It may come as a surprise (until very recently) to many who watch the flashing red headlines spewed forth by Bloomberg and Reuters terminals as each and every firm manages to coincidentally report earnings within a smidge of guidance (and maintain their 'near-perfect' records of 'sustainable' growth) when all around the signals seem to point to an economy in malaise. However, earnings quality - that ephemeral view of just how manipulated the end number really is - remains critical (in the medium-term, if not the short-term thanks to the headline-reading algos). To wit, Bloomberg notes a recent paper (below [4]) that finds 20% of CFOs will "manage earnings to misrepresent economic performance" with 93.5% admitting it is to influence the stock price. 'Red flag's include EPS inconsistent with cash-flows, unusual accruals, or an industry outlier. Amid pressure to maintain stock prices (and keep a career going), 60% of earnings 'management' is to increase income and of course 66% of CFOs hope for fewer accounting rules going forward.
93.45% of CFOs responded the motivation to cheat (our word) was to influence the stock price!!.. and 88.62% to increase their own compensation!!!
[5]
So the next time a CEO/CFO says anything - and it is heralded as something other than self-serving tripe - please read this report one more time!!
Full paper below:
SSRN-id2103384 [6]