Accounting or Corporate Fraud Risk

From Financial Literacy Wiki

Accounting or Corporate Fraud risk means the risk of companies 'cooking their books'. This happens when companies manipulate their accounts, trying to inflate the earnings of their companies thus enabling them to have access to cheaper capital. In most of the prospectuses, for Country-Specific Unit Trusts and Sector-Specific Unit Trusts that invests in emerging markets, it was stated that these unit trusts would be more susceptible to this risk due to the lack of government control and regulation. But we have seen that even in developed markets like US, accounting and corporate frauds do exist. Some examples of firms that committed these frauds are Enron (Energy), World Com (Telecommunications), Merck (Pharmaceutical) and Xerox (Office Equipment). Most of the time when these frauds are discovered, there would be negative repercussions on most stock markets.

As mentioned above, companies have the incentives to manipulate their accounts as this may enable them to have access to cheaper capital. With the introductions of stock options, as part of the remuneration package to attract top talents to high level management, there is a tendency for high management to inflate the earnings of their companies. This would result in the increase in price of company's shares in the market which in turn increasing the value of their options on hand. Judging from the companies involved and the industries they are in, no matter which countries the funds invest in, it is always susceptible to this risk.