Sons, Inc.

Cohen, J., Ding, Y., Lesage, C., & Stolowy, H. (2012). Corporate fraud and managers’ behavior: Evidence from the
press. Entrepreneurship, governance and ethics. Springer.

244
Compilation of References

Colpan, A. M., & Yoshikawa, T. (2012). Performance Sensitivity of Executive Pay: The Role of Foreign Investors and
Affiliated Directors in Japan. Corporate Governance, 20(6), 547–561. doi:10.1111/j.1467-8683.2012.00923.x

Committee of Sponsoring Organizations of the Treadway Commission (COSO). (2011). Internal control-integrated
framework. Coopers and Lybrand.

Connor, G. (1995). The three types of factor models: A comparison of their explanatory power. Financial Analysts
Journal, 51(3), 42–46. doi:10.2469/faj.v51.n3.1904

Conyon, M. J., & He, L. (2016). Executive compensation and corporate fraud in China. Journal of Business Ethics,
134(4), 669–691. doi:10.100710551-014-2390-6

Coram, P., Ferguson, C., & Moroney, R. (2006). The value of internal audit in fraud detection. Journal of Accounting
and Finance, 48(4), 543–559.

Coram, P., Ferguson, C., & Moroney, R. (2008). Internal Audit, Alternative Internal Audit Structures and The Level of
Misappropriation of Assets Fraud. Accounting and Finance, 48(0), 543–559. doi:10.1111/j.1467-629X.2007.00247.x

Cremers, K. M., & Petajisto, A. (2009). How active is your fund manager? A new measure that predicts performance.
Review of Financial Studies, 22(9), 3329–3365.

Cremers, M., Petajisto, A., & Zitzewitz, E. (2012). Should benchmark indices have alpha? Revisiting performance evalu-
ation. Critical Finance Review, 2(1), 1–48.

Cressey, D. R. (1953). Other People’s Money. Montcl air. Patterson Smith.

Cressey, D. R. (1953). Other people’s money: a study in the social psychology of embezzlement. The Free Press.

Cross, C. (2013). Anatomy of a Ponzi: Scams past and present. Slice Publishing.

Cross, M., & Shinder, D. L. (2008). Scene of the cybercrime. Syngress Pub.

Crutchley, C. E., Jensen, M. R., & Marshall, B. B. (2007). Climate for scandal: Corporate environments that contribute
to accounting fraud. Financial Review, 42(1), 53–73. doi:10.1111/j.1540-6288.2007.00161.x

Cruz, M., Peters, G., & Shevchenko, P. (2015). Fundamental aspects of Operational Risk and Insurance Analytics. A
handbook of Operational Risk. John Wiley & Sons, Hoboken N. Jersey and Canada Deloite. Basel III final rule sum-
mary. Understanding the new operational risk capital standard. Available at: https://www2.deloitte.com/us/en/pages/
risk/articles/basel-final-rules-takeaways-highlights-us-banks.html

Cultrera, L., & Brédart, X. (2015). Bankruptcy prediction: The case of Belgian SMEs. Review of Accounting and Finance,
15(1), 101–119. doi:10.1108/RAF-06-2014-0059

Cuthbertson, K., Nitzsche, D., & O’Sullivan, N. (2010). Mutual fund performance: Measurement and Evidence1. Finan-
cial Markets, Institutions and Instruments, 19(2), 95–187. doi:10.1111/j.1468-0416.2010.00156.x

Dahi, D. (1996). Management turnover and successor accounting discretion, bank loan loss provision after resignation,
retirement or death. Research in Accounting Regulation, 10(95), 110.

Dahlquist, M., & Robertsson, G. (2001). Direct foreign ownership, institutional investors, and firm characteristics. Journal
of Financial Economics, 59(3), 413–440. doi:10.1016/S0304-405X(00)00092-1

Daniel, K., Grinblatt, M., Titman, S., & Wermers, R. (1997). Measuring mutual fund performance with characteristic-
based benchmarks. The Journal of Finance, 52(3), 1035–1058. doi:10.1111/j.1540-6261.1997.tb02724.x

245
Compilation of References

Davidson, B. I., Desai, N. K., & Gerard, G. J. (2013). The Effect of Continuous Auditing on the Relationship between
Internal Audit Sourcing and the External Auditor’s Reliance on the Internal Audit Function. Journal of Information
System. American Accounting Association, 27(1), 41–59. doi:10.2308/isys-50430

DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: The use of account-
ing performance measures in proxy contests. Journal of Accounting and Economics, 10(1), 3–36. doi:10.1016/0165-
4101(88)90021-3

Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation: An
analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research, 13(1), 1–36.
doi:10.1111/j.1911-3846.1996.tb00489.x

Deloitte. (2010). Public Sector Fraud Identifying the Risk Areas. Available at: https://www2.deloitte.com/content/dam/
Deloitte/ie/Documents/Finance/Corporate%20Finance/2010_public_sector_fraud_deloitte_ireland.pdf

Deloitte. (2014). Decoding Frauds in the Manufacturing sector. Available at: https://www2.deloitte.com/content/dam/
Deloitte/in/Documents/finance/Forensic-Sector-Services/in-fa-manufacturing-noexp.pdf

Deloitte. (n.d.). Profiling the fraudster: understanding the threat of insider fraud. Available at: https://www2.deloitte.
com/mt/en/pages/risk/articles/mt-risk-article-profiling-the-fraudster.html

Deng, S., Willis, R. H., & Xu, L. (2014). Shareholder litigation, reputational loss, and bank loan contracting. Journal of
Financial and Quantitative Analysis, 49(4), 1101–1132. doi:10.1017/S002210901400057X

Desai, N. K., Gerard, G. J., & Tripathy, A. (2008). Co-sourcing and External Auditors’ Reliance on the Internal Audit
Function. The Institute of Internal Auditors Research Foundation.

DeWit, G. W. (1982). Underwriting and Uncertainty. Insurance, Mathematics & Economics, 1(4), 277–285.
doi:10.1016/0167-6687(82)90028-2

Ding, S., Jia, C., Li, Y., & Wu, Z. (2012). Reactivity and passivity after enforcement actions: Better late than never. In
Entrepreneurship, Governance and Ethics. Springer.

Dittenhofer, M. (2001). Internal Auditing Effectiveness: An Expansion of Present Methods. Managerial Auditing Journal,
16(8), 443-445.

Dong, Y., Girardone, C., & Kuo, J. M. (2017). Governance, efficiency and risk taking in Chinese banking. The British
Accounting Review, 49(2), 211–229. doi:10.1016/j.bar.2016.08.001

Dorf, R. C., & Bishop, R. H. (2017). Modern Control Systems (13th ed.). Pearson.

Doumpos, M., & Zopounidis, C. (2014). Multicriteria Analysis in Finance. Springer. doi:10.1007/978-3-319-05864-1

Doupnik, T. S. (2008). Influence of culture on earnings management: A note. Abacus, 44(3), 317–340. doi:10.1111/j.1467-
6281.2008.00265.x

Driel, H. v. (2018). Financial fraud, scandals, and regulation: A conceptual framework and literature review. Business
History.

Duncan, S. M. (2009). The Empirics of Governance and Fraud. University of Pittsburgh Law Review. University of
Pittsburgh. School of Law, 70(3), 465–486.

Dunning, J. H. (2015). The eclectic paradigm of international production: a restatement and some possible extensions.
In The Eclectic Paradigm. Springer.

246
Compilation of References

Dvorak, T. (2001). Do domestic investors have an information advantage. Evidence from Indonesia.

Ebaid, I. E. (2011). Internal audit function: An exploratory study from Egyptian listed firms. International Journal of
Law and Management, 53(2), 108–128. doi:10.1108/17542431111119397

Edwards, D. (2012). I’m feeling lucky: The confessions of Google’s employee number 59. Mariner Books.

El Kalak, I., & Hudson, R. (2016). The effect of size on the failure probabilities of SMEs: An empirical study on the US
market using discrete hazard model. International Review of Financial Analysis, 43, 135–145. doi:10.1016/j.irfa.2015.11.009

El-Erian, M. (2017). How healthy is the global financial system. The Guardian. https://www.theguardian.com/busi-
ness/2017/jul/10/how-healthy-global-financial-system-mohamed-el-erian

Elkington, J. (1998). Partnerships from cannibals with forks: The triple bottom line of 21st‐century business. Environ-
mental Quality Management, 8(1), 37–51. doi:10.1002/tqem.3310080106

Ellul, A., & Yerramilli, V. (2013). Stronger risk controls, lower risk: Evidence from US bank holding companies. The
Journal of Finance, 68(5), 1757–1803. doi:10.1111/jofi.12057

Elton, E. J., Gruber, M. J., & Blake, C. R. (2012). An examination of mutual fund timing ability using monthly holdings
data. Review of Finance, 16(3), 619–645. doi:10.1093/rof/rfr007

Ernst & Young. (2015). Creating trust in the digital world: EY’s Global Information Security survey 2015, Flaglien,
O. A. (2018). The digital forensics process. In A. Arnes (Ed.), Digital Forensics (pp. 13–48). John Wiley & Sons, Inc.

Evan, W. M. & Freeman, R. E. (1988). A stakeholder theory of the modern corporation: Kantian capitalism. Academic
Press.

Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. The Journal of Finance, 47(2), 427–465.
doi:10.1111/j.1540-6261.1992.tb04398.x

Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial
Economics, 33(1), 3–56. doi:10.1016/0304-405X(93)90023-5

Fama, E. F., & French, K. R. (2010). Luck versus skill in the cross-section of mutual fund returns. The Journal of Fi-
nance, 65(5), 1915–1947.

Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1–22.

Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. The Journal of Law & Economics, 26(2),
301–325. doi:10.1086/467037

Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. Journal of Political Economy,
81(3), 607–636. doi:10.1086/260061

Farber, D. B. (2005). Restoring trust after fraud: Does corporate governance matter? The Accounting Review, 50(2),
539–561. doi:10.2308/accr.2005.80.2.539

Farquhar, T., Rosenberg, B., & Rudd, A. (1982). Factor-related and specific returns of commonstocks: Serial correlation
and market inefficiency. The Journal of Finance, 37(2), 543–554. doi:10.1111/j.1540-6261.1982.tb03575.x

Farrell, J. L. Jr. (1974). Analyzing covariation of returns to determine homogeneous stock groupings. The Journal of
Business, 47(2), 186–207. doi:10.1086/295630

Felix, L. (2018). Auditing, Assurance Services, and Forensics. Springer International Publishing.

247
Compilation of References

Ferreira, M. A., Keswani, A., Miguel, A. F., & Ramos, S. B. (2019). What determines fund performance persistence?
International evidence. Financial Review, 54(4), 679–708. doi:10.1111/fire.12202

Ferson, W. E. (2013). Ruminations on investment performance measurement. European Financial Management, 19(1),
4–13. doi:10.1111/j.1468-036X.2012.00657.x

Ferson, W. E., & Schadt, R. W. (1996). Measuring fund strategy and performance in changing economic conditions. The
Journal of Finance, 51(2), 425–461. doi:10.1111/j.1540-6261.1996.tb02690.x

Ferson, W., & Lin, J. (2014). Alpha and performance measurement: The effects of investor disagreement and heterogene-
ity. The Journal of Finance, 69(4), 1565–1596.

Financial Stability Institute (FSI). (2015). The “four lines of defense model” for financial institutions. Occasional Paper
No. 11.

Firth, M., Rui, O. M., & Wu, W. (2011). Cooking the books: Recipes and costs of falsified financial statements in China.
Journal of Corporate Finance, 17(2), 371–390. doi:10.1016/j.jcorpfin.2010.09.002

Foerster, S. R., & Huen, B. C. (2004). Does corporate governance matter to Canadian investors. Canadian Investment
Review, (17), 19–23.

Folli Follie Online. (2020). Retrieved 8 10, 2020, from www.follifollie.com: https://www.follifollie.com/gr-el/follifollie/
our-history

Fombrun, C. J. (1983). Corporate culture, environment, and strategy. Human Resource Management, 22(1–2), 139–152.
doi:10.1002/hrm.3930220118

FRC. (2018). ICAEW. Retrieved July 2020, from icaew.com: https://www.icaew.com/technical/corporate-governance/

codes-and-reports/uk-corporate-governance-code

Friedman, J. H. (2001). Greedy function approximation: A gradient boosting machine. Annals of Statistics, 29(5),
1189–1232. doi:10.1214/aos/1013203451

Fullér. (1995). Neural Fuzzy Systems, Lecture notes, Abo Akademi University.

