Detecting misrepresentation of financial information: a literature review and a call for future studies

Purpose - This paper aims to present the instruments and methodologies available to help detect any form of misrepresentation of financial information in annual reports. The paper presents a theoretical framework and makes a call for future research in this field of study. Design/methodology/approach - The literature review identifies impression and earnings management as two possible forms of misrepresentation. For the former, we present the specific reporting choices available to mislead the interpretation of the firm’s performance; for the latter, we discuss different model specifications to detect window-dressing behaviors. Findings - Insiders can opportunistically represent the firm’s performance by using pictures, violating graph construction principles or exercising reporting discretion. Manipulations of the substance of annual reports are detectable using specifications that, using an evolutionary approach, this paper classifies into “first-generation” models, ratio analysis and “second-generation” models. Originality/value - The paper provides novel classifications of the instruments and methodologies that help detect impressions and earnings management in annual reports. Using a matrix, our theoretical framework shows that existing protocols are not suitable for investigating possible relationships between these two forms of misrepresentation in terms of whether impression management and earnings management can be both interchangeable or complementary in annual reports. Thus, future studies investigating both forms of misrepresentation might position their offerings in one of the matrix squares or introduce protocols that can detect both forms of misrepresentation. For practice, the paper has particular implications for standard setters. Specifically, in addition to improving the existing accounting standards to obstruct earnings management, they should also issue a standard that prevents impression management, which is currently lacking.