Financial Statement Fraud Detection Using Fraud Diamond Theory: A Study of Manufacturing Companies Listed in Pakistan Stock Exchange

Abstract

Financial statement fraud poses a significant challenge to the credibility of reports, investor confidence, and overall market stability, particularly in complex sectors such as the manufacturing industry. This paper examines the performance of the Fraud Diamond Theory in identifying fraud among manufacturing companies listed on the Pakistan Stock Exchange (PSX). Our design was quantitative and explanatory, using secondary data from audited annual reports for 2015-2024, providing balanced panel data. The F-score model, which combines accruals (RSST) and performance measures, was used to measure fraud. The four Fraud Diamond components are presented as independent variables, namely pressure (proxied by changes in total assets), opportunity (represented by the ratio of receivables to sales), rationalization (proxied by changes in auditors), and capability (changes in directors). To determine the relationships between these variables and fraudulent reporting, we ran panel regressions and used descriptive statistics, correlation, and diagnostic tests. The paper aims to provide evidence of the impact of behavioral and financial drivers on the risk of fraud in manufacturing. This paper extends the Fraud Diamond to a new market and seeks to provide auditors, regulators, and managers with practical resources to better assess and mitigate the risk of fraud and enhance financial reporting.