Fung, B. (2014). The demand and need for transparency and disclosure in corporate governance. Universal Journal of
Management, 2(2), 72–80.

Gaganis, C., Pasiouras, F., Spathis, C., & Zopounidis, C. (2007). A cormarison of nearest neighbours, disciminant
and logit models for auditing decisions. Intelligent Systems in Accounting, Finance & Management, 15(1-2), 23–40.
doi:10.1002/isaf.283

Geiger, M. A., Lowe, D. J., & Pany, K. J. (2002). Appearences Are Important: Outsourced Internal Audit Services and
the Perception of Auditor Independence. The CPA Journal, 72(4), 20–25.

Gillan, S., & Starks, L. T. (2003). Corporate governance, corporate ownership, and the role of institutional investors: A
global perspective. Journal of Applied Finance (JAF), 13. doi:10.2139srn.439500

Gill-De-Albornoz, B., & Rusanescu, S. (2018). Foreign ownership and financial reporting quality in private subsidiaries.
Spanish Journal of Finance and Accounting. Revista Española de Financiación y Contabilidad, 47(2), 181–213. doi:1
0.1080/02102412.2017.1394104

Glode, V. (2011). Why mutual funds underperform. Journal of Financial Economics, 99(3), 546–559.

248
Compilation of References

Glover, J. (2017). Bank of England focuses on consumer-credit risk to stability. Bloomberg. https://www.bloomberg.
com/news/articles/2017-04-04/bank-of-england-focuses-on-consumer-credit-risk-to-stability

Glover, S. M., Prawitt, D. F., & Wood, D. A. (2008). Internal Audit Sourcing Arrangement and the Extemal Auditor’s
Reliance Decision. Contemporary Accounting Research, 25(1), 193–213. doi:10.1506/car.25.1.7

Goetzmann, W. N., & Ibbotson, R. G. (1994). Do winners repeat? Journal of Portfolio Management, 20(2), 9–18.
doi:10.3905/jpm.1994.9

Goetzmann, W. N., & Koll, E. (2005). The history of corporate ownership in China: State patronage, company legislation,
and the issue of control. A history of corporate governance around the world: Family business groups to professional
managers. University of Chicago Press.

Goldmann, P. D., & Kaufman, H. (2009). Anti-Fraud Risk and Control Workbook. John Wiley & Sons.

Gordini, N. (2014). A genetic algorithm approach for SMEs bankruptcy prediction: Empirical evidence from Italy. Expert
Systems with Applications, 41(14), 6433–6455. doi:10.1016/j.eswa.2014.04.026

Governance, K. C., & King, M. (2016). King IV Report on Corporate Governance for South Africa. Institute of Direc-
tors in Southern Africa.

Graham, J. R., Harvey, C. R., Popadak, J., & Rajgopal, S. (2015). Corporate culture: Evidence from the field. Available
at Retrieved from www.newyorkfed.org

Graham, J. R., Li, S., & Qiu, J. (2008). Corporate misreporting and bank loan contracting. Journal of Financial Econom-
ics, 89(1), 44–61. doi:10.1016/j.jfineco.2007.08.005

Gray, K. R., Clark, G. W. Jr, & Frieder, L. A. (2005). Corporate scandals: The many faces of greed. Paragon House.

Gray, R., Laughlin, R., Milne, M., & Owen, D. (2002). Of messiness, systems and sustainability: Towards a more social
and environmental finance and accounting. The British Accounting Review, 34(4), 357–386. doi:10.1006/bare.2002.0217

Green, S. (2004). Manager’s guide to the Sarbanes-Oxley Act: Improving internal controls to prevent fraud. Wiley.

Grinblatt, M., & Titman, S. (1992). The persistence of mutual fund performance. The Journal of Finance, 47(5),
1977–1984. doi:10.1111/j.1540-6261.1992.tb04692.x

Grinblatt, M., & Titman, S. (1993). Performance measurement without benchmarks: An examination of mutual fund
returns. The Journal of Business, 47–68.

Grossman, S. J., & Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. The American Eco-
nomic Review, 70(3), 393–408.

Grove, H., Patelli, L., Victoravich, L., & Xu, P. (2011). Corporate governance and performance in the wake of the
financial crisis: Evidence from US commercial banks. Corporate Governance, 19(5), 418–436. doi:10.1111/j.1467-
8683.2011.00882.x

Gulati, K., Gupta, S., & Gupta, C. (2020). The Transformation of Governance System: A Decade Long Experience of
Corporate Governance Using Meta-analysis. Global Journal of Flexible Systems Management, 1-30.

Gul, F. (1991). A Theory of Disappointment Aversion. Econometrica, 59(3), 667–686. doi:10.2307/2938223

249
Compilation of References

Guo, F., & Ma, S. (2015). Ownership characteristics and earnings management in China. Chinese Economy, 48(5),
372–395. doi:10.1080/10971475.2015.1067086

Guo, J., Huang, P., Zhang, Y., & Zhou, N. (2015). Foreign ownership and real earnings management: Evidence from
Japan. Journal of International Accounting Research, 14(2), 185–213. doi:10.2308/jiar-51274

Gwilliam, D., & Russell, T. (1991, January). Polly Peck: Where were the analysts? Accountancy (London), ▪▪▪, 25–26.

Habib, M., & Zurawicki, L. (2002). Corruption and foreign direct investment. Journal of International Business Studies,
33(2), 291–307. doi:10.1057/palgrave.jibs.8491017

Halbouni, S. S., Obeid, N., & Garbou, A. (2016). Corporate governance and information technology in fraud prevention
and detection. Managerial Auditing Journal, 31(6/7), 589–628. doi:10.1108/MAJ-02-2015-1163

Han, S., Kang, T., Salter, S., & Yoo, Y. K. (2010). A cross-country study on the effects of national culture on earnings
management. Journal of International Business Studies, 41(1), 123–141. doi:10.1057/jibs.2008.78

Hargraves, K. (2003). Privacy: Assessing the risk. The IIA Research Foundation.

Harlow, W. V., & Rao, R. K. S. (1989). Asset pricing in a generalized mean-lower partial moment framework: Theory
and evidence. Journal of Financial and Quantitative Analysis, 24(3), 285–311. doi:10.2307/2330813

Harrast, S. A., & Mason, O. (2007). Can Audit Committee Prevent Management Fraud? The Accounting Journal., 77(1),
24–28.

Haß, L. H., Vergauwe, S., & Zhang, Z. (2019). State-ownership and bank loan contracting: Evidence from corporate
fraud. European Journal of Finance, 25(6), 550–567. doi:10.1080/1351847X.2017.1328454

Hastie, T., & Tibshirani, R. (1990). Generalized additive models. Chapman and Hall.

Healy, P. M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7(1-
3), 85–107. doi:10.1016/0165-4101(85)90029-1

Healy, P., & Serafeim, G. (2012). Causes and Consequences of firms’ self-reported anticorruption efforts. Harvard
Business School. doi:10.2139srn.2229039

Heinrich, C., Maffioli, A., & Vazquez, G. (2010). A primer for applying propensity-score matching. Inter-American
Development Bank.

Hemingway, C., & Maclagan, P. (2004). Managers’ personal values as drivers of corporate social responsibility. Journal
of Business Ethics, 50(1), 33–44. doi:10.1023/B:BUSI.0000020964.80208.c9

Henriksson, R. D., & Merton, R. C. (1981). On market timing and investment performance. II. Statistical procedures for
evaluating forecasting skills. The Journal of Business, 54(4), 513–533. doi:10.1086/296144

Hermalin, B. E., & Weisbach, M. S. (2001). Boards of directors as an endogenously determined institution: A survey of
the economic literature. National Bureau of Economic Research. doi:10.3386/w8161

Hofstede, G. (1980). Culture’s consequences: International differences in work related values. Sage Publications.

Hofstede, G. (2001). Culture’s consequences: Comparing values, behaviors, institutions, and organizations across na-
tions. Sage Publications.

Hogan, W. W., & Warren, J. M. (1974). Toward the development of an equilibriumcapital-market model based on semi-
variance. Journal of Financial and Quantitative Analysis, 9(1), 1–11. doi:10.2307/2329964

250
Compilation of References

Huang, C. (2008). Company law and the independent director system in contemporary China. Hastings International
and Comparative Law Review, 31.

Huij, J., & Verbeek, M. (2009). On the use of multifactor models to evaluate mutual fund performance. Financial Man-
agement, 38(1), 75–102.

Hung, Y. S., & Cheng, Y. C. (2018). The impact of information complexity on audit failures from corporate fraud:
Individual auditor level analysis. Asia Pacific Management Review, 23(2), 72–85. doi:10.1016/j.apmrv.2017.09.002

Hunter, D., Kandel, E., Kandel, S., & Wermers, R. (2014). Mutual fund performance evaluation with active peer bench-
marks. Journal of Financial Economics, 112(1), 1–29.

Iannotta, G., Nocera, G., & Sironi, A. (2007). Ownership structure, risk and performance in the European banking in-
dustry. Journal of Banking & Finance, 31(7), 2127–2149. doi:10.1016/j.jbankfin.2006.07.013

IIA. (2007). Common body of Knowledge 2006, A global summary. IIA Research Foundation.

In’airat, M. (2015). The Role of Corporate Governance in Fraud Reduction-A Perception Study in the Saudi Arabia
Business Environment. Journal of Accounting & Finance, 15(2), 2158–3625.

Indarto, S. L., & Ghozali, I. (2016). Fraud diamond: Detection analysis on the fraudulent financial reporting. Risk Gov-
ernance & Control: Financial Markets and Institution, 6(4), 116–124. doi:10.22495/rcgv6i4c1art1

Indonesia, A. P. J. I. (2019). Mengawali integritas era digital 2019 - Magazine APJI. Asosiasi Penyelenggara Jasa In-
ternet Indonesia.

Institute of International Finance (IFF). (2008). Interim report of the IIF committee on market best practices. April. IIF.

International Monetary Fund (IMF). (2000). Macroprudential indicators of financial system soundness. Occasional
Paper 192, Washington, DC: IMF.

Inua, O. I., & Abianga, E. U. (2015). The Effect of the Internal Audit Outsourcing on Auditor Independence: The Nigerian
Experience. Research Journal of Finance and Accounting, 6(10), 36–45.

Investment Company Institute. (2020). Investment Company Fact Book. Author.

Iwata, E. (2002, July 24). Banks face accusations in Enron case. USA Today.

Jahankhani, A. (1976). E-V and E-S capital asset pricing models: Some empirical tests. Journal of Financial and Quan-
titative Analysis, 11(4), 513–528. doi:10.2307/2330199

James, K. L. (2003). The Effects of Internal Audit Structure on Perceived Financial Statement Fraud Prevention. Ac-
counting Horizons, 17(4), 315–327. doi:10.2308/acch.2003.17.4.315

Jang, J.-S. R., & Sun, C.-T. (1995). Neuro-fuzzy modelling and control. Proceedings of the IEEE, 83(3), 378–406.
doi:10.1109/5.364486

Jang, J.-S. R., & Sun, C.-T. (1997). Neuro-Fuzzy and Soft Computing. Prentice Hall.

Jayadev, M. (2013). Basel III implementation: Issues and challenges for Indian banks. IIMB Management Review, 25(2),
115–130. doi:10.1016/j.iimb.2013.03.010

Jennings, M. M. (2006). The Seven Signs of Ethical Collapse: How to Spot Moral Meltdowns in Companies... Before
It’s Too Late. St. Martin’s Press.

