LAW AND ECONOMICS WORKSHOP
presents
Professor Lynnette Purda
Queen's University School of Business
Detecting Fraud from the Language of Financial Reports
Tuesday, February 15, 2011
4:10 - 2:00 PM
Solarium (Room FA2) - Falconer Hall
84 Queen's Park
We ask whether the text of the Management Discussion and Analysis section (MD&A) of quarterly and annual reports holds important clues regarding the integrity of the financial report. By building a detection algorithm based on all words present in a sample of 4,895 fraudulent and truthful reports, we correctly classify approximately 87% of all reports as either fraudulent or not. This rate falls to 80% for a hold-out-sample excluded from the training set. While the method is particularly strong in correctly capturing financial misrepresentations, truthful statements are incorrectly labeled as fraudulent approximately 16% of the time. These false positive classifications frequently occur in quarters immediately surrounding actual occurrences of fraud with approximately 16% happening within one quarter of the fraud and 46% happening within one year. We compare our method to a more traditional approach suggested by Dechow, Ge, Larson and Sloan (2009) that is based on quantitative financial variables. Correct classification rates for both truthful and fraudulent reports are higher using the text of the MD&A report compared to quantitative variables alone. We find that the correlation between predictions from the two methods is only 0.13 suggesting that the text of financial reports can be a powerful supplement to the identification of fraudulent reports.
Dr. Purda is an Associate Professor and the Royal Bank of Canada Fellow of Finance at Queen’s School of Business. Lynnette’s research focuses on empirical topics related to corporate finance and financial institutions. Much of her work examines potential monitors of firm behaviour including internal monitors such as the board of directors and external monitors such as credit rating agencies and regulators. Her current research emphasizes the role of these parties in improving the information environment of the firm and their ability to accurately detect corporate fraud. Her work has been published in several leading academic journals such as the Journal of International Business Studies and the Journal of Financial Research. Lynnette has been invited to present this work at the Bank of Canada and numerous academic conferences. She is also a popular speaker for practitioner events including conferences for pension fund managers and continuing education studies for financial executives. She currently sits on the Board of Directors of the Queen’s University Investment Counsel.
Lynnette received her PhD from the Rotman School of Management at the University of Toronto in 2003and obtained her Chartered Financial Analyst designation in 2000. Prior to commencing her PhD she worked in investment banking with Nesbitt Burns as part of their oil and gas team.
For more workshop information, please contact Nadia Gulezko at n.gulezko@utoronto.ca.
