Private Investigations and Self-Disclosure of Suspected Fraud: Experimental Evidence on Forensic Accounting Services

Abstract

When a company internally suspects material fraud, it faces difficult choices. It can choose to investigate internally or engage an external specialist. Additionally, it can choose to disclose the investigation or take the risk that the investigation is leaked to the public. I analyze whether the choice to engage an external specialist, rather than investigate internally, changes investors’ willingness to invest in the company. I argue that, when engaging external specialists, disclosure choices matter. Conceptualizing the engagement of external specialists as an external credibility signal, I hypothesize that, when engaging external specialists, self-disclosure increases investors’ willingness to invest compared to when the press reveals the investigation. Results from a 2 x 2 between-subjects experiment with 128 non-professional investors support my hypothesis. This suggests that aligning a signal of credible investigation efforts with forthcoming disclosure could be beneficial. Hence, companies conducting genuine investigations could benefit from resisting temptation of non-disclosure.