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BLOOMINGTON, Ind. — Enhanced oversight over the auditing profession and firms’ financial reporting has led to a proliferation of models to predict financial statement fraud.
But one of the first forensic models, the M-Score, devised by an Indiana University Kelley School of Business professor in the late 90s, remains accurate and is the most economically viable for investors to use, according to a forthcoming paper in The Accounting Review — the official journal of the American Accounting Association.
The article, “The Costs of Fraud Prediction Errors,” co-authored by M. Daniel Beneish, professor of accounting and the Alva L. Prickett Chair at Kelley, compares seven fraud prediction models with a cost-based measure that nets the benefits of correctly anticipating instances of fraud against the costs borne by incorrectly identifying non-fraud firms as fraudulent.
Even though newer fraud models early doubled the success rate of M-Score, which Beneish developed, they did so at the cost of a much larger number of false positives. As a result, the other models are not used in practice by auditors because they are too costly to implement as all flagged firms must be carefully investigated.
“I have long known from my experience consulting with Arthur Andersen — for whom my model detected Enron before the debacle — and other public accounting firms, that litigation concerns relating to false positives — firms incorrectly flagged as having fraudulent financial statements — created an unwillingness by auditors’ general counsel to use fraud prediction models in practice,” Beneish said.
“My efforts back then to improve the M-Score in the context of auditing failed because I could not increase the model’s success rate without increasing the number of false positives. It seems that the new models cannot either,” he added.
Interestingly, as early as 2017 the M-Score flagged Kangmei Pharmaceutical, a Chinese publicly traded company that was involved in financial reporting fraud between 2016 and 2018. Like the Enron scandal in the U.S., the Kangmei Pharmaceutical scandal helped trigger new regulation in China that increased regulatory penalties for financial fraud (effective March 2020) and last November became China’s first successful class-action lawsuit involving corporate fraud. Its chairman was sentenced to 12 years in prison.
“The main purpose of our paper is to provide evidence on the costs and benefits of using fraud prediction models, and to show whether using these models is economically viable for auditors, investors and regulators,” Beneish said. “This is important because the traditional measures commonly used in recent research to justify new models are misleading about model performance in fraud samples as the proportion of fraud firms in the population is very small, and as they typically assume that the cost of a false positive and false negatives (missed detections) are equal.”
For example, assume that among 10,000 publicly traded firms, there are about 60 fraud firms and 9,940 firms without misreporting. The newer models detected 42 frauds (70% of the total frauds), and incorrectly flagged 3,976 firms (40% of the non-frauds). The latter is too large a number for most decision makers to investigate.
“Our evidence that a cost-based assessment of models is preferable to traditional model comparison measures (e.g., area under the curve), should become even more important as efforts by future researchers in the areas of data mining and machine learning intensify,” Beneish said.
Patrick Vorst of Maastricht University, assistant professor in financial accounting and accounting & information management, co-authored the paper with Beneish.
This year’s NFL Championship, best known as the Super Bowl, will again be one of the most watched events. But public interest in live events appears to be declining, even for the “Big Game,” say two marketing professors at the Indiana University Kelley School of Business.
“Live sports events are the last stand for live TV, with the Super Bowl being the biggest spectacle to unite the American audience. Live events like this are languishing. Need proof? Look at record low ratings for award shows,” said Ann Bastianelli, teaching professor of marketing at Kelley, who added that the Super Bowl remains “a rare opportunity to gauge the U.S. cultural consciousness.”
“The early reports and teasers suggest that Super Bowl viewers are in for a smorgasbord of memorable and even humorous commercials, providing some much-needed laughs during the ongoing pandemic. Even so, the Super Bowl isn’t enjoying the same viewership it once had which should prompt changes in marketing decisions,” added Demetra Andrews, clinical associate professor of marketing.
With a television audience of more than 90 million last year, the Super Bowl continues to provide the biggest platform for advertisers. But, according to Andrews, television viewership of the Super Bowl has declined fairly steadily for years and the increase in livestreaming of the game does not account for the decline.
Of note, she said, is a persistent decline in watchers aged 18-49 since 2008, a key component of the Super Bowl audience. According to Morning Consult, 40% of Generation Z-aged American aren’t sports fans, compared to only 24% of Millennials opting out of sports. Gen Z may be more likely to watch and share ads online than during the sporting event.
“Despite this, the price for advertising during the Super Bowl has remained high for a 30-second ad. This is likely to prompt marketing organizations to reexamine the value of the Super Bowl as a promotional platform,” Andrews said.
The cost of a 30-second commercial in the 2022 game is $6.5 million, up significantly from the $5.5 million price tag of just a year ago. “Clearly, the network is not bashful about asking that, even with the misgivings that advertisers have had in the past few years,” Bastianelli said.
Super Bowl parties traditionally have been a big part of the game day experience and something most attractive to advertisers. But with larger gatherings discouraged and even restricted last year, this aspect was greatly diminished for the 55th Super Bowl. More people may gather to watch the game, while others will be hesitant to do so.
“Without Super Bowl parties, brands might not get the same return on investment, because people couldn’t discuss ads in real-time with others, so brands shifted to digital/online advertising to avoid the $5.5 million price tag,” Bastianelli said. They also do this “because spending money online builds reach and frequency and gives brands valuable data to maximize customer engagement much more cost-efficiently.
“The downside is that, while culture spreads at the speed of social, it’s much harder to stand out with sustained hype,” she added.
Reevaluation of the Super Bowl as a promotional platform should include a determination of whether an organizations’ target customer groups are likely to watch or attend a Super Bowl event, Andrews said.
Both professors are available for interviews. Contact George Vlahakis at vlahakis@iu.edu for assistance.
Many companies have used the Olympics as an ideal platform for positioning their brand to worldwide audience. However, with the games being held in a nation facing international criticism over human rights and privacy issues, the 2022 Olympics in Beijing Feb. 4-20 will present challenges in marketing.
Kim Saxton, clinical professor of marketing, said China’s human rights policies present a predicament for Olympic sponsors. While some companies – such as the Coca Cola Co. – have said they won’t advertise at the games, others that do may take a different approach than they have in the past.
“It creates an interesting challenge. There is more airtime available and the controversy is stoked. The athletes deserve the support. In fact, they depend on it. But with the U.S. government not sending a delegate, it creates an air of caution,” Saxton said, adding “the U.S. government has not expressly said that companies cannot advertise.
“There are other issues to consider as well. First, the winter Olympics have been very quiet. It’s quite unusual to have summer and winter Olympics within one year. Many consumers need that bi-annual cadence in order to process information about the Olympics and get excitement up,” she added. “Many Americans right now probably cannot name an athlete in more than one sport. And the games start in about two weeks.
“Traditionally, the Olympics is one of the few places that advertisers can find a critical mass of viewers on TV today. The Super Bowl, the Olympics and the FIFA World Cup are the largest TV audiences. So, advertisers have to be creative this year. Some will not mention the host city. Some will run ads that don’t mention the Olympics. Some will stay away. Finally, some will move their efforts to PR. They will balance a fine line of promoting their brands and athletes, while not promoting China.”
Saxton can be reached at mksaxton@iupui.edu.
