Several times a year, Corporations across the country feel the pressure of hitting analysts’ earnings expectations, and the very real possibility of missing those expectations. The consequences for missing earnings expectations goes much farther than management’s job certainty, and can directly affect the view that investors have on a company. Earnings management (EM) helps make meeting these expectations more manageable. However, there are a multitude of problems associated with earnings management. Exercising accounting discretions in relation to EM can be motivated by agency concerns, shareholder perception, stock price motivation, or possibly existing debt covenants. However, the problem arises when the you cross the invisible line of
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Good Business Practice In both the case of Worldcom and Enron both companies met the knowledge and intention portions of defining fraud. Fraud by definition is: “Wrongful or criminal deception intended to result in financial or personal gain.”
Yet, finding a clear definition for what constitutes “good business practice” is seemingly impossible. An overwhelming majority of CFOs prefer smooth earnings (versus volatile earnings). Holding cash flows constant, volatile earnings are thought to be riskier than smooth earnings. Moreover, smooth earnings ease the analyst’s task of predicting future earnings. From CFO opinion one can assess that income smoothing, an earnings management technique, is within the realm of good business practice. Corporations globally are operating during a time period that is both highly regulated, and highly scrutinized, and must tread lightly. There may never be a time that we can clearly differentiate between a company fraudulently manipulating their earnings and participating in good business practice. Speculations should rise when a CEO is being compensated very highly with stock options. While it is clear that many forms of EM are consistent with GAAP and IFRS practices, that does not potentially exclude them from efforts to deceive
Good Business Practice In both the case of Worldcom and Enron both companies met the knowledge and intention portions of defining fraud. Fraud by definition is: “Wrongful or criminal deception intended to result in financial or personal gain.”
Yet, finding a clear definition for what constitutes “good business practice” is seemingly impossible. An overwhelming majority of CFOs prefer smooth earnings (versus volatile earnings). Holding cash flows constant, volatile earnings are thought to be riskier than smooth earnings. Moreover, smooth earnings ease the analyst’s task of predicting future earnings. From CFO opinion one can assess that income smoothing, an earnings management technique, is within the realm of good business practice. Corporations globally are operating during a time period that is both highly regulated, and highly scrutinized, and must tread lightly. There may never be a time that we can clearly differentiate between a company fraudulently manipulating their earnings and participating in good business practice. Speculations should rise when a CEO is being compensated very highly with stock options. While it is clear that many forms of EM are consistent with GAAP and IFRS practices, that does not potentially exclude them from efforts to deceive