Corporate Financial Stability and Fraudulent Financial Reporting: The Role of Quality of Corporate Governance Mechanisms

Objective: Recent corporate scandals, global financial crises, and global environmental issues have led to a growing demand from diverse stakeholders for transparency and regular disclosure of information. The financial statements provide all the financial information related to the financial condition, financial performance and cash flows of the company that is beneficial to all stakeholders. Accordingly, these statements are not merely a set of numbers, but a means of making economic decisions for multiple stakeholders. The importance of the content of financial statement information motivates management to improve its performance to ensure the existence and survival of the company. But sometimes the company can not perform well, so the information in the financial statements will not be satisfactory. This is why management tends to commit fraud, so it manipulates financial statement information to make it look good. For many years, fraudulent reporting has become an important topic that has attracted the attention of many researchers to investigate its determinants. The history of many cases of corporate fraud has shown that management fraud has the most serious and most threatening effects. Organizational management fraud reflects a failure in the corporate governance structure, because the mechanisms that limit the extravagance of senior managers are essentially embedded in corporate governance.
A company's financial sustainability is defined in terms of its ability to facilitate and enhance economic resources, manage risks, and resolve shocks. In cases where the financial condition of the firm is unstable and growth is below industry average, management may be inclined to fraudulent financial reporting to present a picture of stable and robust financial health of the company. Fraudulent reporting is considered as a failure in its corporate governance structure. So, it is argued that the higher the quality of corporate governance, the lower the propensity for fraudulent reporting. Assets are a reflection of the wealth of a company that can be used as a benchmark by investors. In many studies, asset growth has been introduced as a measure of financial stability, in addition, Z-Score has been used as a measure of financial stability which assesses the distance from insolvency and the likelihood of bankruptcy. The higher the Z-Score, the lower the risk of bankruptcy and financial distress of company, and therefore the greater the financial stability. In general, companies with good financial stability tend to avoid from the pressure so that they control themselves not to commit fraudulent practices, while the companies with financial distress tend to have a greater pressure to commit fraudulent practices. Therefore, they will have more motivation to commit fraud. Accordingly, the purpose of this study is to Empirical test the association between financial stability and fraudulent financial reporting and to examine the moderating role of quality of corporate governance mechanisms on this relationship.
 
Method: The research is applied in terms of purpose, cross-sectional in terms of execution time and descriptive-correlation in terms of the nature of execution. In order to Empirical test the association between financial stability and fraudulent financial reporting and to examine the moderating role of quality of corporate governance mechanisms on this relationship, Four research hypotheses were presented as follows:
Hypothesis 1: There is a significant relationship between the growth of company assets (financial stability) and the likelihood of fraudulent financial reporting.
Hypothesis 2: The lower the Z-Score (financial stability), the greater the likelihood of fraudulent financial reporting.
Hypothesis 3: The quality of corporate governance mechanisms moderates the relationship between asset growth (financial stability) and fraudulent reporting.
Hypothesis 4: The lower the Z-Score (financial stability), the lower the likelihood of fraudulent financial reporting as the quality of corporate governance mechanisms increases.
research sample includes 102 companies listed on the Tehran Stock Exchange during the period 2016 to 2020 were used. financial stability is measured by using asset growth and Z-Score and research hypotheses were tested using logistic regression.
Result: In the first two hypotheses, the relationship between financial stability in terms of asset growth criteria and Z-Score with fraudulent financial reporting was proposed. The results of testing the first hypothesis indicate a positive and significant relationship between asset growth and fraudulent financial reporting. This indicates that an increase in the ratio of changes in net assets increases the risk of fraudulent financial reporting. The results of testing the second hypothesis showed that there is no significant relationship between Z-Score and fraudulent financial reporting, although the negative coefficient of the variable indicates a negative relationship between this two variables.
In the third and fourth hypotheses, the moderating role of the quality of corporate governance mechanisms on the relationship between financial stability (in terms of its dual criteria) and fraudulent financial reporting was investigated. The quality of corporate governance mechanisms were measured and considered in three headings: board of directors index, shareholders' rights index and information transparency index.
The results of the third hypothesis test showed that the interactive relationship of financial stability in terms of asset growth and quality of corporate governance mechanisms is not significant in two of the three indicators, in other words, the quality of corporate governance mechanisms on the relationship between financial stability and fraudulent financial reporting, adjusting role does not have.
The result of examining the moderating role of all three indicators of corporate governance mechanisms on the relationship between financial stability in terms of Z-Score and fraudulent financial reporting has shown that the shareholders' equity index is not significant. In other words, the high quality of corporate governance mechanisms in terms of shareholder rights reduces the possibility of fraudulent reporting in the absence of a Z-Score. Regarding the indicators of board of directors and information transparency, the significance of the interactive variable of corporate governance quality and Z-Score indicates the moderating role of this index.
Conclusion: Under conditions of weak financial stability, the fraudulent financial reporting motivation increases. This motivation is doubled in an environment with inappropriate controls. In financial instability, improving the quality of corporate governance mechanisms can reduce the likelihood of fraudulent financial reporting. Despite the fact that the new corporate governance requirements have been mentioned with reference to financial stability, but considering that there are several indicators for measuring financial sustainability, it is suggested that more requirements be set by considering other indicators of financial stability.