COMPANY accounting restatements serve as “handbooks of trickery” a US professor has claimed in a new study which suggests that restatements actually prompt peer companies to misstate their own earnings.
Terming this spread of misconduct “public contagion” the study distinguishes it from what it calls “contemporaneous adoption of earnings management.”
“If the peer firm begins earnings management… when there is no public knowledge of misconduct at the target firm, it is likely due to similar economic pressures to misrepresent or from private knowledge of such practices [that] could be obtained from a common tax auditor’s office or common board member,” the report notes.
“Hence, we rely on a significant increase in the likelihood that a peer firm begins misrepresenting after the announcement of a restatement by the target firm as evidence consistent with [public contagion].”
Kevin Koh of Nanyang Business School (Singapore), one of the report’s authors, cites the case of America Service Group, a large healthcare provider that restated its earnings after revealing manipulation of almost $2.5m over the course of five years. Within two and a half months of this restatement, three firms in the same industry began to manage earnings, according to starting dates specified in subsequent restatements of their own – Metropolitan Health Network Services, Hooper Holmes, and AMN Healthcare Services.
“Of course, where just a few firms are involved, the link may be coincidental,” Proffessor Koh said. “But for our sample as a whole, consisting of thousands of firms, the chance that the public contagion we have documented was just a coincidence is extremely slim.”
Restatements appear to provide something akin to a learning opportunity for peer companies, the study suggests.
Professor Shivaram Rajgopal of Columbia University Business School said: “A pattern we saw frequently was for peer firms to follow the lead of announcement companies in what they misreported and how they misreported it. Thus, if an announcing firm misstates revenues, peers commonly do the same – and so on with other ploys, whether they involve expense accounts or inventory or something else. In a sense, restatements serve as handbooks of trickery.”
The paper’s findings emerge from an analysis of restatements in a large database of companies during the 12 years from 1997 through 2008. Restatements or their absence were examined firm by firm, year by year, with the data totaling 57,288 firm-years.
The study is set to be published by the American Accounting Association.