251
Compilation of References

Jennings, M. M., Pany, K. J., & Reckers, P. M. (2006). Strong corporate governance and audit firm rotation: Effects
on judges’ independence perceptions and litigation judgments. Accounting Horizons, 20(3), 253–270. doi:10.2308/
acch.2006.20.3.253

Jensen, M. C. (1968). The performance of mutual funds in the period 1945–1964. The Journal of Finance, 23(2), 389–416.
doi:10.1111/j.1540-6261.1968.tb00815.x

Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure.
Journal of Financial Economics, 3(4), 305–360. doi:10.1016/0304-405X(76)90026-X

Jensen, M. C., & Meckling, W. H. (1979). Theory of the firm: Managerial behavior, agency costs, and ownership struc-
ture. In Economics social institutions. In In Economics social institutions (pp. 163–231). Springer. doi:10.1007/978-
94-009-9257-3_8

Jia, C., Ding, S., Li, Y., & Wu, Z. (2009). Fraud, enforcement action, and the role of corporate governance: Evidence
from China. Journal of Business Ethics, 90(4), 561–576. doi:10.100710551-009-0061-9

Jiang, G., Lee, C. M., & Yue, H. (2010). Tunneling through intercorporate loans: The China experience. Journal of
Financial Economics, 98(1), 1–20. doi:10.1016/j.jfineco.2010.05.002

Jiménez, G., Lopez, J. A., & Saurina, J. (2013). How does competition affect bank risk-taking? Journal of Financial
Stability, 9(2), 185–195. doi:10.1016/j.jfs.2013.02.004

John, K., & Senbet, L. (1998). Corporate governance and board effectiveness. Journal of Banking & Finance, 22(4),
371–403. doi:10.1016/S0378-4266(98)00005-3

Johnson, S. A., Ryan, H. E., & Tian, Y. S. (2003). Executive compensation and corporate fraud (Unpublished paper).
Lousiana State University, Baton Rouge, LA.

Johnson, W. C., Xie, W., & Yi, S. (2014). Corporate fraud and the value of reputations in the product market. Journal
of Corporate Finance, 25, 16–39. doi:10.1016/j.jcorpfin.2013.10.005

Jones, M. (2011). Introduction—Setting the Scene. Creative accounting, fraud and international accounting scandals, 1-19.

Kacperczyk, M., Nieuwerburgh, S. V., & Veldkamp, L. (2014). Time-varying fund manager skill. The Journal of Fi-
nance, 69(4), 1455–1484.

Kadous, K., Magro, A. M., & Spilker, B. C. (2008). Do effects of client preference on accounting professionals’ in-
formation search and subsequent judgments persist with high practice risk? The Accounting Review, 83(1), 133–156.
doi:10.2308/accr.2008.83.1.133

Kanagaretnam, K., Lim, C. Y., & Lobo, G. J. (2011). Effects of national culture on earnings management in banks.
Journal of International Business Studies, 42(6), 853–874. doi:10.1057/jibs.2011.26

Kanagaretnam, K., Lim, C. Y., & Lobo, G. J. (2013). Influence of national culture on accounting conservatism and risk-
taking in the banking industry. The Accounting Review, 89(3), 1115–1149. doi:10.2308/accr-50682

Kandilov, I. T., & Senses, M. Z. (2016). The effects of wrongful discharge protection on foreign multinationals: Evidence
from transaction‐level data. The Canadian Journal of Economics. Revue Canadienne d’Economique, 49(1), 111–146.
doi:10.1111/caje.12192

Kanellis, P., Kiountouzis, E., Kolokotronics, N., & Markatos, D. (2006). Digital Crime and Forensic Science in Cyber-
space. Idea Grroup Pub. doi:10.4018/978-1-59140-872-7

252
Compilation of References

Kaplan, R. S. (2011). Accounting scholarship that advances professional knowledge and practice. The Accounting Review,
86(2), 367–383. doi:10.2308/accr.00000031

Karius, T. (2016). Intellectual property and intangible assets: Alternative valuation and financing approaches for the
knowledge economy in Luxembourg (No. 3). EIKV-Schriftenreihe zum Wissens-und Wertemanagement.

Karpoff, J. M., Lee, D. S., & Martin, G. S. (2008). The cost to firms of cooking the books. Journal of Financial and
Quantitative Analysis, 43(3), 581–611. doi:10.1017/S0022109000004221

Karpoff, J. M., & Lott, J. R. Jr. (1993). The reputational penalty firms bear from committing criminal fraud. The Journal
of Law & Economics, 36(2), 757–802. doi:10.1086/467297

Kassem, R., & Higson, A. (2012). The new fraud triangle model. Journal of Emerging Trends in Economics and Man-
agement Science, 3(3), 191–195.

Kävrestad, J. (2018). Fundamentals of Digital Forensics: Theary, Methods, and Real - Life Applications. Springer In-
ternational Publising AG. doi:10.1007/978-3-319-96319-8

Kerr, O. S. (2005). Digital Evidence and the New Criminal Procedure. Columbia Law Review, 105(1), 279–318.

Keys, B. J., Mukherjee, T., Seru, A., & Vig, V. (2009). Financial regulation and securitization: Evidence from subprime
loans. Journal of Monetary Economics, 56(5), 700–720. doi:10.1016/j.jmoneco.2009.04.005

Khanna, T., & Palepu, K. (2000). Emerging market business groups, foreign intermediaries, and corporate governance.
Concentrated corporate ownership. University of Chicago Press.

Kim, I. J., Eppler-Kim, J., Kim, W. S., & Byun, S. J. (2010). Foreign investors and corporate governance in Korea.
Pacific-Basin Finance Journal, 18(4), 390–402. doi:10.1016/j.pacfin.2010.04.002

King, B. F. (1966). Market and industry factors in stock price behavior. The Journal of Business, 39(1), 139–190.
doi:10.1086/294847

Kirkpatrick, G. (2009). The corporate governance lessons from the financial crisis. OECD Journal: Financial Market
Trends, 2009(1), 61–87. doi:10.1787/fmt-v2009-art3-en

Kizza, J. M. (2010). Ethical and Social Issues in the Information Age. Springer.

Klein, B., & Leffler, K. B. (1981). The role of market forces in assuring contractual performance. Journal of Political
Economy, 89(4), 615–641. doi:10.1086/260996

Kleinow, J., Moreira, F., Strobl, S., & Vähämaa, S. (2017). Measuring systemic risk: A comparison of alternative market-
based approaches. Finance Research Letters, 21, 40–46. doi:10.1016/j.frl.2017.01.003

Klomp, J., & De Haan, J. (2012). Banking risk and regulation: Does one size fit all? Journal of Banking & Finance,
36(12), 3197–3212. doi:10.1016/j.jbankfin.2011.10.006

Kong, D., Xiang, J., Zhang, J., & Lu, Y. (2019). Politically connected independent directors and corporate fraud in China.
Accounting and Finance, 58(5), 1347–1383. doi:10.1111/acfi.12449

Kosowski, R., Timmermann, A., Wermers, R., & White, H. (2006). Can mutual fund starsreally pick stocks? New evi-
dence from a bootstrap analysis. The Journal of Finance, 61(6), 2551–2595.

Kothari, S. P., & Warner, J. B. (2001). Evaluating mutual fund performance. The Journal of Finance, 56(5), 1985–2010.

253
Compilation of References

Kourakis, N. (2001). Economic crime in Greece today. In Economic Crimes in Cyprus: A Multi disciplinary Approach
(pp. 323–353). Sakkoulas Publishers. (in Greek)

KPMG. (2014). Fraud risk management. Developing a strategy for prevention, detection, and response. Available at: https://
assets.kpmg/content/dam/kpmg/pdf/2014/05/fraud-risk-management-strategy-prevention-detection-response-O-201405.
pdf

KPMG. (2015). The KPMG survey of corporate responsibility reporting 2015. Retrieved 8 3, 2020, from https://home.
kpmg/xx/en/home/insights/2015/11/kpmg-international-survey-of-corporate-responsibility-reporting-2015.html

KPMG. (2016a). Fraud risk increases in difficult economies. Available at: https://assets.kpmg/content/dam/kpmg/
pdf/2016/07/kpmg-forensic-focus-fraud-risk-in-difficult-economies.pdf

KPMG. (2016b). Global profiles of the Fraudster: Technology enables and weak controls fuel the fraud. KPMG Inter-
national. Available at: https://assets.kpmg/content/dam/kpmg/pdf/2016/05/profiles-of-the-fraudster.pdf

Kranacher, M. J., Riley, R., & Wells, J. T. (2019). Forensic accounting and fraud examination. John Wiley & Sons.

KratchmanS.SmithJ. L.SmithM. (2008). The Perpetration and Prevention of Cybercrimes. Available at SSRN 1123743

Kristo, E. (2011). Being aware of the fraud risk. Special Conference Paper. Bank of Greece, Economic Research Depart-
ment – Special Studies Division.

Kummer, T., Singh, K., & Best, P. (2015). The effectiveness of fraud detection instruments in not-for-profit organiza-
tions. Managerial Auditing Journal, 30(4/5), 435–455. doi:10.1108/MAJ-08-2014-1083

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2000). Investor protection and corporate governance.
Journal of Financial Economics, 58(1), 3–27. doi:10.1016/S0304-405X(00)00065-9

Laeven, L., & Levine, R. (2009). Bank governance, regulation and risk taking. Journal of Financial Economics, 93(2),
259–275. doi:10.1016/j.jfineco.2008.09.003

Laitinen, E. K., Lukason, O., & Suvas, A. (2014). Are firm failure processes different? evidence from seven countries.
Investment Management and Financial Innovations, 11(4), 212–222.

Laitinen, E. K., & Suvas, A. (2016). Financial distress prediction in an international context: Moderating effects of
hofstede’s original cultural dimensions. Journal of Behavioral and Experimental Finance, 9, 98–118. doi:10.1016/j.
jbef.2015.11.003

Lakshmi, S. V. S. S., & Kavilla, S. D. (2018). Machine Learning For Credit Card Fraud Detection System. International
Journal of Applied Engineering Research: IJAER, 13(24), 16819–16824.

Larcker, D. F., & Rusticus, T. O. (2010). On the use of instrumental variables in accounting research. Journal of Ac-
counting and Economics, 49(3), 186–205. doi:10.1016/j.jacceco.2009.11.004

Law, P. (2011). Corporate governance and no fraud occurrence in organizations. Managerial Auditing Journal, 26(6),
501–518. doi:10.1108/02686901111142558

Lee, E. M., Park, S.-Y., & Lee, H. J. (2013, October). Employee perception of CSR activities: Its antecedents and con-
sequences. Journal of Business Research, 10(66), 1716–1724. doi:10.1016/j.jbusres.2012.11.008

254
Compilation of References

Lemonakis, C., Ballas, P., Balla, V., & Garefalakis, A. (2018). Audit fees and pricing strategy: Do restatements of inter-
nal control reports and earnings matter? Risk Governance and Control: Financial Markets & Institutions, 8(2), 63–73.
doi:10.22495/rgcv8i2p4

Liao, J., Smith, D., & Liu, X. (2019). Female CFOs and accounting fraud: Evidence from China. Pacific-Basin Finance
Journal, 53, 449–463. doi:10.1016/j.pacfin.2019.01.003

Lim, C. Y., Woods, M., Humphrey, C., & Seow, J. L. (2017). The paradoxes of risk management in the banking sector.
The British Accounting Review, 49(1), 75–90. doi:10.1016/j.bar.2016.09.002

Limei, C., Wanfu, L., & Limin, Z. (2015). Audit mode change, corporate governance and audit effort. China Journal of
Accounting Research, 8(4), 315–335. doi:10.1016/j.cjar.2015.05.002

Lin, C., Song, F., & Sun, Z. (2013). Corporate fraud, external debt and corporate cash policy. Chinese University of
Hong Kong. doi:10.2139srn.2255410

Li, W. (2001). Corporate Governance. Nankai University Press Inc. (in Chinese)

Lowe, D. J., Geiger, M. A., & Pany, K. (1999). The Effects of Internal Audit Outsourcing on Perceived External Auditor
Independence. Auditing, 18(Supplement), 7–26. doi:10.2308/aud.1999.18.supplement.7

Lugovskaya, L. (2010). Predicting default of russian SMEs on the basis of financial and non-financial variables. Journal
of Financial Services Marketing, 14(4), 301–313. doi:10.1057/fsm.2009.28

Machado, M. R. R., & Gartner, I. R. (2018). The Cressey hypothesis (1953) and an investigation into the occurrence of
corporate fraud: An empirical analysis conducted in Brazilian banking institutions. Revista Contabilidade & Finanças,
29(76), 60–81. doi:10.1590/1808-057x201803270

Mangena, M., & Tauringana, V. (2007). Disclosure, corporate governance and foreign share ownership on the Zimba-
bwe stock exchange. Journal of International Financial Management & Accounting, 18(2), 53–85. doi:10.1111/j.1467-
646X.2007.01008.x

Markowitz, H. M. (1952, March). Portfolio Selection. The Journal of Finance, 7, 77–91.

