Whether Cost Stickiness Stimulates the Occurrence of Financial

Reporting Fraud? Evidence in the Digital Economy Background

Yingke Zhao

Accounting School, Guangzhou College of Technology and Business, Guangzhou510000, Guangdong Province, China

Keywords: Cost Stickiness, Financial Reporting Fraud, Government Subsidies, Digital Economic.

Abstract: In the context of the rapid development of digital economy technology, more and more Chinese enterprises

have started to carry out digital reform. This paper attempts to study the impact of cost stickiness on financial

reporting fraud based on the environment of digital economy development. Through the empirical analysis of

rare event regression model, it is found that there is a significant positive relationship between cost stickiness

and financial reporting fraud. Meanwhile, this paper finds that government subsidies can play a significant

inhibited role in above relationship. It is worth mentioning that firms with higher digitalization are less likely

to experience financial reporting fraud, even with higher cost stickiness. The harmful relationship is weakened

by digital. The results show that enterprises should pay attention to the level of cost stickiness and promote

digitalization actively.

1 INTRODUCTION

For the past few years, the occurrence of financial

reporting fraud never stopped in capital market.

Fraudulent financial reporting is a social and

economic issue of serious concern. On the one hand,

the importance of financial reporting information for

resource allocation is well documented. Therefore,

financial reporting fraud threatens the sustainable

development of enterprises, affects the effectiveness

of capital markets, and weakens the resource

allocation function of capital markets. On the other

hand, financial reporting fraud impairs the trust

between corporation, regulators and market

participants who require the information and engage

in commerce. This paper attempts to explore that

under the digital economy background, whether cost

stickiness stimulates the occurrence of financial

reporting fraud.

After 40 years of unremitting efforts of reform

and opening, China's economic development has

made remarkable achievements. At present, China's

economy has moved from high-speed development to

high-quality development. Also, as the IT technology

and artificial intelligence development, digital

economy has advanced rapid economic growth,

improved people’s living standards, increased

efficient utilization of resources, and strengthened

environmental protection. In the future, digital

economy may play a more important role in resource

allocation.

An increasing number of researchers found that

cost stickiness is prevalent. For enterprise

management, cost behavior determines the accuracy

of subsequent cost management and business

forecast. The existence of cost asymmetry can lead to

biased cost and earnings forecasts by managers, and

companies may blindly over-invest based on the

motivation of increasing revenue and expanding

profits. So, the existence of cost stickiness will affect

the cost management of enterprises, intensify the

fluctuation of surplus, and thus increase the business

risk. The Fraud Triangle is commonly used by both

sociologists and psychologists to account for crime in

organizations to recognize the financial reporting

fraud. Based on the fraud triangle theory, when an

enterprise has unstable business conditions and

increased business risks, managers will face

operational pressure. Therefore, when a company has

highly cost stickiness, the likelihood of financial

statement fraud increases accordingly.

When the risks of enterprises are increasing and

complex, government subsidies, as an important

external means for the government to guide the

survival and development of enterprises can convey

the good reputation and future development potential

of enterprises to the outside world, broaden the

Zhao, Y.

Whether Cost Stickiness Stimulates the Occurrence of Financial Reporting Fraud? Evidence in the Digital Economy Background.

DOI: 10.5220/0012029900003620

In Proceedings of the 4th International Conference on Economic Management and Model Engineering (ICEMME 2022), pages 301-309

ISBN: 978-989-758-636-1

 2023 by SCITEPRESS – Science and Technology Publications, Lda. Under CC license (CC BY-NC-ND 4.0)

301

financing channels of enterprises and reduce the

business risks of enterprises. Meanwhile, government

subsidies are able to help guiding and promoting the

firm’s survive and development, reduce the risk of

corporates and show the positive attitude to the

public. Based on this, when a company receives

government subsidies, the likelihood of financial

reporting fraud caused by cost stickiness is

correspondingly reduced.

To further explore the impact of digital economy

on cost stickiness and financial reporting fraud, this

paper refers to part of method in Li, Y. et al. (2021).

The results show that companies with a high degree

of digitization help to suppress the impact of cost

stickiness on financial reporting fraud.

