Fraudulent financial reporting motivations in emerging markets

1. Introduction

Fraudulent financial reporting has become as one of the most important and challenging issues in the financial markets. This not only has brought a great risk to the markets, i.e. users of the financial statements but also to audit profession as a whole and especially auditors. It can demolish the trust of the users in the market and public confidence in the audit function resulting in increased cost of capital for companies. In this situation, auditors face a higher level of risk (e.g. lawsuit) and have to spend more time for discovering probable frauds leading to increased cost of audit as well. There are many questions about motivations, process, scope and costs of fraud for the community and the measures that have to be taken to identify and prevent such actions (Lister, 2007). Therefore, studying the incentives (motivations) for fraudulent financial reporting is one of the top priorities in this regard (Zainudin and Hashim, 2016).

Prior research show that contextual factors such as culture, legal systems, inflation levels, levels of economic development affect the financial reporting in each country (Gray, 1988; Perera, 1989; Meek and Saudagaran, 1990; Jaggi and Low, 2000; Askary, 2006). This implies that the interests and incentives (i.e. engaging in fraudulent financial reporting) of the financial statements providers can be different in different markets resulting in different level of financial reporting quality.

There are also some differences between developed and emerging markets. For examples, developed markets are more efficient (Walczak, 1999) and provide more protection for shareholders and creditors than emerging markets (LaPorta et al., 1998). Therefore, the type and level of conflicts of interest are different in these markets (Gul and Qiu, 2002) resulting in different incentives for fraudulent financial reporting. Therefore, in emerging markets such as the Tehran Stock Exchange (TSE) [1] and Iraq Stock Exchange (ISX), the incentives for fraudulent financial reporting can be different from developed markets. This provides another justification for doing this research.

In addition, this study investigates the incentives for fraudulent financial reporting because of the following three reasons presented by Kassem and Higson (2012) including: first, financial reporting fraud is the most expensive type of corporate fraud. Second, in the wake of big corporate scandals like Enron and WordCom, investors’ concern...