Marshall, C. (2001). Measuring and Managing operational risks in financial institutions. Tools, Techniques and Other
Resources. John Wiley & Sons.

Martin, C. L., & Lavine, M. K. (2000). Outsourcing The Internal Audit Function. The CPA Journal.

Martinez-Miera, D., & Repullo, R. (2010). Does competition reduce the risk of bank failure? Review of Financial Stud-
ies, 23(10), 3638–3664. doi:10.1093/rfs/hhq057

Martínez-Sáncheza, J. F., Martínez-Palaciosa, M. T. V., & Venegas-Martínez, F. (2016). An analysis on operational

risk in international banking: A Bayesian approach (2007–2011). Estudios Gerenciales, 32(140), 208-220. Available at:
https://www.sciencedirect.com/science/article/pii/S0123592316300390

Martins, O. S., & Ventura Júnior, R. (2020). The Influence of Corporate Governance on the Mitigation of Fraudulent
Financial Reporting. Revista Brasileira de Gestão de Negócios, 22(1), 65–84. doi:10.7819/rbgn.v22i1.4039

Mason, A. (2013). Equity investment styles. In H. K. Baker & G. Filbeck (Eds.), Portfolio theory and management.
Oxford University Press. doi:10.1093/acprof:oso/9780199829699.003.0023

McCrum, D. (2018). Folli Follie: $1bn of fake sales, and what to learn from the debacle. Financial Times.

255
Compilation of References

McGuire, S. T., Omer, T. C., & Sharp, N. Y. (2011). The impact of religion on financial reporting irregularities. The
Accounting Review, 87(2), 645–673. doi:10.2308/accr-10206

Mclellan, J. (2005). All Above Board: Great governance for the government sector. Paperback, Australian Institute of
Company Directors.

McMahon, R., Pence, D., Bressler, L., & Bressler, L. S. (2016). New tactics in fighting financial crimes: Moving beyond
the fraud triangle. Journal of Legal. Ethical and Regulatory Issues, 19(1), 16.

McNichols, M. F., & Stubben, S. R. (2008). Does earnings management affect firms’ investment decisions? The Ac-
counting Review, 83(6), 1571–1603. doi:10.2308/accr.2008.83.6.1571

McQuade, S. C. (2009). Encyclopedia of cybercrime. Academic Press.

Meng, Y., Clements, M. P., & Padgett, C. (2018). Independent directors, information costs and foreign ownership in
Chinese companies. Journal of International Financial Markets, Institutions and Money, 53, 139–157. doi:10.1016/j.
intfin.2017.09.016

Menzly, L., & Ozbas, O. (2010). Market segmentation and cross-predictability of returns. The Journal of Finance, 65(4),
1555–1580.

Michaels, M. (2018). The most memorable and expensive financial fraud cases of all time. Business Insider. Available
at: https://www.businessinsider.com/fraud-financial-scandals-notable-and-expensive-2018-4

Minton, B., Taillard, J. P. A., & Williamson, R. (2010). Do independence and financial expertise of the board matter
for risk taking and performance? Working Paper, Ohio State University.

Mohay, G., Anderson, A., Collie, B., Vel, O. D., & McKemmish, R. (2003). Computer and intrusion forensics. Artech
House.

Mongiardino, A., & Plath, C. (2010). Risk governance at large banks: Have any lessons been learned? Journal of Risk
Management in Financial Institutions, 3, 116–123.

Moorcraft, B. (2018). What is trade credit insurance? https://www.insurancebusinessmag.com/asia/news/breaking-news/

what-is-trade-credit-insurance-116058.aspx

Mpellos, I. (2018). Πόρισμα-κόλαφος για τη Folli Follie. Athens: Academic Press.

Mulford, C. W., & Comiskey, E. E. (2011). The financial numbers game: detecting creative accounting practices. John
Wiley and Sons.

Mumby, K., & Clarke, A. (2000). Co-Sourcing vs Contracting Internal Audit. Management.

Munro, L., & Stewart, J. (2010). External auditors’ reliance on internal audit: The impact of sourcing arrangements and
consulting activities. Accounting and Finance, 50(2), 371–387. doi:10.1111/j.1467-629X.2009.00322.x

Mustafa, S. T., & Meier, H.H. (2006). Audit Committees and Misappropriation of Assets: Publicly Held Companies in
the United States. Canadian Accounting Perspectives, 5(2), 307-333.

Nandrajog, A. B. (2018). Mutual fund performance: An empirical analysis of growth schemes. Finance India, 32(4),
1287–1300.

Nantell, T. J., & Price, B. (1979). An analytical comparison of variance and semivariance capital market theories. Journal
of Financial and Quantitative Analysis, 2(2), 221–242. doi:10.2307/2330500

256
Compilation of References

Nantell, T. J., Price, K., & Price, B. (1982, December). Mean-Lower Partial Moment Asset Pricing Model: Some Empiri-
cal Evidence. Journal of Financial and Quantitative Analysis, 17(5), 763–782. doi:10.2307/2330861

Nelson, M. W., & Rupar, K. K. (2014). Numerical formats within risk disclosures and the moderating effect of investors’
concerns about management discretion. The Accounting Review, 90(3), 1149–1168. doi:10.2308/accr-50916

Nichols, C., Wahlen, J., & Wieland, M. (2009). Publicly traded versus privately held: Implications for conditional con-
servatism in banking accounting. Review of Accounting Studies, 14(1), 88–122. doi:10.100711142-008-9082-3

Niskanen, J., & Keloharju, M. (2000). Earnings cosmetics in a tax-driven accounting environment: Evidence from Finn-
ish public firms. European Accounting Review, 9(3), 443–452. doi:10.1080/09638180020017159

Niu, G., Yu, L., Fan, G.-Z., & Zhang, D. (2019). Corporate fraud, risk avoidance, and housing investment in China.
Emerging Markets Review, 39, 18–33. doi:10.1016/j.ememar.2019.03.003

Organisation for Economic Co-operation and Development – OECD. (2015). G20/OECD Principles of Corporate
Governance, OECD Publishing, Paris Office of the Comptroller of the Currency – OCC (2019). Operational Risk:
Fraud Risk Management Principles. OCC Bulletin 2019-37. Available at: https://www.occ.treas.gov/news-issuances/
bulletins/2019/bulletin-2019-37.html

Othman, R., Aris, N. A., Mardziyah, A., Zainan, N., & Amin, N. M. (2015). Fraud Detection and Prevention Methods
in the Malaysian Public Sector: Accountants’ and Internal Auditors’ Perceptions. Procedia Economics and Finance, 28,
59–67. doi:10.1016/S2212-5671(15)01082-5

Oxford Concise English Dictionary. (1999). (10th ed.). OUP.

Palmrose, Z.-V., Richardson, V. J., & Scholz, S. (2004). Determinants of market reactions to restatement announcements.
Journal of Accounting and Economics, 37(1), 59–89. doi:10.1016/j.jacceco.2003.06.003

Pamungkas, I., Ghozali, I., Achmad, T., Khaddafi, M., & Hidayah, R. (2018). Corporate governance mechanisms in
preventing accounting fraud: A study of fraud pentagon model. Journal of Applied Economic Sciences, 13(2), 549–560.

Papageorgiou, E., Yasseen, Y., & Padia, N. (2012). Internal audit function: Current status and perception of outsourcing.
African Journal of Business Management, 6(49), 11828–11838.

Pathan, S. (2009). Strong boards, CEO power and bank risk-taking. Journal of Banking & Finance, 33(7), 1340–1350.
doi:10.1016/j.jbankfin.2009.02.001

Pearson, T. A., & Singleton, T. W. (2008). Fraud and forensic accounting in the digital environment. Issues in Accounting
Education, 23(4), 545–559. doi:10.2308/iace.2008.23.4.545

Persons, O. S. (2012). Stock option and cash compensation of independent directors and likelihood of fraudulent financial
reporting. The Journal of Business and Economic Studies, 18, 54.

Peursem, K. V., & Jiang, L. (2008). Internal audit outsourcing practice and rationales: SME evidence from New Zealand.
Asian Review of Accounting, 16(3), 219–245. doi:10.1108/13217340810906681

Pfeifer, R. (2013). Crash course in Fuzzy Logic. In Real-world computing. University of Zurich.

Phua, C., Lee, V., Smith, K., & Gayler, R. (2010). A comprehensive survey of data mining-based fraud detection research.
arXiv preprint arXiv:1009.6119

Pickett, K. H. S. (2012). Fraud Smart. John Wiley & Sons, Inc. doi:10.1002/9781119208853

Pickett, S. (2006). Enterprise Risk Management: A Manager’s Journey. John Wiley & Sons Inc.

257
Compilation of References

Plant, K. (2014). Internal audit outsourcing practices in the South African public sector. African Journal of Public Af-
fairs, 7(3), 73–87.

Post, T., Vliet, P., & Lansdorp, S. (2009). Sorting out downside beta. Academic Press.

Prawitt, D. F., Sharp, N. Y., & Wood, D. A. (2012). Internal Audit Outsourcing and the Risk of Misleading or Fraudu-
lent Financial Reporting: Did Sarbanes-Oxley Get It Wrong? Contemporary Accounting Research, 29(4), 1109–1136.
doi:10.1111/j.1911-3846.2012.01141.x

Price Waterhouse Coopers. (2008). Fraud. A guide to its prevention, detection and investigation. Available at: https://
www.pwc.com.au/consulting/assets/risk-controls/fraud-control-jul08.pdf

Price Waterhouse Coopers. (2020). Fighting fraud: A never-ending battle. PwC’s Global Economic Crime and Fraud Sur-
vey. Available at: https://www.pwc.com/gx/en/forensics/gecs-2020/pdf/global-economic-crime-and-fraud-survey-2020.pdf

PwC’s Global Economic Crime and Fraud Survey. (2020). https://www.pwc.com/gx/en/services/advisory/forensics/

economic-crime-survey.html

Qian, X., Zhang, G., & Liu, H. (2015). Officials on boards and the prudential behaviour of banks: Evidence from China’s
city commercial banks. China Economic Review, 32, 84–96. doi:10.1016/j.chieco.2014.11.010

Qian, Y. (1995). Reform on the Chinese Corporate Governance Structure and Financing Structure. [in Chinese]. Eco-
nomic Research Journal, (1), 20–29.

Ramamoorti, S. (2019). Fraud. Books and Book Chapters by University of Dayton Faculty. 39. Available at: https://
ecommons.udayton.edu/books/39

Randhawa, K., Loo, C. K., Seera, M., Lim, C. P., & Nandi, A. K. (2018). Credit card fraud detection using AdaBoost and
majority voting. IEEE Access: Practical Innovations, Open Solutions, 6, 14277–14284. doi:10.1109/ACCESS.2018.2806420

Rasha, K., & Andrew, H. (2012). The New Fraud Triangle. Journal of Emerging Trends in Economics and Management
Science, 3(3).

Refinitiv. (2020). Lipper Fund Performance Data. Author.

Rehman, A., & Hashim, F. (2018). Literature review: Preventive Role of Forensic accounting and Corporate Governance.
Journal of Governance and Integrity, 1(2), 68–93.

Renjith, S. (2018). Detection of Fraudulent Sellers in Online Marketplaces using Support Vector Machine Approach.
International Journal of Engineering Trends and Technology.

Rezaee, Z. (2002). Financial statement fraud: prevention and detection. John Wiley and Sons.

Rittenberg, L. E. (1999). Discussion of The Effects of Internal Audit Outsourcing on Perceived External Audit Indepen-
dence. Auditing: A Journal of Practice & Theory, 18, 27-35.

Robertson, C. J., & Watson, A. (2004). Corruption and change: The impact of foreign direct investment. Strategic Man-
agement Journal, 25(4), 385–396. doi:10.1002mj.382

Ross, I. (2015). Exposing fraud: Skills, process and practicalities. John Wiley & Sons. doi:10.1002/9781119177494

258
Compilation of References

Roth, J. (2003). Internal Audit’s Role in Corporate Governance: Sarbanes-Oxley Compliance. The IIA Research Foundation.

