A Study on Reliability of Reporting Earnings Number in Each Credit Grade Using Benford s Law

Purpose - A company with a high credit rating will increase the convenience of financing, reduce borrowing interest, and give credibility to consumers, thereby contributing to sales. Therefore, companies will have incentives to adjust their earnings directly or indirectly to obtain a high credit rating. An arbitrary earnings management will hinder the credibility of accounting information. Therefore, this study tried to verify the possibility of earnings management by credit rating using Benford s law. Benford’s law, sometimes called the first-digit law, states that the first digit in many types of data sets are distributed in a non-uniform way. In fact, this law says that the number 1 will appear as the first digit about 30% of the time and the number 2 will appear as the first digit about 18% of the time, whereas the number 9 will only appear first about 5% of the time. Benford s Law is used to analyze financial data and identify red flags. If the data doesnRevised or supplemented thesis for master s degree. t look anything like the distribution predicted by Benford s Law, it may mean the numbers have been manipulated. Research design, data and methodology - Reported earnings of companies listed in KOSDAQ and stock exchanges from 2006 to 2015 have been tested by using Benford s law. Results - The results of the study show that firms with a grade of 6th or below are less likely to comply with the Benford distribution than those with the highest grade. In addition, it also shows earnings management for entry into the third grade credit rating, which is substantially grade 4th but ranked as 3rd. Companies reporting net losses also show greater likelihood of earnings management than those reporting net earnings. Conclusions - The results suggest that low-grade firms may be more likely to adjust earnings than top-ranking firms. This result is consistent with the results of Lee (2015) that the deviation of the Benford’s distribution from the supervisory firm is larger than the Benford’s distribution deviation of the counterpart firm. In other word, The results show that firms with higher credit ratings overall are more likely to report reliable profits numbers than those with lower credit ratings.