As the frequency of financial statement fraud is

low, we run the rare event regression to better

estimate the relation between cost stickiness and

financial reporting fraud. Using data from 2016 to

2021, this paper finds that there is a significant

positive relationship between cost stickiness and

financial reporting fraud, and government subsidies

can suppress this relationship to some extent. And the

relationship between cost stickiness and financial

reporting fraud is stable and not endogenous.

The contributions of this paper include four

aspects. Firstly, this paper bridges the gap in the

theoretical basis of the impact of cost stickiness on

financial reporting fraud. The current literatures have

focused on corporate governance, executive

behavior, and external regulation with respect to the

factors influencing financial reporting fraud. In terms

of corporate governance, relevant studies mainly

show that internal control and internal audit have

impacts on financial reporting fraud. About executive

behavior, the executives’ behaviors affect the

likelihood of financial reporting fraud to some extent.

As for external regulation, mandatory auditing is the

main factor of financial reporting fraud, due to poor

quality of mandatory audits and audit tenure.

However, few researchers have investigated the

possibility of financial reporting fraud in relation to

the operational risk arising from the phenomenon of

cost stickiness. Secondly, broadening the

consequences of cost stickiness is also a contribution.

Many papers focus on the reasons of cost stickiness

happened, only a few papers consider the influence of

cost stickiness. Third, this paper helps Chinese

enterprises and regulators pay attention to the impact

of over-investment and resource misallocation on the

occurrence of financial statement fraud. Fourth, this

paper further investigates the role of digitalization on

cost stickiness and financial reporting fraud, which

provides a foundation for encouraging companies to

make digital changes.

In the following section, literature is reviewed and

hypothesizes are raised on the correlation between

cost stickiness and financial reporting fraud in section

2. Based on the proposed hypothesis, an empirical

study is conducted in the section 3 and the conclusion

is drawn in the section 4.

2 LITERATURE REVIEW AND

HYPOTHESES

DEVELOPMENT

Cost stickiness is a phenomenon in which costs do not

change in proportion to business volume. Anderson

(2003) and Subramaniam (2003) found that the

proportion of cost increases when sales revenue

increases by one unit is greater than the proportion of

cost decreases when sales revenue decreases by one

unit through regression analysis of a large sample of

U.S. listed companies, and they defined this

phenomenon as "cost stickiness". Regarding the

causes of the cost stickiness problem, Banker et al.

(2006) divided the causes into three points:

adjustment costs, agency problems, and managers'

over-optimism. However, the existing research on the

economic consequences of cost stickiness is very

limited. Most scholars believe that cost stickiness will

have negative effects on firms, mainly because it will

weaken the firm's earning smoothness and increase

the instability of coming surplus. Weiss (2010) found

that higher cost stickiness will lead to bias or even

error in surplus forecast; Homburg et al. (2018)

argued that the instability of surplus brought by cost

stickiness will lead to the increase of default and

overall credit risk.

Regarding the drivers of the occurrence of

financial statement fraud, Dan Amiram et al. (2018)

summarized the relevant literature mainly from three

perspectives, i.e., law, accounting, and finance;

standing on the perspective of law, numerous legal

scholars have studied fraud based on their own

experiences. Davison’s (2022) study explored the

relationship between executive equity compensation

and financial, pointed out that executives had

stronger equity incentives in fraud cases. Based on

the same theory, Gheachang Im et al. (2019) found

that both corporate ethics and managerial ethics have

an impact on the quality of financial reporting fraud.

When analyzing specific fraud cases, a common

model used by many experts and scholars is the fraud

triangle, including pressure, motivation, and

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opportunity. In the fraud triangle, Schuchter et al.

(2016) points out that “feeling pressure is obviously

to most frauds’ cases”, which means pressure may

play the most important "fraud trigger" for fraudulent

behavior.

To sum up, cost stickiness can weaken earnings

smoothness, lead to fluctuations in surplus, affect the

accuracy of managers' cost management and

forecasting, and increase the business risk of the

company. Undoubtably, inaccuracies of cost

management and surplus forecast increase firms’

operation risk, managers will perceive pressure and

the likelihood of financial statement fraud will

increase simultaneously. Therefore, the first

hypothesis is raised:

H1: Cost stickiness increases financial reporting

fraud.