Roy, A. D. (1952). Safety first and the holding of assets. Econometrica, 20(3), 431–449. doi:10.2307/1907413

Sabato, G. (2010). Financial crisis: Where did risk management fail? International Review of Applied Financial Issues
and Economics, 2(2), 315.

Sadasivam, G. S., Subrahmanyam, M., Himachalam, D., Pinnamaneni, B. P., & Lakshme, S. M. (2016). Corporate gov-
ernance fraud detection from annual reports using big data analytics. Int. J. Big Data Intelligence, 3(1), 51. doi:10.1504/
IJBDI.2016.073895

Sadgali, I., Sael, N., & Benabbou, F. (2019). Performance of machine learning techniques in the detection of financial
frauds. Procedia Computer Science, 148, 45–54. doi:10.1016/j.procs.2019.01.007

Salameh. (2011). Alternative Internal Audit Structures and Perceived Effectiveness of Internal Audit in Fraud Preven-
tion: Evidence from Jordanian Banking Industry. Canadian Social Science, 7(3), 40-50.

Sanusi, Z. M., Rameli, M. N. F., & Isa, Y. M. (2015). Fraud Schemes in the Banking Institutions: Prevention Measures
to Avoid Severe Financial Loss. Procedia Economics and Finance, 28, 107–113. doi:10.1016/S2212-5671(15)01088-6

Sawyer, L. (1988). Sawyer’s Internal Auditing. The Institute of Internal Auditors.

Schuchter, A., & Levi, M. (2016). The fraud triangle revisited. Security Journal, 29(2), 107–121. doi:10.1057j.2013.1

Schultz, P. (2010). Rational cross-sectional differences in market efficiency: Evidence from mutual fund returns. Journal
of Financial and Quantitative Analysis, 45(4), 847–881.

Schwartz, M. (2013). Developing and sustaining an ethical corporate culture: The core elements. Business Horizons,
56(1), 39–50. doi:10.1016/j.bushor.2012.09.002

Seetharaman, A., Krishna Moorthy, M., & Saravanan, A. S. (2008). Outsourcing of Internal Audit and Independence of
Auditors. Corporate Board: Role, Duties &Composition, 4(2), 40-49.

Seguí-Mas, E., Bollas-Araya, H. M., & Polo-Garrido, F. (2018). Assurance on corporate governance reports in Spain:
Towards an enhanced accountability or a new form of public relations? Administrative Sciences, 8(3), 32. doi:10.3390/
admsci8030032

Selim, G., & Yiannakas, A. (2000). Outsourcing the Internal Audit Function: A Survey of the UK Public and Private
Sectors. International Journal of Auditing, 4(3), 213–226. doi:10.1111/1099-1123.00314

Sensoy, B. A. (2009). Performance evaluation and self-designated benchmark indexes in the mutual fund industry. Journal
of Financial Economics, 92(1), 25–39.

Shapiro, A. F. (2005). Insurance applications of Fuzzy Logic, In Proceedings of the Institute of Actuaries 2005 Biennial
Convention. Actuaries Institute

Shapiro, A. F. (2007). An Overview of Insurance Uses of Fuzzy Logic. In S. H. Chen, P. P. Wang, & T. W. Kuo (Eds.),
Computational Intelligence in Economics and Finance. Springer. doi:10.1007/978-3-540-72821-4_2

Sharma, D. S., & Subramaniam, N. (2005). Outsourcing Of Internal Audit Services in Australian Firms: Some Prelimi-
nary Evidence. Asian Academy of Management Journal of Accounting, 1, 33–52.

Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of
Finance, 19(3), 425–442.

Sharpe, W. F. (1967). Portfolio analysis. Journal of Financial and Quantitative Analysis, 2(2), 76–84. doi:10.2307/2329895

259
Compilation of References

Sharpe, W. F. (1992). Asset allocation: Management style and performance measurement. Journal of Portfolio Manage-
ment, 18(2), 7–19. doi:10.3905/jpm.1992.409394

Shipman, J. E., Swanquist, Q. T., & Whited, R. L. (2016). Propensity score matching in accounting research. The Ac-
counting Review, 92(1), 213–244. doi:10.2308/accr-51449

Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737–783.
doi:10.1111/j.1540-6261.1997.tb04820.x

Singh, A., Ikuesan, A. R., & Venter, H. S. (2019). Digital Forensic Readiness Framework for Ransomware Investigation.
In F. Breitinger & I. Baggili (Eds.), Digital Forensics and Cyber Crime. doi:10.1007/978-3-030-05487-8_5

Singleton-Green, B. (2012). Commentary: Financial reporting and financial stability: Causes and effects. Australian
Accounting Review, 22(1), 15–17. doi:10.1111/j.1835-2561.2011.00161.x

Singleton, T. W., & Singleton, A. J. (2010). Fraud auditing and forensic accounting. John Wiley & Sons.
doi:10.1002/9781118269183

Siringoringo, R. (2018). Klasifikasi Data Tidak Seimbang Menggunakan Algoritma Smote Dan K-Nearest Neighbor.
Journal Information System Development, 3, 1.

Skalak, S. L., Golden, T. W., Clayton, M., & Bill, J. (2011). A guide to forensic accounting investigation. John Wiley
& Sons.

Snell, R. S., & Herndon, N. C. Jr. (2000). An evaluation of Hong Kong’s corporate code of ethics initiative. Asia Pacific
Journal of Management, 17(3), 493–518. doi:10.1023/A:1015846617296

Sobel, P. (2005). Auditor’s Risk Management Guide: Integrating Auditing and ERM. CCH Incorporated.

Sokolovska, O. (2017). Trade Credit Insurance and Asymmetric Information Problem. Scientific Annals of Economics
and Business, 64(1), 123–137. doi:10.1515aeb-2017-0008

Song, X. P., Hu, Z. H., Du, J. G., & Sheng, Z. H. (2014). Application of machine learning methods to risk assessment of
financial statement fraud: Evidence from China. Journal of Forecasting, 33(8), 611–626. doi:10.1002/for.2294

Spathis, C. T. (2002). Detecting false financial statements using published data: Some evidence from Greece. Manage-
rial Auditing Journal, 17(4), 179–191. doi:10.1108/02686900210424321

Spekl’e, R. F., van Elten, H. J., & Kruis, A.-M. (2007). Sourcing of Internal Auditing: An Empirical Study. Management
Accounting Research, 18(1), 102–124. doi:10.1016/j.mar.2006.10.001

Spraakman, G. (2001). Internal Audit At The Historical Hudson’s Bay Company: A Challenge To Accepted History.
The Accounting Historians Journal, 28(1), 19–41. doi:10.2308/0148-4184.28.1.19

Sreekantha, D. K., & Kulkarni, R. V. (2010). Expert system design for credit risk evaluation using neuro-fuzzy logic.
Expert Systems: International Journal of Knowledge Engineering and Neural Networks, 29(1), 56–69. doi:10.1111/j.1468-
0394.2010.00562.x

statista.com. (2018). Retail e-commerce revenue forecast from 2017 to 2023 (in billion U.S. dollars). Retrieved April
2018, from Indonesia: https://www.statista.com/statistics/280925/e-commerce-revenue-forecast-in-indonesia/

Stein, J. C. (2002). Information production and capital allocation: Decentralized versus hierarchical firms. The Journal
of Finance, 57(5), 1891–1921. doi:10.1111/0022-1082.00483

260
Compilation of References

Stein, M. J. (2008). Beyond the boardroom: Governmental perspectives on corporate governance. Accounting, Auditing
& Accountability Journal, 21(7), 1001–1025. doi:10.1108/09513570810907456

Stivers, C., & Sun, L. (2010). Cross-sectional return dispersion and time variation in value and momentum premiums.
Journal of Financial and Quantitative Analysis, 45(4), 987–1014. doi:10.1017/S0022109010000384

Stolowy, H., & Breton, G. (2003). Accounts Manipulation: A Literature Review and Proposed Conceptual Framework.
Academic Press.

Suh, J., & Shim, H. (2020). The effect of ethical corporate culture on anti-fraud strategies in South Korean financial
companies: Mediation of whistleblowing and a sectoral comparison approach in depository institutions. International
Journal of Law, Crime and Justice, 60, 100361. doi:10.1016/j.ijlcj.2019.100361

Suleiman, D. M., & Dandago, K. I. (2014). The extent of internal audit functions outsourcing by Nigerian deposit money
banks. Procedia: Social and Behavioral Sciences, 164, 222–229. doi:10.1016/j.sbspro.2014.11.070

Sundarajan, V. (2007). Risk Characteristics of Islamic Products: Implications for Risk Measurement and Supervision.
In Islamic Finance: The Regulatory Challenge. John Wiley & Son (Asia) Pte Ltd.

Swanger, S. L., & Chewning, E. G. Jr. (2001). The Effect of Internal Audit Outsourcing on Financial Analysts’ Percep-
tions of External Auditor Independence. Auditing, 20(2), 115–129. doi:10.2308/aud.2001.20.2.115

Sweeney, A. P. (1994). Debt-covenant violations and managers’ accounting responses. Journal of Accounting and Eco-
nomics, 17(3), 281–308. doi:10.1016/0165-4101(94)90030-2

Tairidis, G. K. (2016). Optimal design of smart structures with intelligent control (Ph.D. Dissertation). Technical Uni-
versity of Crete.

Tairidis, G. K., & Stavroulakis, G. E. (2019). Fuzzy and neuro-fuzzy control for smart structures. In M. Khakifirooz,
M. Fathi, & P. Pardalos (Eds.), Computational intelligence and optimization methods for control engineering. Springer.
doi:10.1007/978-3-030-25446-9_4

Tan, D. T., Chapple, L., & Walsh, K. D. (2017). Corporate fraud culture: Re‐examining the corporate governance and
performance relation. Accounting and Finance, 57(2), 597–620. doi:10.1111/acfi.12156

Tianqi, C., & Guestrin, C. (2016). XGBoost: A Scalable Tree Boosting System. KDD ’16: Proceedings of the 22nd ACM
SIGKDD International Conference on Knowledge Discovery and Data Mining, 785-794.

Tobback, E., Bellotti, T., Moeyersoms, J., Stankova, M., & Martens, D. (2017). Bankruptcy prediction for SMEs using
relational data. Decision Support Systems, 102, 69–81. doi:10.1016/j.dss.2017.07.004

Treynor, J., & Mazuy, K. (1966). Can mutual funds outguess the market? Harvard Business Review, 44(4), 131–136.

Tsang, A., Xie, F., & Xin, X. (2019). Foreign institutional investors and corporate voluntary disclosure around the World.
The Accounting Review, 94(5), 319–348. doi:10.2308/accr-52353

Tunji, S. T. (2013). Effective internal controls system as antidote for distress in the banking industry in Nigeria. Journal
of Economics and International BusinessResearch, 1(5), 106–121.

Turley, S., & Zaman, M. (2007). Audit committee effectiveness: Informal processes and behavioural effects. Accounting,
Auditing & Accountability Journal, 20(5), 765–788. doi:10.1108/09513570710779036

Ujiyantho & Pramuka. (2007). Mekanisme Corporate Governance, Manajemen Laba dan Kinerja Keuangan. Simposium
Nasional Akuntansi X.

261
Compilation of References

Van der Stede, W. A. (2011). Management accounting research in the wake of the crisis: Some reflections. European
Accounting Review, 20(4), 605–623. doi:10.1080/09638180.2011.627678

Vassiliou, D., Heriotis, N., Menexiadis, M., & Balios, D. (2017). Internal Audit. Rosili.

Verschoor, C. (2008). Audit Committee Essentials. Wiley & Sons Inc.

Vives, X. (2019). Competition and stability in modern banking: A post-crisis perspective. International Journal of
Industrial Organization, 64, 55–69. doi:10.1016/j.ijindorg.2018.08.011

Vo, X. V. (2016). Foreign investors and corporate risk taking behavior in an emerging market. Finance Research Letters,
18, 273–277. doi:10.1016/j.frl.2016.04.027

Wagner, N., & Winter, E. (2013). A new family of equity style indices and mutual fund performance: Do liquidity and
idiosyncratic risk matter? Journal of Empirical Finance, 21, 69–85. doi:10.1016/j.jempfin.2012.12.005

Wahal, S., & Yavuz, M. D. (2013). Style investing, comovement and return predictability. Journal of Financial Econom-
ics, 107(1), 136–154.

