With the development of the stock markets and the huge grow in the volume of money traded in them, over the past 20 years a rising attention has been aimed at towards the importance of truthful and fair accounting. The real interest in how companies chase their financial reporting has developed in the wake of a multitude of large corporate scandals that has occurred worldwide. Two of the best known examples so far for significant manipulation of accounting data and the consequences thereof are the collapses of Enron and World Com.But now, before I continue with these two cases and concentrate in the matter of the false or “not so true and fair accounting” will focus on what is the definition of earning management, and what drives the CEO’s of these corporations to pursue the earning management style of working.
The speed at which worldwide business and trade are growing has given new characteristic to the multi-functional roles managers are forced to play. Nowadays the majority of Managers of the “blue chips” companies are more than well paid, experienced speculators.Criticism all over the world has been raised suggesting that style of management executed by those CEO’s in which the performance of the company is measured not by the output of production, neither by the satisfaction of its customers, but by the boost of its financial accounting numbers, creates incentives for the managers to act in opportunistic manners at the cost of the corporation shareholders. “Newly appointed CEOs manipulate earnings in order to boost their salaries and to give a good impression of their work. 1 This quotation from Swedish magazine shows a CEO’s point of view over the earning management.
Earning management is one definition with many names and different aspects all over the world. According to Joshua Ronen and Varda Yaari in their book the definition of earning management is “ a strategy of generating accounting earnings which is accomplished through managerial discretion over accounting choices and operation cash flows. Or in other words “Any action on the part of management which affects reported income and which provides no true economic advantage to the organization and may in fact, in the long-term, be detrimental. ”3 No matter how we call it ; income smoothing, earnings smoothing, cosmetic accounting or what is popular in Europe ;creative accounting there are many different ways in which earnings can be managed. For a variable to qualify as an instrument for earnings management, it must be at least to a partial degree at the discretion of management.Earning management was and continue to be pursued by the financial regulations organs all over the world.
Even that there are general rules covering the accounting practices of corporations there are a major part of subjective fundamentals involved. These regulations consist of a given amount of flexibility in a sense that accounting directive often permits a choice of policy, for example in respect to asset valuation, depreciation and etc. Significant differs may occur in the financial statement of a company, depending on what type of policy or practice a company decide to use.The other problem is that the fact today is that there are a too much spheres in the accounting that are not well regulated. I specifically had a 2nd degree Accounting diploma, and because of the knowledge I have acquired I know that a specific level of freedom in the financial reporting and preparation of accounting reports can help or improve the effectiveness of accounting procedures and the quality of the book-keeping information.
However, if someone has incentives to manipulate accounting numbers in an opportunistic manner, this freedom in accounting practice provides opportunities to do so .We already mentioned that earning management happens in the world and is very common practice nowadays, not only in big worldwide corporations, but also in not so big national companies looking for high accounting numbers, that will help them reach additional bank loans easily. But, is the earning management policy practiced by the firms, affects the stock prices and investors decisions. The investment or in other words “speculation” decisions most of the times depend on expectations of the future movement of the specific stock.In other words, the majority of non professional investors or speculators decide to buy or sell a certain stock on basis on their expectation rather than what is stated in most of books, “what they are ready to pay for it, based on their “sophisticated” analysis”. For example, if investors see that a company X has reported a 20% growth this year, or became number one in a specific sector, then the investors presentiment became bullish, creating a good environment for a significant growth due to speculators expectation.
For example let us take the case of Enron – one of the biggest US companies in early 2000’s.Enron was leading company in electricity, communication, pulp, paper and natural gas sphere. In 2000 Enron Corporation reported nearly $101 billion. According to BBC site, “ it was the first to realize energy and water could be bought, sold, and hedged just like shares and bonds. Enron became a huge "market-maker" in the US, acting as the main broker in energy products, also taking financial gambles far bigger than its actual core business.
As a result, in just 15 years it grew from nowhere to become America's seventh largest company, employing 21,000 staff in more than 40 countries. Fortune magazine namedEnron "America's Most Innovative Company" for six consecutive years from 1996 to 2001. ”. The situation around Enron is the following.
Enron has speculated and trade in the commodity markets with long and complicated deals. Many of these transactions and gambles on the future raw material (like crude sweet oil, natural gas and etc. ) Prices, has generate huge losses. This loses was spread across many so called partnership companies, that was in fact like Enron’s trash bin, where they allocate their negative financial results, leaving their financial report shiny and attractive for the investors.These partnership companies were set-up by Enron officials (executives, relatives and etc.
) . Those stakeholders – executives, also benefit from the Enron fall, they short sell their shares (they had received millions of shares as bonuses of going “so well”) just before the Enron information go public, generating enormous profits on the back of one dying empire. In 2001 “Enron left behind $31. 8bn (? 18bn) of debts, its shares become worthless, and 21,000 workers around the world lost their jobs. ”6 If we can talk that “earning management comes in two basic forms: smoothing and falsifying.
Then, in Enron case, we definitely could talk about falsifying, because the amount of data that was misrepresented has got a major impact on other stakeholders presentiments and acts. The next main point, I will concentrate is how the Security Exchange Commissions and regulatory organs, both in US and UK differs and on what basis, they found, investigate and pursue this type of frauds. One of the problems that regulatory organs over the world are facing is the fact that the accounting and reporting standards differs around countries.This means that there is no standardized regulation for the international companies over the world. Europe and many other countries in the world has adopted IFRS (International Financial Reporting Standards).
In recent years, Brazil, Canada, China and India have all committed to formal timelines for adoption of IFRS, and Japan has made 2011 its target for convergence to IFRS. The Securities and Exchange Commission in USA also agreed to reduce its reconciliation obligation, with instant consequence, for non-US companies using IFRS as set by the IASB.The SEC is even giving serious consideration to a proposal to permit US companies to use IFRS. Without any doubt, these implementation by the US official regulatory organs would make it easier to compare and evaluate the financial and accounting report and performance of corporation across the world. These would result in a lower cost of international corporations that would now prepare one universal report, leading to lower capital costs for firms and would improve the efficiency of rivalry for worldwide funds and make global funds markets more efficient.Of course the benefits listed above are based on the understanding that the use of IFRS would result in improved quality of the financial reporting.
And as any other accounting standard in Europe so far, IFRS gives only a restricted role in supervising the financial reports of the companies leaded by the earning management style. The United States Security and Exchange Commission announce that it would accept the IFRS report as compatible with its administration, so that non-American companies that operate in USA market can easily transfer their work and working manners in USA.On the other hand is the fact that the USA SEC and other regulatory organs, has got a significantly better result than any other supervision or control organ over the world. The suspected number of white collar crime in USA and Europe is relatively the same.
But the cases of investigated and proved crimes in Europe is around 5% of USA’s ones. Which means that the USA professional organs and supervisions do their job a lot better and their regulatory system is more well developed then Europe’s more “liberal” one?Everything depends on how the individual consider the earning management... s a fraud or as a normal representing of the present looked from other angel. My opinion is that in today’s world in which the financial markets are opened to the masses, just in one click, the regulatory organs, should uses even more regulations over the big corporations then before.
If the Stock Exchanges over the world wants and are ready to use every people’s money. Then they should provide an adequate information and true, fair and “viewed from the correct angel” accounting reports of the companies listed for market trading.