Government subsidies are usually regarded as an

important means of government economic

intervention in the market and play an important role

in addressing market failures. Claro (2006) points out

that funds from government grants can help firms

overcome the constraints of capital shortage. So,

government subsidies play an invaluable role in

supporting and promoting the development of firms.

Soratana et al. (2014) finds through a study of

Chinese firms that government subsidies can have a

positive relationship on the performance of new

energy firms. Peng H et al (2018) and Luo et al.

(2021) point out that government subsidies have a

positive impact on the long-term financial

performance of Chinese new energy power

generation firms. Meuleman et al. (2012) support that

government subsidies convey that the firm has great

potential for future development and good reputation,

which can help the firm to obtain bank loans and

social funds, reduce financial risks.

Since government subsidies can effectively help

enterprises reduce the costs and risks. It is beneficial

to reduce the risk of the firm and has a positive

contribution to the financial quality of the firm, that

is, government subsidies can inhibit the occurrence of

financial reporting fraud caused by cost stickiness.

Therefore, the second hypothesis of this paper is

made:

H2: Government subsidies have a positive

moderating effect on the relationship between

corporate cost stickiness and financial statement

fraud.

3 RESEARCH DESIGN

3.1 Sample and Data

This paper takes the A-share listed companies from

2016-2021 as the initial data, and in order to eliminate

the effects of extreme and erroneous values, this

paper screens the data as follows: (1) exclude

financial and insurance listed companies and real

estate listed companies; (2) exclude ST companies

and ST* companies with abnormal business

environment and unrepresentative data; (3) eliminate

companies with missing data or data that do not meet

the requirements of data measurement; (4) shrink the

tails of the sample at the level of upper and lower 1%

for continuous variables. After screening, this paper

finally obtains 11208 sample observations.

The data used in this paper are mainly from the

CSMAR database.

3.2 Variable Definition

）

Dependent Variable: Financial Reporting

Fraud: In this paper, Financial Reporting Fraud

represents all types of violations disclosed by the

China Securities Regulatory Commission, Shenzhen

Stock Exchange, Shanghai Stock Exchange, and

Ministry of Finance for listed companies, including

fictitious profits, false listing of assets, material

omissions, and inaccurate disclosures. Indicators

variable equals to 1 for a firm with fraudulent matters

and equals to 0 otherwise.

）

Independent Variable: Cost Stickiness:

As for cost stickiness, the commonly used models are

ABJ’s model and Weiss’s model, but ABJ’s model is

usually used to measure the level of cost stickiness in

an industry, only applicable to test the influence of

other factors on cost stickiness and unable to be

treated as an independent variable. Therefore, in this

paper, based on the cost stickiness measurement

model proposed by Weiss (2010) and modified with

reference to the methods of Rouxelin et al. (2018),

cost stickiness is valued by model 1.

𝑆𝑇𝐼𝐶𝐾𝑌

,

=𝐿𝑁

∆𝐶𝑂𝑆𝑇

∆𝑆𝐴𝐿𝐸





−𝐿𝑁

∆𝐶𝑂𝑆𝑇

∆𝑆𝐴𝐿𝐸



，

𝑡,𝑡,

∈(𝑡,…,𝑡−3).

(1)

In model 1, 𝑡 and 𝑡

is the most recent of the last

four quarters with an increase (decrease) in

sales, ∆𝐶𝑂𝑆𝑇 = 𝐶𝑂𝑆𝑇

,

−𝐶𝑂𝑆𝑇

，

and

∆𝑆𝐴𝐿𝐸 = 𝑆𝐴𝐿𝐸

,

−𝑆𝐴𝐿𝐸

，

. For more accurate

Whether Cost Stickiness Stimulates the Occurrence of Financial Reporting Fraud? Evidence in the Digital Economy Background

303

values, I took the absolute value of 𝑆𝑇𝐼𝐶𝐾𝑌 .

Therefore, the higher values mean imply more cost

asymmetry level.

）

Regulatory Variable: Government

Subsidies

：

Following Luo et al. (2019), this paper

uses the amount of direct government subsidies to

measure government subsidies. Specifically, in order

to minimize large number of subsidies, I took the

natural logarithm of government subsidies for the

empirical research.