Wall, D. (2011). Micro frauds: Virtual robberies, stings and scams in the information age. Academic Press.

Wan, A. A., Wan, M. R., & Roshayani, A. (2014). Disclosure of corporate governance structure and the likelihood of
fraudulent financial reporting. Procedia: Social and Behavioral Sciences, 145, 243–253. doi:10.1016/j.sbspro.2014.06.032

Wang, Z., Chen, M.-H., Chin, C. L., & Zheng, Q. (2017). Managerial ability, political connections, and fraudulent finan-
cial reporting in China. Journal of Accounting and Public Policy, 36(2), 141–162. doi:10.1016/j.jaccpubpol.2017.02.004

Warrick, D. D. (2017). What leaders need to know about organizational culture. Business Horizons, 60(3), 395–404.
doi:10.1016/j.bushor.2017.01.011

Watts, R. L., & Zimmerman, J. L. (1990). Positive accounting theory: A ten year perspective. The Accounting Review,
131–156.

Wells, J. T. (2005). Principles of Fraud Examination. Wiley.

Wernz, J. (2020). Bank Management and Control. Strategy, Pricing, Capital and Risk Management. Springer Nature,
Management for Professionals. doi:10.1007/978-3-030-42866-2

Whitehouse, M. (2017). How much have banks really cut their risks? Bloomberg. https://www.bloomberg.com/view/
articles/2017-09-11/how-much-have-banks-really-cut-their-risks

Whiting, D. G., Hansen, J. V., McDonald, J. B., Albrecht, C., & Albrecht, W. S. (2012). Machine learning methods for de-
tecting patterns of management fraud. Computational Intelligence, 28(4), 505–527. doi:10.1111/j.1467-8640.2012.00425.x

Widener, S. K., & Selto, F. H. (1999). Management Control Systems and Botmdaries of the Firm: Why do Firms Out-
source Internal Auditing Activities? JMAR: Journal of Management Accounting Research, 11, 45–73.

Widrow, B., & Lehr, M. A. (1990). 30 years of adaptive neural networks: Perceptron, madline, and backpropagation.
Proceedings of the IEEE, 78(9), 1415–1442. doi:10.1109/5.58323

Wu, P., Gao, L., Chen, Z., & Li, X. (2016). Managing reputation loss in China: In-depth analyses of financial restate-
ments. Chinese Management Studies, 10(2), 312–345. doi:10.1108/CMS-12-2015-0275

262
Compilation of References

Wu, X., & Wang, J. (2018). Management’s Materiality Criteria of Internal Control Weaknesses and Corporate Fraud:
Evidence from China. The International Journal of Accounting, 53(1), 1–19. doi:10.1016/j.intacc.2018.02.001

Xin, Q., Zhou, J., & Hu, F. (2018). The economic consequences of financial fraud: Evidence from the product market
in China. China Journal of Accounting Studies, 6(1), 1–23. doi:10.1080/21697213.2018.1480005

Xu, L. (2004). Types of large shareholders, corporate governance, and firm performance: evidence from China’s listed
companies. Hong Kong Polytechnic University.

YangY.ZhangK. (2020). Operational Risk Identification: An Effective and Explainable Design Approach. Available at:
doi:10.2139srn.3603702

Yazdani, H., & Kwasnicka, H. (2012). Fuzzy Classification Method in Credit Risk. In Computational Collective In-
telligence. Technologies and Applications. ICCCI 2012. Lecture Notes in Computer Science, (vol 7653). Springer.
doi:10.1007/978-3-642-34630-9_51

Yiannakas, A. (n.d.). Outsourcing the Internal Audit Function With Special Reference to the UK Public and Private
Sectors (Doktora Tezi). City University Business School, Department of Accounting and Finance.

Yoshikawa, T., Rasheed, A. A., & Del Brio, E. B. (2010). The impact of firm strategy and foreign ownership on executive
bonus compensation in Japanese firms. Journal of Business Research, 63(11), 1254–1260. doi:10.1016/j.jbusres.2010.06.012

Zabihollah & Riley. (2010). Financial Statement Fraud: Prevention and Detection (2nd ed.). John Wiley & Sons, Inc.

Zadeh, L. A. (1965). Fuzzy Sets. Information and Control, 8(3), 338–353. doi:10.1016/S0019-9958(65)90241-X

Zahra, S. A., Priem, R. L., & Rasheed, A. A. (2005). The antecedents and consequences of top management fraud.
Journal of Management, 31(6), 803–828. doi:10.1177/0149206305279598

Zang, A. Y. (2011). Evidence on the trade-off between real activities manipulation and accrual-based earnings manage-
ment. The Accounting Review, 87(2), 675–703. doi:10.2308/accr-10196

ZhangY. 2004. Law, corporate governance, and corporate scandal in an emerging economy: Insights from China. Avail-
able at SSRN 957549. doi:10.2139srn.957549

Zhao, J., Lau, R. Y. K., Zhang, W., Zhang, K., Chen, X., & Tang, D. (2016). Extracting and reasoning about implicit
behavioral evidences for detecting fraudulent online transactions in e-Commerce. Decision Support Systems, 86, 109–121.
doi:10.1016/j.dss.2016.04.003

Zhou, H., Owusu-Ansah, S., & Maggina, A. (2018). Board of directors, audit committee, and firm performance: Evidence
from Greece. Journal of International Accounting, Auditing & Taxation, 31, 20–36. doi:10.1016/j.intaccaudtax.2018.03.002

263
264

About the Contributors

Alexandros Garefalakis is Certified Public Accountant (Fellow of CPA), Certified Management

Accountant (CMA) and he is an Assistant Professor at the Dept. of Business Administration and Tour-
ism at Hellenic Mediterranean University (HMU) in Greece. Also, he has co-authored 7 books on Audit
Accounting, Financial Accounting, Management Accounting and Research Methods for Business issues
and his areas of research interest include the Disclosure Narrative information, ESG, I.F.R.S, Manage-
ment Commentary Index (Ma.Co.I), Auditing, Quality of Financial Statements, Weighting models in
Accounting, Accounting and Operation Research, Multiple Criteria Decision‐Making in Management
Accounting.

***

Y. Acar Ugurlu is a Dr. Lecturer in Accounting and Tax Applications Program at Arel University
where she has been a lecturer since 2010. She received her Ph.D. in Accounting in 2019 from Istanbul
University.

V. Evrim Altuk gained her bachelor’s degree from Marmara University, the Faculty of Business
Administration in 2000. She received her Ph.D. in Accounting and Finance from Marmara University
in 2013. Her research interest includes IFRS, auditing, fraud, forensic accounting and earnings manage-
ment. She is currently working as assistant professor at Trakya University.

Konstantina K. Ainatzoglou has completed her undergraduate degree in Production Engineering

and Management at the Technical University of Crete. She is currently a postgraduate student in the
MSc Financial Risk Management, University College London.

Çağla Demir Pali received her PhD degree in Accounting from Istanbul University in 2018. She
works as a senior internal auditor in TYH Textile and a part-time instructor in Istanbul Bilgi University.
Her research focuses on risk management and auditing.

Marianna Eskantar in a postgraduate student in the Department of Production Engineering and

Management at Technical University of Crete and member of the Financial Engineering Laboratory,
School of Production Engineering and Management, Technical University of Crete.

About the Contributors

Evangelos Grigoroudis is Professor on management of quality processes in the School of Produc-

tion Engineering and Management of the Technical University of Crete, Greece (2002-). He followed
postgraduate studies in Technical University of Crete, Greece from where he received his Ph.D degree
in 1999. He has received distinctions from the Hellenic Operational Research Society, the Academy of
Business and Administrative Sciences, the World Automation Congress, the Foundation of Ioannis and
Vasileia Karayianni, the Technical University of Crete, and the State Scholarships Foundation of Greece.
He acts as reviewer for more than 70 scientific journals, and he is Associate Editor and member of the
Editorial Board of several scientific journals. He coauthored/coedited more than 15 books in service
quality measurement, corporate strategy and published more than 170 articles in scientific journal,
books and conference proceedings. His research interests include service quality measurement processes,
customer and employee satisfaction, performance evaluation, business excellence, operational research,
multicriteria decision analysis, data analysis, and marketing.

Alkebsee Hussien is a Ph.D. student in School of Management, Xi’an Jiaotong University, China. His
area of research interest is corporate finance, corporate governance, executive’s compensation, financial
reporting quality. Currently, his Ph.D. research work revolves around the governance role of ownership
structure and financial reporting quality.

Sunil Joshi is currently working as a Assistant Professor in Department of CS & IT in Samrat Ashok
Technological Institute of Science and Technology, Vidisha (M.P) an Autonomous Institute Under
RGPV University Bhopal. He has a 18 Years Teaching and 9 Years of Research Experience. His Area
of specialization are Theory of Computation, Data Mining and Machine Learning.

Anastasios Konstantinidis is an assistant professor in the Department of Accounting and Finance

at the University of Western Macedonia. He holds a master’s degree in Business Informatics from the
University of Macedonia. He holds a PhD in Production and Management Engineering from Democritus
University in Behavioral Finance and Financial Investment Decisions. He has extensive professional
experience in financial investments as an investment consultant and his scientific interests are in the
field of Behavioral Finance and in finance in general with extensive research work in both journals and
conferences.

Marios-Nikolaos Kouskoukis is a Scientific Collaborator at the Department of Management and

Marketing of European University of Cyprus. Dr. Kouskoukis holds a Bachelor Degree in Economics
from Democritus University of Thrace, a Master of Business Administration (M.B.A.) Degree in Total
Quality Management from University of Piraeus and a Ph.D. in Economics with high distinction from
Panteion University of Social and Political Sciences. He has been academic staff in the past in different
Departments of different Universities and he has supervised and evaluated undergraduate assignments
at the Panteion University of Social and Political Sciences, as well as postgraduate dissertations at the
University of Piraeus and at the Neapolis University of Pafos. In addition, he has working experience,
both in public and private sectors, specifically in the fields of Consulting, Education, Health and Finance.
His published work includes articles, papers and book chapters in the research fields of Investment, Ac-
counting, Regional Economic Development and Economic Evaluation of Renewable Energy Sources.

265
About the Contributors

Christos Lemonakis is an Assistant Professor of Business Administration on SMEs Management

at the Hellenic Mediterranean University, Department of Management Science and Technology (Agios
Nikolaos, Crete, Greece). His research interests are Cost Accounting and Responsible Management
Education, Corporate Governance, and Entities Sustainability.

Manish Manoria was born on 12 Jan 1969. He have completed his Ph.D from RGTU Bhopal in 2007.
He have 28 Year of Experience of academics and Research of different Institution Like SATI Vidisha
(Autonomous Under RGPV Bhopal), Truba College Bhopal, etc. Currently he is working as a Director
& Group Coordinator in Sagar Institute of Research and Technology, Bhopal. He has 78 international
research publication and 5 Books in field of computer science and engineering. He have guided 25 PG
and 02 Ph.D students. He have received 15 + Lac Research grant from different Govt. Agency. He is a
good Enterprise Academic Leader with rich experience of educational institutions through innovations
and streamlining operation.

Antonia Maravelaki is a PhD Candidate in Corporate Governance and Auditing, Hellenic Mediter-
ranean University.

Jay Prakash Maurya was born in India on June, 1987. He received the Engineering degree, B.Tech.
in Computer Science and Information Technology from Institute of Engineering & Technology (IET),
Mahatma Jyotiba Phule Rohilkhand University, Bareilly(U.P), India in 2008. He has completed a com-
pleted post graduate diploma in System database Administration from CDAC, Noida(U.P), India. He have
completed his Post Graduate degree M. Tech. in Computer Science and engineering from Bansal Institute
of Science & Technology, Bhopal (M.P), India in 2013. He is pursuing Ph.D from SATI(Autonomous),
RGPV, Bhopal (M.P), and India. He is currently working as a Assistant Professor in the Department
of Computer Science and engineering, at LNCT, Bhopal Madhya Pradesh, India. He has 06 years of
experience in teaching & research. He have guided 06 P.G Dissertation under him. He has published
more than 25 scientific papers in International and National reputed Journals and conference proceed-
ings (Including SCOPUS index and UGC Paper), 01 Book Chapter in the field of data mining, image
processing, and Network security. His current research interests include Data Mining, Machine Learning,
Soft Computing, and IoT. He also has the experience of conducting workshops with collaboration of
IIT-Bombay for the project “SMART CLASSROOM” and “BODHI TREE”, & Spoken Tutorial Project.

