Winning Investors Over. Baruch Lev
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Название: Winning Investors Over

Автор: Baruch Lev

Издательство: Ingram

Жанр: Экономика

Серия:

isbn: 9781422142332

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СКАЧАТЬ supplies, engaged in an elaborate manipulation of earnings from 2001 to 2003, according to the SEC.26 The company regularly released earnings forecasts it could not meet and made the numbers by a practice euphemistically called “booking to budget.” This, stripped to its essence, meant recording fictitious “budgeted” revenues and expenses instead of the actual numbers. At the end of each quarter, the increasing gaps between real and booked (budgeted) amounts were bridged by income from vendors’ allowances and rebates granted on large inventory purchases Daisy had made.27 The vendor allowances recorded as income were substantial, often exceeding reported earnings, such as in 2002, when Daisytek reported net income of $10.85 million, while vendor allowances were $22 million. Reported earnings were thus significantly inflated by rebates from the acquisition of unnecessary, often obsolete inventory.

      Not surprisingly, inventory levels at Daisytek spiraled: $83.6 million, $115.4 million, and $190.7 million at the end of 2001, 2002, and the first nine months of 2003, respectively. Total revenues for the corresponding periods rose only slightly: $1.01 billion, $1.19 billion, and $1.33 billion. Throughout, Daisytek assured investors that “Our purchases of inventory generally are closely tied to sales.” As an aside, since both inventories and sales figures were publicly reported and prominently displayed, one wonders about the gullibility of investors and analysts who failed to realize the increasing misalignment between Daisytek’s inventories and sales. Ultimately, the large inventory purchases, often of hard-to-sell items, had a devastating effect on the company’s liquidity and operations, leading suppliers to place it on a credit hold, until it mercifully filed for Chapter 11 in May 2003.

      Daisytek’s schemes, aimed at meeting its own performance forecasts, demonstrate the recklessness and shortsightedness of some managers, willing to mortally hurt the company—purchasing large quantities of unneeded, obsolete inventory—to temporarily mask a deteriorating business, and even paying taxes on fictitious income. Daisytek’s managers apparently believed that they were immune to detection because they manipulated earnings by real actions—excess inventory purchases—rather than by twisting accounting rules. Managing earnings by actions like R & D cuts or deeply discounted sales, some managers believe, is safer than by misapplying accounting techniques, because business decisions are rarely second guessed.28 Earnings manipulation by actions, however, is often more costly than by accounting means, as clearly demonstrated by Daisytek’s bankruptcy.

      Made in America?

      Finally, lest you think from the previous cases that information manipulation is made in the United States, thirty countries, mostly developed, suffer from more acute cases of manipulitis (see figure 3-1). The researchers producing the graph in the figure, Christian Leuz, Dhananjay Nanda, and Peter Wysocki, developed an earnings manipulation score that reflects various characteristics of managed earnings, such as high volatility relative to cash flows (managed earnings deviate from cash flows more than truthful earnings) and loss avoidance (managed earnings frequently transform small losses to profits).29 By this score, earnings management is, surprisingly, less prevalent in the United States than in other countries, including Switzerland, Denmark, Germany, Japan, and the United Kingdom. Nor are manipulations by large companies restricted to the United States. Royal Dutch Shell (U.K. and the Netherlands); Parmalat (Italy); Nortel (Canada); Nikko Cordial, Sanyo Electric, and Livedoor (Japan); Bawag Bank (Austria); and Ahold (the Netherlands)—a very partial list of sizeable offenders—attest to the globalization of information manipulation. And yet, not being the worst offender is, of course, hardly a consolation for Americans.

      FIGURE 3-1

      Earnings management around the world

      AGGREGATE EARNINGS MANAGEMENT SCORE

      Source: Christian Leuz, Dhananjay Nanda, and Peter Wysocki, “Earnings management and investor protection: An international comparison,” working paper, Wharton School of the University of Pennsylvania, 2002.

      Why They Do It?

      Why do managers manipulate financial information? There are numerous reasons for such a complex, widespread phenomenon. Enhancing managers’ compensation, which is frequently based on reported performance (earnings, sales) as well as on stock price changes—which in turn are affected by corporate performance—is a frequent manipulation motive.30 Others include thwarting proxy contests or activist shareholders by a pretense of improved performance; inflating share prices for larger takes at IPOs and secondary stock issues; avoiding violation of loan covenants; or deflecting regulatory (e.g., antitrust) interventions.31 The wide array of incentives to manipulate financial information as well as the items manipulated arise from the varied uses of this information in contractual arrangements between the company and its employees (to determine bonuses), lenders (loan covenant violations), patent licensees (royalty amounts), and other stakeholders.

      But, as the cases show, the major objective of information manipulation is undoubtedly to obscure from investors the deterioration in the company’s operations or in its financial condition, thereby preserving managers’ jobs and reputations. Thus, Gateway embellished its reported revenues and earnings to conceal from investors the decline in demand for its computers after the tech bubble burst, and Coca-Cola aggressively pushed its concentrates on Japanese bottlers to mask the adverse effects of the intensified competition in the mid-1990s. Often, particularly companies in growth sectors (high-tech, biotech, environmental), manipulate reported information to preserve the image of the growth so coveted by investors. Thus, i2 Technologies, while growing reasonably well, front-loaded revenues to meet the increasingly aggressive growth expectations of analysts, and Charter Communications attempted to maintain the growth facade by refusing to disconnect delinquent and switching customers. My research on companies that restate their earnings corroborates the growth-at-all-costs objective. Restatements offer a unique opportunity to compare previously reported (misstated) earnings with true ones.32 A sample of 189 restating companies shows that the originally reported mean earnings growth rates in the two restated years were 3.8 percent and 6.7 percent, whereas the mean growth rates of the restated (true) earnings were rather anemic: 0.3 percent and 3.2 percent. Masking the end of growth is clearly the major objective of the manipulators.

      This leaves us with a nagging question: don’t managers—on the whole, a smart lot—know that report manipulation is fraught with dangers (see next section) and is unsustainable, as the preceding cases show? How can rational persons engage in such a self-destructive activity? The answer probably lies in a prevalent cognitive trait of managers: overconfidence. Studies have shown that overconfidence—possessing unrealistically positive beliefs about the future performance of the company—is pervasive among executives, leading to both positive (increased investment in basic R & D) and negative (reckless acquisitions) outcomes.33 Here is the common scenario of report manipulation perpetrated by an overconfident manager:

      The company’s operations hit a snag: sales growth flattens or operating costs unexpectedly increase. To avoid missing the consensus or their own guidance, managers front-load or bring forward a modest amount of revenue from next quarter to make the numbers. They, of course, know that next quarter’s revenue will start with a deficit, but here is where overconfidence comes in. Managers are convinced that revenues in the next quarter or year will be sufficiently high to cover the front-loading and then some. It rarely is, however, and small frauds quickly mushroom and burst. This was vividly confirmed by the CEO of Satyam, a large Indian information services company, who in his 2009 letter to the board disclosing the massive manipulation that he perpetrated over several years wrote: “What started as a marginal gap between actual operating profit and the one reflected in the books of accounts [and publicly reported] continued to grow over the years. It has attained unmanageable proportions.”34

      Innocent СКАЧАТЬ