The Cost of Fraud Prediction Errors

Messod Daniel Beneish*, Patrick Vorst*

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

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We compare seven fraud prediction models with a cost-based measure that nets the benefits of correctly anticipating instances of fraud, against the costs borne by incorrectly flagging non-fraud firms. We find that even the best models trade off false to true positives at rates exceeding 100:1. Indeed, the high number of false positives makes all seven models considered too costly for auditors to implement, even in subsamples where misreporting is more likely. For investors, M-Score and at higher cut-offs the F-Score, are the only models providing a net benefit. For regulators, several models are economically viable as false positive costs are limited by the number of investigations regulators can initiate, and by the relatively low market value loss a "falsely accused" firm would bear in denials of requests under the Freedom of Information Act (FOIA). Our results are similar whether we consider fraud or two alternative restatement samples.
Original languageEnglish
Pages (from-to)91–121
Number of pages31
JournalAccounting Review
Issue number6
Early online date16 Dec 2021
Publication statusPublished - Oct 2022

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