Stelios Papadakis is dean of the School of Management and Economics Sciences and Professor in
the Department of Administrative Science and Technology in Hellenic Mediterranean University.

Ioannis Passas is an Economist and Certified Management Accountant (CMA Diploma) from the
Association of Certified Public Accountants Int’l. Also, he holds a Degree in Business Administration
from International Hellenic University and a Master’s degree in Business Administration in Hospital-
ity & Tourism from Hellenic Mediterranean University. Currently is a Ph.D. Candidate in the field of
Accounting in Hellenic Mediterranean University. He has co-authored four Academic books. Three of
them are based on Accounting and Management Accounting issues and the other one based on Research
Methodology.

266
About the Contributors

Deepak Rathore was born in India on July, 1987. He received the Engineering degree, B.E. in Com-
puter Science and engineering from MITS (An Autonoums institute) Gwalior in 2008 and post graduate
degree M. Tech. in Computer Science and engineering from RITS, Bhopal in 2012. He is currently an
Assistant Professor in the Department of Computer Science and engineering, at LNCT, Bhopal Madhya
Pradesh, India. He possesses 06 years of experience including teaching. He has published more than 10
scientific papers in International and National reputed Journals and conference proceedings (Including
SCOPUS index and UGC Paper) in the field of soft computing, image processing, and Network security.
His current research interests include Machine Learning, Soft Computing, Mobile Ad-hoc Network
and IoT. He also has the experience of conducting workshops with collaboration of IIT-Bombay for the
project “SMART CLASSROOM” and “BODHI TREE”

Vivek Richhariya has a Ph.D. in Computer Science & Engineering form Rabindranath Tagore Uni-
versity (Formerly known as AISECT University), Bhopal (M.P.) in 2016. M.Tech. in Computer Science
& Engineering from R.G.P.V., Bhopal (M.P.) with 76% in 2006. He is currently working as a Professor
in the Department of Computer Science and engineering at LNCT, Bhopal, Madhya Pradesh, India. He
has more than 20 years of experience in teaching & research including software development. He has
published more than 35 research papers in International and National reputed Journals and conference
proceedings (Including SCOPUS index and UGC Paper). He is author one book namely Database Man-
agement System Concepts & Normalization. His current research interests include Wireless Network,
Network Security, Machine Learning and IoT.

Konstantinos Spinthiropoulos is an assistant professor in the Field of Economic Development and

the Sustainability of International Businesses and Organizations, in the Department of Management
Science & Technology in University of West Macedonia (Kozani-Greece). He holds two undergraduate
degrees in the field of Applied Finance and Business Administration while he received his MSc from the
Department of Applied Informatics, Faculty of Economic and Social Sciences, University of Macedonia
of Thessaloniki. He also holds a Ph.D. Diploma from the Department of International and European
Studies of the University of Macedonia (Thessaloniki). He has worked for more than a decade in Greek
companies while also being a research associate at the Western Macedonia Technological Educational
Institute in the field of applied economics. He has written more than 50 papers in different Journals or
Conferences.

Irini Stavropoulou holds a degree in Finance from the Technological Educational Institution of
Western Macedonia and a postgraduate degree from the Open University of Cyprus, specializing in
Business Administration (Banking / Finance). She is in the process of starting her doctoral dissertation
on the subject of Building Balanced Scorecard in complex organizations with various effective manage-
rial tools and performance strategies.

Georgios Tairidis studied Production engineering and management at the Democritus University
of Thrace (2005). He holds a M.Sc. on Production Systems with expertise on soft computing methods
(fuzzy control) on smart structures (2009) and a PhD on the optimal design of smart structures with
intelligent control (2016) from the Technical University of Crete. He received a Postdoctoral Fellowship
from the State Scholarships Foundation (IKY) through the IKY- SIEMENS Program and two Fellowships
from the French Government for short 3-month visits at the Conservatoire National des Arts et Métiers

267
About the Contributors

(CNAM) in Paris, where he started working on shunted piezoelectric composites for damping. Currently,
he works on a post-doc research program on multimode shunts and smart metamaterials with a 2-year
fellowship for post-graduate studies from IKY. He also has 4-year teaching experience, after PhD, from
the School of Production Engineering and Management (Technical University of Crete) and the Depart-
ments of Mechanical Engineering, and Electrical Engineering (Hellenic Mediterranean University). He
has also taken part in several research programs at the Technical University of Crete, Ionian University
and Technological Institute of Epirus.

Gaoliang Tian is a Professor and Vice dean of School of Management, Xi’an Jiaotong University,
China. His area of research interest is the internal control, corporate governance, corporate social
responsibility, executives’ compensation and audit quality etc. His research work has been published
(accepted) in international journals of good repute, e.g., Accounting Review, Journal of Accounting and
Public Policy, Journal of Business Ethics, etc.

Elpida Tsitsiridi received her Bachelor Degree in International Economic Relations & Development
from the Democritus University of Thrace in 2006 and her M.Sc. in Engineering Management from
the Technical University of Crete (Department of Production Engineering & Management) in 2010.
During her M.Sc. studies, she was a member of the Financial Engineering Laboratory of the Technical
University of Crete, when she participated to research studies, conferences and publications. For more
than 6 years, she worked at the Risk Management Division of the Cooperative Bank of Chania. In 2014,
she became the Advisor to the Mayor of Chania on economic affairs, a post she held until June of 2018,
when she became Vice-Mayor of the Municipality of Chania for Tourism, Culture, European Affairs
and IT. Her research interests include Decision Theory, Operational Efficiency and Optimization, Risk
Management, Multicriteria Analysis and Regional Policy.

Constantin Zopounidis is Professor of Financial Engineering and Operations Research, at Technical

University of Crete (Greece), Distinguished Research Professor in Audencia Business School (France),
and Senior Academician of both the Royal Academy of Doctors and the Royal Academy of Econom-
ics and Financial Sciences of Spain. He is Editor-in-Chief in The International Journal of Multicriteria
Decision Making (Inderscience), The Operational Research: An International Journal (Springer), The
International Journal of Financial Engineering and Risk Management (Inderscience) and Associate
Editor in International Journal of Banking, Accounting and Finance (Inderscience), International Jour-
nal of Data Analysis Techniques and Strategies (Inderscience), and Member of the Editorial Board in
the European Journal of Operational Research (Elsevier). In 2013 he received the Edgeworth-Pareto
prestigious Award from the International Society of Multicriteria Decision Making. He has edited and
authored 100 books in international publishers and more than 500 research papers in scientific journals,
edited volumes, conference proceedings and encyclopaedias in the areas of finance, accounting, opera-
tions research, and management science.

268
269

Index

A co-sourcing 166-167, 169-173, 177, 179-182, 184

credit insurance 201-202, 214-221
anti-fraud strategy 75, 90 crisis 51, 65, 76, 90-92, 152, 169, 185-189, 193-200, 216
asset pricing models 138, 143, 146 cybercrime 83, 114, 126-131, 134-136
Assurance Services 12, 172, 184 CyberSecurity 126, 135
audit 1, 3, 7-15, 32, 34, 37-39, 41-48, 53-54, 56-57,
66, 68, 73, 87-88, 92, 111-112, 124, 130, 153, D
166-184, 188, 190, 194, 197
Audit Committee 3, 7, 15, 32, 37-39, 41, 43-45, 48, data mining 108-113, 116, 119, 122-125, 131, 235
56-57, 66, 168, 173, 177-179 data processing 16, 225
auditors 1, 3, 7, 11, 17, 37-38, 41-43, 45-47, 50, 53, dataset 21-23, 27, 108, 112-113, 119-120, 212-213,
56, 64, 66, 68, 73, 84, 93, 166, 168-184, 190-191 218-219
decision tree 21-23, 26, 108, 117, 131
B Denial of Service (DoS) 137
downside risk premium 138-139, 141, 144, 146
banking 3, 13, 29, 57, 75-78, 80-81, 84, 86, 89-94, 104,
110, 114, 128-130, 173, 183, 185-186, 190-191, F
193-195, 197-200, 217, 221, 224, 227, 234
bankruptcy 3, 17, 65, 190, 202, 216, 223-225, 230, factor models 95-99, 101, 104
234-235 financial fraud 1, 11-12, 50, 59, 64, 71, 76, 78, 88, 93,
Business Fraud 92, 108-110 112, 115, 131, 152, 161
financial institutions 68, 76-77, 83, 87, 93, 185-187,
C 189-196, 198, 200
Financial Statement User 184
CAMP 95 foreign direct investment 148-160, 164
China 7, 12, 14, 66, 136, 148-154, 157-161, 200 foreign investors 148-154, 156-158, 160-161
computer fraud 114, 128 foreign ownership 148, 150, 153-161, 165
Consultancy Services 184 fraud 1, 3-4, 7-8, 11-14, 16-23, 25-27, 29-31, 37, 44,
control 2, 7-8, 10-11, 13-14, 18, 32-35, 37-48, 50-51, 46, 48-76, 78-94, 108-117, 122-124, 126-132,
53-54, 65-67, 72, 77, 86, 90, 94, 110, 123, 135, 134-137, 148-161, 164, 169, 172-173, 180-184
150-151, 153-156, 159, 161, 167-168, 171-172, fraud detection 1, 12, 16, 19, 21-23, 30-31, 57, 73, 75,
175-176, 180, 183-184, 188, 191-192, 194, 197, 86-87, 91-93, 108, 110-117, 122-124, 131, 173
201-202, 211-212, 214, 221-222 Fraud Mitigation 1
control effectiveness 32, 90 fraud prevention 19-21, 30, 53-54, 75, 86-88, 91, 94,
corporate fraud 7, 12-14, 16-18, 29-30, 52, 55, 93, 116, 135, 173, 182-183
109, 131, 148-161, 164 fraudulent 3, 8, 11, 13-14, 16-17, 20, 31, 50-51, 53,
corporate governance 1-3, 7, 11-14, 20, 30-38, 41-43, 57, 61, 64-65, 78-79, 81-87, 90-91, 111-115, 122-
45, 47-53, 56-57, 61, 64, 66, 72-73, 86, 89-93, 123, 127-128, 130, 151-152, 160-161, 183, 186
104, 149-150, 153-161, 168, 181, 186, 194-199 Fuzzy Systems 201, 203, 212, 219, 221

Index

H N
Hidden correlation 16 Neurofuzzy Systems 201, 211-212

I O
independent auditor 42, 168-169, 174-175, 177, 181, occupational fraud 56, 61-62, 75, 78, 80-82, 91
184 operational risk 75-78, 90-94, 189-190, 197
in-house 166-167, 169-171, 173-174, 176-178, 181- outsourcing 46, 53, 166-167, 169-184
182, 184
intellectual property 127, 129-130, 135, 137 P
intelligent control systems 201-202
internal audit 12, 38-39, 41-48, 53, 56-57, 87-88, phishing 79, 114, 128-130, 137
166-184, 194, 197 prediction 16, 23, 111, 115, 117, 132, 213, 223-224,
internal auditor 46, 168-169, 171-172, 174, 176, 178, 229, 233-235
180, 182, 184
Internal Control system 32, 37-39, 43, 45-48, 51, 53, R
77, 154
investment management 95, 97-98, 103, 235 risk management 2, 14, 39-40, 45, 48, 51-53, 55, 77,
investment performance 95-101, 103, 105-106 80, 89-94, 167-168, 172, 184-187, 193-197,
199-200, 234
K risks 32, 34-35, 39-43, 45-48, 51-54, 65, 69, 76-78,
91, 93, 108, 129, 139, 142, 167, 172, 185-194,
K-Nearest Neighbour 108, 117, 119 196, 200, 216-217
Rule based fraud detection 16
M
S
machine learning 16, 21-22, 30-31, 87, 91, 94, 108-111,
113, 115-119, 123-124, 131, 134, 136, 185-187, skill 95-97, 100-106
223-224, 227, 229-231, 234 Small and medium sized enterprises 223
management 1-4, 7-8, 11-14, 19, 31-48, 50-57, 59-61, supervised learning 108, 110, 113, 117-119, 122
63-65, 68-73, 75, 77-81, 85, 89-98, 102-103, 105- Support Vector Machine 31, 108, 117-119, 131
107, 124, 128, 136, 138, 149-151, 155, 157-161,
166-173, 176, 179-180, 182-187, 189-201, 203, T
208, 217-218, 223-225, 234-235
Methods to Uncover Fraud 126 types of fraud 17, 19, 59, 81, 126-129
mutual funds 95-97, 99, 102, 104-107