）

Control Variables: Referring to Salim

et al. (2021), five financial factors are selected in this

paper as control variables, which are: rate of assets,

receivables, firm age, capital, and leverage of firm.

Additionally, basing on pervious lectures, two factors

also are participated in as control variables, which

are: rate of equity and size. Variable definitions are

shown in Table 1.

Table 1: Variable Definitions.

Variables Definition

Dependent Variable

FRAUD

Indicator variable equal to 1 for fraud firms at the beginning of the

year reporting fraud begins, and 0 otherwise.

Inde

endent Variable

STICKY The absolute value of Model (1)

Control Variables

LEV

Total debts including long- and short-term debt divided by total

assets.

ROA Net income divided by total assets.

ital Net

ert

lant, and e

ment scaled b

total assets.

Receivable Accounts receivable scaled by total assets.

ROE Net income divided b

uit

AGE The years of existence

SIZE Natural lo

arithm of total assets.

Regulated Variable

Subsidies Natural logarithm of total government subsidies in that yea

3.3 Model Setting

Based on the above variables, the model used for

regression analysis in this paper is set as follows:

𝐹𝑅𝐴𝑈𝐷 = 𝛼



+𝛼



×𝑆𝑇𝐼𝐶𝐾𝑌

+ 𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 + 𝜕

(2)

Since the values of FRAUD are 0 or 1, the

regression using logit model. If 𝛼



is significant

positive, it means that there is a positive relationship

between the degree of cost stickiness and corporate

financial reporting fraud, i.e., the higher the degree of

cost stickiness, the higher the possibility of corporate

financial reporting fraud; on the contrary, 𝛼



significant negative, it means that there is a negative

relationship between the degree of cost stickiness and

corporate financial statement fraud. That is, the

higher the degree of cost stickiness, the lower the

possibility of financial statement fraud of enterprises.

In order to verify the moderating effect of

government subsidies on the relationship between

cost stickiness and financial statement fraud, the

following regression model is set up in this paper:

𝐹𝑅𝐴𝑈𝐷 = 𝛼



+𝛼



× 𝑆𝑇𝐼𝐶𝐾𝑌 +𝛼



×𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑒𝑠

+𝛼



× 𝑆𝑇𝐼𝐶𝐾𝑌 × 𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑒𝑠

+ 𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 + 𝜕

(3)

The moderating effect of government subsidies

between cost stickiness and financial reporting fraud

is determined by 𝛼



. In this model, 𝛼



is matters.

4 EMPIRICAL RESULTS

4.1 Descriptive Statistics

The results of descriptive statistics of the main

variables of this study are shown in the Table 2.

According to Table 2, the median of the financial

reporting fraud is 0, and the mean is 0.016, which

proves that most of the listed companies are free from

financial reporting fraud. So, the rare event regression

model is used. The standard deviation of cost

stickiness is 0.827, which indicates that cost

stickiness level is not large difference among

different listed companies. The mean and median are

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0.669 and 0.361 respectively, which means the cost

stickiness situation is common among listed

companies in China. For government subsidies, the

standard deviation is 1.699, and the mean is 16.776,

which indicates that the amount of government

subsidies varies widely among different listed

companies.

Table 2: Descriptive Statistics.

Variable Mean

Standard

Deviation

Min Media Max Sample

Fraud 0.016 0.126 0.000 0 1 11208

STICKY 0.669 0.827 0.003 0.361 4.870 11208

ROA 0.048 0.039 0.002 0.039 0.192 11208

ROE 0.085 0.063 0.003 0.072 0.331 11208

Receivable 0.122 0.063 0.001 0.098 0.493 11208

Age 20.35 5.503 5.000 20 63 11208

Capital 0.449 0.198 0.002 0.434 0.977 11208

Size 22.59 1.315 17.55 22.43 28.64 11208

Lev 0.429 0.187 0.01 0.423 0.999 11208

Subsidies 16.776 1.699 2.536 16.807 23.231 11208

4.2 Main Regression Results

The results of the main regression and moderating

variables are shown on Table 3.

The results of the main regression as Column 1

shows.

For Model 2, the results show in Column 1. There

is a significant positive relationship between Sticky

and Fraud with a correlation coefficient of 18.3%,

which is significant at the 5% level. This indicates

that as the degree of cost stickiness of the firm

increases, the more likely the firm is to experience

Fraud, which is consistent with the assumptions of

hypothesis one.

