Application of Benford Law in the Analysis of Financial Distress in Public Companies

Financial distress and bankruptcy of companies lead to wasting of resources and not benefiting from investment opportunities. Timely detection of the companies which are about to financial distress is highly desirable because it prevents investment in wrong and inefficient cases for market participants. The phenomenon of earnings manipulation is a joint issue in the border between accounting knowledge and financial issues, which has always been presented in professional contexts as one of the most controversial discussions of accounting. The main purpose of the present study is to evaluate the existence of earnings manipulation in financially distressed companies, as well as the role of existence of governmental ownership in modifying this relationship. For this purpose, firstly the sample companies were selected among the companies listed in Tehran Stock Exchange (the statistical population), through screening method (applying the conditions in the population), and then, based on the considered variables using Benford Law, the existence or absence of earnings manipulation in each group of companies was examined. The hypotheses test results based on the data (648 year-company) of the audited financial statements of the sample companies for a 9-year period (2008 to 2016) indicate that managers of financially distressed companies have manipulated the earnings, and in fact, the earnings figures in these types of companies do not follow Benford Law, and if the companies have an governmental ownership, there is no change in non-compliance of companies with Benford Law.