| Prior literature and anecdotal evidence suggest that failing firms are likely to overstate earnings in periods prior to bankruptcy. I expect that bankrupt firms that do not appear to be distressed, first employ within GAAP earnings management techniques that overstate earnings but not materially. I further predict and find that as these firms approach bankruptcy, their financial statements reflect material income-increasing accruals for receivables, inventories, payables, property, plant, and equipment, and sales in non-going concern years. The behavior of a sub-sample of SEC sanctioned bankrupt firms is consistent with the findings of the 1999 COSO study of SEC sanctioned firms. The (non-sanctioned) non-stressed bankrupt firms resemble the sanctioned firms, but the magnitudes of the income-increasing accruals are lower. Finally, I predict and find that financial statements of both SEC sanctioned firms and non sanctioned non-stressed bankrupt firms reflect evidence, in going concern years immediately preceding or following bankruptcy, of auditor prompted reversal of the previous overstatements. |
