Benford’s Law, Earnings Management, and Accounting Conservatism : The UK Evidence

Benford's Law, which is the law of digit distributions, is widely applied to study fraud or bias in a data set. In this paper, we applied Benford's Law to examine the first digits of financial statement items of UK listed companies. The evidence shows that the first digits conform to Benford's Law at both the firm-specific and market level. Further analysis shows that deviations from Benford's Law of the first digits of income statement items are larger than those of balance sheet items and cash flow items, suggesting that income statements may contain more errors. The evidence also supports our hypothesis that first-digit deviations are positively related to earnings management and conditional conservatism. A possible explanation is that earnings management and some mechanisms through which conditional conservatism occurs introduce biases to financial statements to the extent which makes accounting figures deviate from the law of digit distributions. The results have implications for auditors