Detecting biotechnology industry's earnings management using Bayesian network, principal component analysis, back propagation neural network, and decision tree

a r t i c l e i n f o JEL classification: G3 C8 M4 M1 Keywords: Data mining Bayesian network (BN) Back propagation neural network (BPN) Principal component analysis (PCA) C5.0 decision tree Accrual earnings management The characteristic of long value chain, high-risk, high cost of research and development are belong to high knowledge based content in the biotech medical industry, and the reliability of biotechnology industry's financial statements and the earnings management behavior conducted by the management in their accrual manipulation have been a critical issue. In recent years, some studies have used the data mining technique to detect earnings management , with which the accuracy has therefore risen. As such, this study attempts to diagnose the detecting biotechnology industry earnings management by integrating suitable computing models, we first screened the earnings management variables with the principal component analysis (PCA) and Bayesian network (BN), followed by further constructing the integrated model with the back propagation neural network (BPN) and C5.0 (decision tree) to detect if a company's earnings were seriously manipulated. The empirical results show that combining the BN screening method with C5.0 decision tree has the best performance with an accuracy rate of 98.51%. From the rules set in the final additional testing of the study, it is also found that an enterprise's prior period discretionary accruals play an important role in affecting the serious degree of accrual earnings management. Nowadays biotechnology is not only a burgeoning industry but also a newest target of investors in the universe. More and more people tend to rely on biotechnology for extending life expectancy or maintaining youth; the potential of the biotechnology industry has greatly improved. Biotechnology industry is characterized of a complicated system , a long value chain, specialized divisions of labor, and a prolonged timeline of product development. The biotechnology company's performance is more difficult to accurately evaluate from traditional financial reports (Kessel and Frank, 2007). Earnings are commonly deemed to be the status of an enterprise's past business performance. Given the fact that the stakeholders of an enterprise (usually including investors, creditors , analysts and customers) cannot be directly aware of the enterprise's operating performance, most of them regard corporate earnings as an important index. As a result, earnings management has turned out to be the major impetus for the management. Nevertheless, if earnings management becomes a norm, financial statement users are very likely to have …