270

Frozen Foods Market in India 2023-2028 Part-I
No ratings yet
Frozen Foods Market in India 2023-2028 Part-I
32 pages
Data-Analytics AB
No ratings yet
Data-Analytics AB
5 pages
Cours Calcul Stochastique
100% (1)
Cours Calcul Stochastique
68 pages
Predictive Analytics in Insurance
No ratings yet
Predictive Analytics in Insurance
12 pages
2003 Makipaa 1
No ratings yet
2003 Makipaa 1
15 pages
What Is Pointillism?: Paul Signac
No ratings yet
What Is Pointillism?: Paul Signac
11 pages
LPP Simplex
No ratings yet
LPP Simplex
107 pages
Fundamentals of Forecasting Using Excel: Dr. Kenneth D. Lawrence Dr. Ronald K. Klimberg Dr. Sheila M. Lawrence
No ratings yet
Fundamentals of Forecasting Using Excel: Dr. Kenneth D. Lawrence Dr. Ronald K. Klimberg Dr. Sheila M. Lawrence
7 pages
Quant Econ
No ratings yet
Quant Econ
462 pages
TravellingSalesmanProblem PDF
No ratings yet
TravellingSalesmanProblem PDF
212 pages
Temperature Control and Adaptive Fuzzy Systems
No ratings yet
Temperature Control and Adaptive Fuzzy Systems
11 pages
Introduction To ETL in Python: Stefano Francavilla
No ratings yet
Introduction To ETL in Python: Stefano Francavilla
62 pages
Sqlserver Toturial
No ratings yet
Sqlserver Toturial
3,386 pages
Simulation
No ratings yet
Simulation
38 pages
Advanced Logistics and Material Management Course
No ratings yet
Advanced Logistics and Material Management Course
8 pages
Data Analytics & Data Science Job Ready Program
No ratings yet
Data Analytics & Data Science Job Ready Program
4 pages
Multimethod Simulation Modeling For Business Applications
No ratings yet
Multimethod Simulation Modeling For Business Applications
37 pages
Generative AI and Machine Learning Course Content
No ratings yet
Generative AI and Machine Learning Course Content
19 pages
Confusion Matrix
No ratings yet
Confusion Matrix
5 pages
Wall Street Quant - Self-Assessment
No ratings yet
Wall Street Quant - Self-Assessment
3 pages
Roadmap To Build A Machine Learning Model
No ratings yet
Roadmap To Build A Machine Learning Model
12 pages
Feature engineering Complete Self-Assessment Guide
From Everand
Feature engineering Complete Self-Assessment Guide
Gerardus Blokdyk
No ratings yet
(Ebook) RapidMiner: Data Mining Use Cases and Business Analytics Applications by Markus Hofmann, Ralf Klinkenberg ISBN 9781482205503, 1482205505 2024 scribd download
100% (1)
(Ebook) RapidMiner: Data Mining Use Cases and Business Analytics Applications by Markus Hofmann, Ralf Klinkenberg ISBN 9781482205503, 1482205505 2024 scribd download
81 pages
Data Visualization With Ggplot2 PDF
No ratings yet
Data Visualization With Ggplot2 PDF
13 pages
Manual of Simulation With Arena For Lab - Note - 3
No ratings yet
Manual of Simulation With Arena For Lab - Note - 3
16 pages
A Multi-Size Compartment Vehicle Routing Problem For Multi-Product Distribution: Models and Solution Procedures
No ratings yet
A Multi-Size Compartment Vehicle Routing Problem For Multi-Product Distribution: Models and Solution Procedures
21 pages
Best Actuarial Masters PDF
No ratings yet
Best Actuarial Masters PDF
4 pages
Database Toolbox™ User's Guide
No ratings yet
Database Toolbox™ User's Guide
609 pages
TSF GRIP Tasks PDF
No ratings yet
TSF GRIP Tasks PDF
32 pages
Traveling Salesman Problem
100% (1)
Traveling Salesman Problem
67 pages
Analysis and Linear Algebra For Finance Part II
No ratings yet
Analysis and Linear Algebra For Finance Part II
156 pages
MonteCarlo+QuasiMC 2010
No ratings yet
MonteCarlo+QuasiMC 2010
719 pages
A Learning Guide To R PDF
0% (1)
A Learning Guide To R PDF
255 pages
Stored Procedure
No ratings yet
Stored Procedure
23 pages
Stata Excel Spreadsheet
No ratings yet
Stata Excel Spreadsheet
43 pages
Data Analytics
No ratings yet
Data Analytics
183 pages
Solver Frontline Solvers Reference Guide
No ratings yet
Solver Frontline Solvers Reference Guide
305 pages
IntelliTrac X Series Protocol - 305 Standard
No ratings yet
IntelliTrac X Series Protocol - 305 Standard
69 pages
Fashion Recommendation System Using Machine Learning
No ratings yet
Fashion Recommendation System Using Machine Learning
8 pages
CQF June 2021 M3L1 Exercises
No ratings yet
CQF June 2021 M3L1 Exercises
2 pages
Book - Roger D Peng-Exploratory Data Analysis With R-Leanpub (2015) PDF
No ratings yet
Book - Roger D Peng-Exploratory Data Analysis With R-Leanpub (2015) PDF
125 pages
10.1007@978 3 030 49165 9
No ratings yet
10.1007@978 3 030 49165 9
145 pages
Cases in Finance
No ratings yet
Cases in Finance
7 pages
Gpss
No ratings yet
Gpss
462 pages
Simulation in Finance
No ratings yet
Simulation in Finance
62 pages
Example Star Schema For Banking
No ratings yet
Example Star Schema For Banking
16 pages
Artificial Intelligence Machine Learning Engineer Skill Guide 2019 PDF
No ratings yet
Artificial Intelligence Machine Learning Engineer Skill Guide 2019 PDF
12 pages
Data Quality and Master Data Management With Microsoft SQL Server 2008 R2
No ratings yet
Data Quality and Master Data Management With Microsoft SQL Server 2008 R2
226 pages
A Second Course in Statistics: Regression Analysis: Journal of The American Statistical Association June 1997
No ratings yet
A Second Course in Statistics: Regression Analysis: Journal of The American Statistical Association June 1997
9 pages
House Price - Prediction
No ratings yet
House Price - Prediction
4 pages
SAS High Performance Forecasting
No ratings yet
SAS High Performance Forecasting
604 pages
Data Mining: Business Intelligence
No ratings yet
Data Mining: Business Intelligence
68 pages
Download Complete Public vs. private: the early history of school choice in America Gross PDF for All Chapters
100% (7)
Download Complete Public vs. private: the early history of school choice in America Gross PDF for All Chapters
41 pages
STEALLA Tutorial - How To Build A Model in STELLA
No ratings yet
STEALLA Tutorial - How To Build A Model in STELLA
11 pages
QUANTITATIVE ECONOMICS With Julia
100% (1)
QUANTITATIVE ECONOMICS With Julia
509 pages
(Advances in Finance, Accounting, and Economics) Laura Castro-Santos, Félix Puime-Guillén - Financial Management and Risk Analysis Strategies For Business Sustainability-IGI Global (2021)
No ratings yet
(Advances in Finance, Accounting, and Economics) Laura Castro-Santos, Félix Puime-Guillén - Financial Management and Risk Analysis Strategies For Business Sustainability-IGI Global (2021)
340 pages
Foreign Business in China and Opportunities for Technological Innovation and Sustainable Economics 1st Edition Miltiadis Lytras - Download the ebook with all fully detailed chapters
100% (1)
Foreign Business in China and Opportunities for Technological Innovation and Sustainable Economics 1st Edition Miltiadis Lytras - Download the ebook with all fully detailed chapters
75 pages
Foreign Business in China and Opportunities for Technological Innovation and Sustainable Economics 1st Edition Miltiadis Lytras 2024 scribd download
100% (1)
Foreign Business in China and Opportunities for Technological Innovation and Sustainable Economics 1st Edition Miltiadis Lytras 2024 scribd download
65 pages
Banking, Finance, and Accounting Concepts, Methodologies, Tools, and Applications (PDFDrive)
No ratings yet
Banking, Finance, and Accounting Concepts, Methodologies, Tools, and Applications (PDFDrive)
1,626 pages
1 - PDFsam - 978 981 19 1036 4
No ratings yet
1 - PDFsam - 978 981 19 1036 4
109 pages
Understanding The Impact of Technology in Audit and Finance
No ratings yet
Understanding The Impact of Technology in Audit and Finance
17 pages
Emerging Trends in Business Economics
From Everand
Emerging Trends in Business Economics
Dr Daniel Ofori, Dr George Asumadu
No ratings yet
Lauren Wallace - Apr 01 04 S
No ratings yet
Lauren Wallace - Apr 01 04 S
14 pages
Matthew Wendt Vs Shae Newman
No ratings yet
Matthew Wendt Vs Shae Newman
30 pages
The Side Hustle Path Volume 2 - Bonus Min PDF
No ratings yet
The Side Hustle Path Volume 2 - Bonus Min PDF
64 pages
A. History of Tourism Industry
No ratings yet
A. History of Tourism Industry
7 pages
Ion Exchange or Reverse Osmosis
No ratings yet
Ion Exchange or Reverse Osmosis
2 pages
Jesus Christ's Astrology Chart
100% (1)
Jesus Christ's Astrology Chart
4 pages
Ste MP Test Cases
No ratings yet
Ste MP Test Cases
2 pages
FBR - NTN Form PDF
100% (1)
FBR - NTN Form PDF
2 pages
Land Acquisition Branch
No ratings yet
Land Acquisition Branch
19 pages
(Samsung Junior Talent) : Applicant Information
No ratings yet
(Samsung Junior Talent) : Applicant Information
3 pages
Contributions of women and students in the freedom movement for separate homeland for Muslims of British India
No ratings yet
Contributions of women and students in the freedom movement for separate homeland for Muslims of British India
2 pages
Bible Study Notebook
No ratings yet
Bible Study Notebook
1 page
Commercial Law Power Point
No ratings yet
Commercial Law Power Point
333 pages
Human Rights Law
100% (1)
Human Rights Law
13 pages
Daclison Vs Baytion - ESTIPONA
No ratings yet
Daclison Vs Baytion - ESTIPONA
1 page
Uav Training Plan Fi
No ratings yet
Uav Training Plan Fi
9 pages
MKT 208 Project-Part of Final Exam
No ratings yet
MKT 208 Project-Part of Final Exam
2 pages
DBQuest Profile
No ratings yet
DBQuest Profile
2 pages
Eec 231 Module 01
No ratings yet
Eec 231 Module 01
17 pages
Https Retail - Onlinesbi.com Retail Mobilenoupdateguidelines
100% (1)
Https Retail - Onlinesbi.com Retail Mobilenoupdateguidelines
1 page
INV-002839
No ratings yet
INV-002839
2 pages
Microsoft Office Specialist World Championship Is A Global Competition That Assesses
No ratings yet
Microsoft Office Specialist World Championship Is A Global Competition That Assesses
2 pages
IIA IIA-CIA-Part1 Free Practice Exam & Test Training
No ratings yet
IIA IIA-CIA-Part1 Free Practice Exam & Test Training
2 pages
mg341 All
No ratings yet
mg341 All
24 pages
Cesar Chavez
No ratings yet
Cesar Chavez
11 pages
Attack Proof The Ultimate Guide to Personal Protection 2nd ed Edition John Perkins - The full ebook version is available, download now to explore
100% (2)
Attack Proof The Ultimate Guide to Personal Protection 2nd ed Edition John Perkins - The full ebook version is available, download now to explore
71 pages
Noel v. The Boeing Co., 622 F.3d 266, 3rd Cir. (2010)
No ratings yet
Noel v. The Boeing Co., 622 F.3d 266, 3rd Cir. (2010)
18 pages
New Brand New Agreement
No ratings yet
New Brand New Agreement
3 pages