♠ Posted by Emmanuel in Casino Capitalism
at 7/07/2007 12:58:00 AM
Have I got a delightful bit of research for you, ladies and gentlemen. Call me simpleminded, but my belief is that accounting shenanigans are usually revealed after periods of stock manias. Just as Enron, Worldcom, Global Crossing, Tyco, Parmalat, and other sordid creative accounting episodes came to light shortly after the dot-com boom became the dot-com bomb, so am I predicting that when the current private equity fueled boom ends there will be a bevy of incidents involving accounting fraud. To consistently meet or beat earnings expectations by playing the guidance game, some firms are sure to have cut corners IMHO.
So, it's good to note this recent piece of research suggests that firms perceived as "growth" stocks are prone to fiddling around with the numbers. This point is kind of obvious, but it does matter that such incidents are amenable to empirical analysis. Here is the abstract of the paper I've dragged into the blogsphere for your consideration, "Predicting Material Accounting Manipulations." To add to the yuk factor, research for this article was funded by the remaining major accounting firms! Arthur Andersen, we hardly knew ye:We provide a comprehensive analysis of accounting manipulations disclosed between 1982 and 2005. We create our database through a detailed examination of 2,191 SEC Accounting and Auditing Enforcement Releases (AAERs). Our database contains 680 firms that are alleged to have manipulated their quarterly or annual financial statements. We examine the characteristics of manipulating firms and analyze the ability of (i) financial statement variables; (ii) off-balance sheet and non-financial variables; and (iii) market-related variables, to explain and predict manipulations. The financial statement variables that we find useful include measures of accrual quality and firm performance. The useful off-balance sheet and non-financial variables include the existence and use of operating leases, abnormal changes in employees and order backlog. The market-related variables that are useful include book-to-market, earnings-to-price, prior annual stock price performance, and amount of new financing. Our results suggest that manipulations are most common in growth companies experiencing deteriorating operating performance. We compare manipulating firms to the broader population of public firms and develop a model to predict accounting manipulations. The output of this model is a scaled logistic probability that we term a Fraud-Score (F-Score), where values greater than 1.00 indicate higher likelihood of manipulation. We show that over 60 percent of manipulating firms have F-Scores greater than 1.00 and that the selection of an F-Score cut-off is based on the relative costs of Type I versus Type II errors. As an example application of the F-Score, we provide the median F-Score of manipulating clients for each of the major audit firms.
We investigate the characteristics of manipulating firms on various dimensions, including accrual quality, financial performance, non-financial performance, off-balance sheet activities, and market-related variables. We find that at the time of the manipulations, accrual quality is low and both financial and non-financial measures of performance are deteriorating. We also find that financing activities and related off-balance sheet activities are much more likely during manipulation periods [LJM, baby!] Finally, we find that managers of manipulating firms appear to be sensitive to their firm's stock price. These firms have experienced strong recent earnings and price performance and trade at high valuations relative to fundamentals. The manipulations appear to be made with the objective of covering a slowdown in financial performance in order to maintain high stock market valuations.