The results of the moderating variables are shown

in Column 2.

The regression results from Model 3 show that

Fraud is negatively correlated with cost stickiness and

government subsidy cross value at the 5% level with

a correlation coefficient of -0.082. This indicates that

government subsidy can negatively moderate the

relationship between cost stickiness level and

financial reporting fraud.

Table 3: Main Regression Results.

Column 1 Column 2

Fraud Fraud

STICKY 0.177** 1.365**

(2.34) (2.11)

Subsidies - 0.022

- (0.29)

STICKY× Subsidies

- -0.074*

- (-1.85)

ROA -2.987 -1.523

(-1.10) (-0.52)

ROE -0.010* -0.011*

(-1.75) (-1.91)

Receivable 2.592*** 2.361***

(3.96) (3.05)

Whether Cost Stickiness Stimulates the Occurrence of Financial Reporting Fraud? Evidence in the Digital Economy Background

305

Age 0.011 0.010

-0.8 (0.59)

Capital 0.63 0.892*

(1.39) (1.72)

Size -0.197*** -0.168**

(-3.18) (-1.97)

Lev 1.603*** 2.020***

(3.15) (3.41)

Constant -0.855 -2.183

(-0.66) (-1.41)

Year fixed effects Yes Yes

adj_R

0.0319 0.0341

Observation 11208 11208

Note: “*” “**” “***“indicate statistically significant when the correlation coefficient stands at 10%, 5%, and 1%.

4.3 Robustness Test and Endogeneity

Test

To verify the robustness of the evaluation method and

the explanatory power of the indicators in Model 1,

this paper removes the sample during the new crown

epidemic in 2019 and retains the 9197 samples from

2016-2018 and 2020-2021, and regresses the samples

with the same model, and the results shown in Table

4 indicate that fraud remains positively correlated

with the cost stickiness profile of the company at the

5% level, with a correlation coefficient of 17.8%. It

indicates that the relationship between fraud and cost

stickiness still exists in the conventional economic

environment.

Table 4: Robustness Test Results.

Fraud

STICKY 0.170**

(2.03)

ROA -2.154

(-0.77)

ROE -0.011*

(-1.94)

Receivables 2.376***

(3.41)

Age 0.019

(1.40)

Capital 0.328

(0.67)

Size -0.219***

(-3.19)

Lev 1.701***

(3.09)

Constant -0.415

(-0.29)

Year fixed effect Yes

adj_R

0.0337

Observation 9197

Note: “*” “**” “***“indicate statistically significant when the

correlation coefficient stands at 10%, 5%, and 1%

Because the relationship between independent

variable and dependent variable may be driven by

heterogeneity in firm factors that cause they move

together, so I made the Two-stage least squares

estimation. I used the lagging items of STICKY as in

the first stage regression, then used lagging items of

STICKY as a substitution of independent variable in

second stage. The two stages’ results show in Table

Table 5: Endogeneity Test Results.

Varia ble s

Stage 1 Stage 2

STICKY Fraud

STICKY_1 0.146*** 2.390***

(10.54) (4.25)

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ROA 1.427* -17.915***

(1.82) (-3.45)

ROE 0.038 3.580*

(0.09) (1.74)

Receivables -0.111 3.805***

(-1.21) (4.78)

Age 0 -0.016

-0.07 (-0.92)

Capital 0.595*** -0.697

(10.5) (-1.06)

Size -0.006 -0.204**

(-0.73) (-2.46)

Lev -0.455*** 1.548**

(-5.05) (1.96)

Constant 1.171*** -1.23

(2.74) (-0.70)

Year fixed effect Yes Yes

adj_R

0.0801 0.0512

Observation 11208 11208

Note: “*” “**” “***“indicate statistically significant when the

correlation coefficient stands at 10%, 5%, and 1%.

The results of the first stage of the regression are

shown in the first column, and the results indicate that

the independent variable is positively and

significantly related to its lagged term, STICKY_1, at

the 1% level with a coefficient of 0.146. In the second

stage of the regression, the lagged term from the first

stage is used to form STICKY_1 and regressed with

model one, and the results indicate that the

relationship between fraud and sticky is still

significantly and positively related at the 1% level.

