The Effect of Fraud Factors on Earnings Management Based on the Diamond Model

Subject Areas : Ethics and accounting

Ghasem Ghasemi ^{1 *}

1 - Department of Accounting, Sabzevar Branch, Islamic Azad University, Sabzevar, Iran

Received: 2025-02-01 Accepted : 2025-04-06 Published : 2025-08-11

Keywords: Dividends paid, Financial leverage, Audit quality, Free cash flow, Changes in independent auditor, Dual role of CEO, Management ability, Earnings management.,

Abstract :

Introduction: The necessity of profit reporting as a primary source for decision-making by investors, managers, and analysts is well-documented, and profit reporting contributes to the economy of society in various ways, such as providing a basis for calculating taxes, a criterion to evaluate the success of a company's performance, determining the amount of distributable profits, a criterion for managing profit distribution, managing an economic unit, and other cases. Managers often manage profits in order to mislead shareholders about the company's actual economic performance (Kian and Faghih, 2024). One of the most crucial procedures auditors use in their investigations is fraud risk assessment. In this context, the Diamond Fraud models for evaluating fraud risk are discussed in this article. Fraud Triangle Model introduces three dimensions of pressure/motivation, opportunity, and justification as dimensions of fraud, while in Diamond Model, fraud, in addition to the three aforementioned dimensions, also considers the ability dimension to assess fraud risk (Bahrami et al., 2021)

Materials and Methods: Companies' information was collected using Excel software, and data classification and analysis were performed using Eviews statistical software, and the method used was panel data. The following is a discussion of hypotheses, model, and measurement methods of the research variables:

- There is a relationship between dividends paid and earnings management.

- There is a relationship between financial leverage and earnings management.

- There is a relationship between auditor quality and earnings management.

- There is a relationship between free cash flow and earnings management.

- There is a relationship between changes in the independent auditor and earnings management.

- There is a relationship between the duality of CEO's duties and earnings management.

- There is a relationship between management ability and earnings management.

DA_it= β_‌‌0‏+ β_‌‌1DP_it+ β_‌‌2FL_it+ β_‌‌3AI_it‏+ β_‌‌4FCF_it‏+ β_‌‌5CPA Turnover_it+ β_‌‌6CEO Duality_it+ β₇ TMO_i,t+ β_‌‌8 ROE_it‏+
β_‌‌9 Size_it + ε_it

- In this study, modified Jones model was used to measure earnings management (DA) (Qian, 2018)

- Dividends payable (DP); calculated by dividing distributable earnings by company's total shares.

- Financial leverage (FL); calculated by dividing the company's total liabilities by company's total assets.

- Audit quality (AI); Audit fees were used to measure audit quality.

- Free cash flow (FCF); The free cash flows of business unit were used from the Chang et al. (2005) model.

- Change in auditor (CPA Turnover); Binary, the company's auditor has changed from the previous year, number one.

- CEO Duality; Binary, the company's CEO is the chairman or vice chairman of the board, number one.

- Management Ability (TMO); The managerial ownership criterion is used.

- Company Size (Size); The natural logarithm of company's total assets is used.

- Return on Equity (ROE); Return on Equity is net profit divided by equity.

Findings: The first hypothesis of the study posits that the estimated coefficient of dividends paid on discretionary accruals, as shown in the table below, demonstrates a substantial relationship between dividends paid and discretionary accruals at the 0.05 error level. Because p-value calculated for the coefficient of this independent research variable is less than 0.05. Based on the second hypothesis of research, since the estimated coefficient of financial leverage on discretionary accruals in the table below indicated a significant relationship between financial leverage and discretionary accruals at the 0.05 error level. Because p-value calculated for the coefficient of this independent research variable is less than 0.05. The study's third hypothesis is that there is no significant correlation between audit quality and discretionary accruals at the 0.05 error level, as shown by the estimated coefficient of audit quality on discretionary accruals in the table below. Because p-value calculated for the coefficient of this independent research variable is greater than 0.05. Based on the fourth hypothesis of study, since the estimated coefficient of free cash flow on discretionary accruals in the table below indicates a significant relationship between free cash flow and discretionary accruals at 0.05 error level. Because p-value calculated for the coefficient of this independent research variable is less than 0.05. In accordance with the fifth hypothesis of the study, the estimated coefficient of changes in the independent auditor on discretionary accruals in the table below suggests a substantial relationship between changes in the independent auditor and discretionary accruals at the 0.05 error level. Because p-value calculated for the coefficient of this independent research variable is less than 0.05. Based on the sixth hypothesis of research, since the estimated coefficient of CEO duality on discretionary accruals in the table below indicates a significant relationship between CEO duality and discretionary accruals at 0.05 error level. Because p-value calculated for the coefficient of this independent research variable is less than 0.05. The seventh hypothesis of the study indicates that the t-statistic value for managerial ownership (4.062339) demonstrates a positive and substantial impact on the company's profits management at the 5 percent error level. Therefore, it can be stated that the hypothesis is accepted at a confidence level higher than 95 percent. Therefore, according to the results obtained, it can be stated that as managerial ownership increases (decreases), earnings management increases (decreases).

Conclusion: Based on the research hypotheses, the following conclusions can be drawn:

- The higher the amount of dividends payable, the more restricted managers' hands are expected to be in the presence of surplus funds, and thus earnings management is reduced.

- The greater the limiting factors in managers' opportunistic behaviors, including the existence of pressure from debt contracts, and the need to repay debts at maturity, the more likely it is that the amount of earnings management will decrease to reduce the effects of profit fluctuations that have arisen as a result of such risky behaviors.

- Companies in a weak financial position (loss) expect to pay higher audit fees, which leads to an increase in the risk of these companies. Therefore, companies with low profitability pay higher audit fees.

- The source of conflict between the interests of shareholders and managers is the availability of cash after financing profitable projects and distributing cash profits.

- The auditor's stability will enable them to develop more sophisticated audit capabilities by gaining a more comprehensive understanding of the client. Additionally, it will alleviate their concerns regarding client acquisition, enabling them to express their opinions with greater independence and, as a result, reduce opportunistic behaviors of managers and profit management.

- Since CEO is the chairman of the board of directors, it reduces one of the supervisory mechanisms in corporate governance, thus providing the basis for profit management for such companies.

- Considering one of the most important motives for earnings management is tax, because many decisions are made based on profit, such managers tend to manage earnings to reduce taxes or to achieve their goals by smoothing and sometimes managing earnings to increase them to receive facilities, increase stock prices, etc.

 

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