Therefore, the positive correlation result between cost

stickiness and financial reporting fraud can still be

supported.

4.4 Further Test

In order to test the impact of the degree of digital

economy on cost stickiness and financial reporting

fraud, in further test, I partly refer to the method of

Li, Y. et al (2021), and uses the text extraction

method based on the relevant indicators in the

CSMAR database on the evaluation of the degree of

digitalization of enterprises, and extracts "Artificial

Intelligence Technology", "Blockchain Technology",

"Big Data Technology", "Cloud Computing

Technology" and “Digital Technology Application”.

The frequency of these keywords is summarized to

calculate the digitalization degree of enterprises. The

higher the frequency of these keywords, the higher

the degree of digitalization of the enterprise. After

that, the median digitization degree was used as the

basis for sample grouping, and the sample was

divided into high digitization degree (DE high) and

low digitization degree (DE low) to further

investigate the role of digitization degree.

Table 6 presents the relationship between the two

sets of results.

The results show that when firms have low degree

of digitization, fraud and sticky are significantly

positively correlated at the 1% level with a

correlation coefficient of 0.339; while when firms

have high degree of digitization, there is no

correlation between fraud and sticky.

Table 6: Further Test Results.

Varia ble s

DE high DE low

Fraud Fraud

DE high -0.149

(-0.96)

DE low 0.292***

(3.35)

ROA -4.218 -4.485

(-0.99) (-0.87)

ROE 2.581* -1.054

(1.72) (-0.54)

Receivables 3.624*** 2.269***

(3.01) (2.78)

Age -0.006 0.018

(-0.24) (1.09)

Capital 1.702** 0.142

(2.13) (0.25)

Size -0.261*** -0.127

(-2.93) (-1.43)

Lev 1.519 1.318*

(1.63) (1.74)

Constant -0.059 -2.03

(-0.03) (-1.11)

Year fixed effect Yes Yes

Whether Cost Stickiness Stimulates the Occurrence of Financial Reporting Fraud? Evidence in the Digital Economy Background

307

Adj R

0.0526 0,0426

Observation 4312 6896

Note: “*” “**” “***“indicate statistically significant when the

correlation coefficient stands at 10%, 5%, and 1%.

The results show that with the development of

digital economy, the possibility of financial reporting

fraud in enterprises with low digitalization will be

higher than that in enterprises with high digitalization

due to cost stickiness. Therefore, enterprises should

pay attention to digital development and vigorously

promote the digital reform of enterprises.

5 CONCLUSION

To explore the relationship between cost stickiness

and financial reporting fraud, this paper uses rare

event regression model to prove the hypothesis.

Through regression analysis of the data of 11208

listed companies in the five-year period of 2016-

2021, this paper finds that (1) there is a positive

relationship between cost stickiness and financial

reporting fraud; (2) government subsidies, as factors

that can stabilize the development of enterprises, play

a positive correlation between cost stickiness and

financial statement fraud. (3) In the context of digital

economy, the high degree of digitalization of

enterprises can suppress the positive influence of cost

stickiness on financial reporting fraud to a certain

extent, reduce the occurrence of financial reporting

fraud, and improve the level of information

disclosure and the quality of development of

enterprises

The findings of this paper not only enrich the

research on the results of cost stickiness, but also

make inspiration for the high-quality development of

Chinese enterprises, based on which, this paper

makes the following suggestions: (1) Enterprise

managers should pay attention to the impact of the

cost stickiness phenomenon on the stability of

enterprise surpluses. (2) Shareholders should

strengthen the supervision of managers, pay attention

to the efficiency and effectiveness of capital

utilization in the production and operation process.

(3) The state and government should further use the

"visible hand" to reasonably guide the use of

resources by enterprises, pay attention to the

efficiency of the use of government subsidies and use

a variety of ways to encourage companies to make

digital revolution and promote the digital economy.

ACKNOWLEDGMENT

Found by the 2022 Guangzhou College of

Technology and Business scientific research project

“Analysis of the Cost Stickiness Problem of

Manufacturing Enterprises in Guangdong Province

and Research on Countermeasures” (Project

number: KYZC202202)

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