January/ February 2007

Managing aggression: The price of aggressive accounting

Look deep into your imagination and the idealized world of ethical integrity in business is as clear as day. Snap back to reality, though, and the evening news alone will show that corporate fraud occurs often enough. Researchers at Mays have found that there are definitely repercussions for aggressive accounting, and committing the crime means paying the price—but the highest price isn’t always paid from the pocket.

While there are definitely repercussions from the SEC if caught, one of the largest drawbacks of aggressive accounting is actually a private one—the reputational penalty. According to Associate Professor of Accounting Michael S. Wilkins’ co-authored article, “The Reputational Penalty for Aggressive Accounting: Earnings Restatements and Management Turnover,” 60 percent of restating firms experience a turnover of at least one top manager within 24 months of a restatement. This new finding surpasses previous research that showed a 35 percent turnover among similarly aged, sized and industry-matched firms.

Restatements occur when a company must revise and correct previous financial documents, usually because of an accounting irregularity or misrepresentation. Although restatement can result from honest error, the practice became notorious during the wave of corporate scandals in the early 2000s.

According to Wilkins, a restatement can cost you more than job security; for some managers, losing their job means losing their career. For example, Wilkins finds that the rehire rate for managers of firms that have restatements is only about half that of firms without restatements—and the age and tenure of a CEO can be a double edged sword.

It’s arguable that the longer a CEO has been in power, the more power they will have—making it easier for those with longer tenure to keep their job after a restatement. But on the contrary, age discrimination is a factor in the corporate world. While a CEO with longer tenure may have a better chance of keeping his job, if it’s lost, he might not find a new one.

“A high management turnover coupled with a low rehire rate could influence managerial actions and incentives,” Wilkins said. This alone is enough to encourage lawful financial statements. And the knowledge alone of risk for such punishments may reduce the regulatory costs associated with monitoring and enforcing strict adherence to Generally Accepted Accounting Principles (GAAP).

Wilkins’ research also shows that the primary culprits for aggressive accounting are younger firms who need to have access to capital markets. “Young firms are under a huge amount of pressure to meet earning targets,” he said. “This probably is one of the reasons why the SEC seems to scrutinize young firms’ financial statements a little more closely.”

It’s hard to judge the intent of a firm when its financials are being restated, but what’s unquestionable is that there will be consequences for those who falter—and it’s likely that the price to pay will extend far beyond the monetary penalty from the SEC.

Wilkins’ article appeared in the January 2006 issue of The Accounting Review. The article is co-authored by Hemang Desai of Southern Methodist University and Chris E. Hogan of Michigan State University.

— Ashley N. Coker


January/ February 2007
Looking forward to success Managing aggression Where you’re going, where you’ve been Business Vader joins health side Unveiling the influential impact of the good, the bad and the ugly Building pie charts or baking apple pie? Sink or swim? Search and you shall find? Counting on accounting Service Innovation Keeps Them Coming Making Derivative Transactions Transparent New-Product Pre-Announcements Boost Shareholder Value Watching Buffett: The Power to Move Markets	Managing aggression: The price of aggressive accounting Look deep into your imagination and the idealized world of ethical integrity in business is as clear as day. Snap back to reality, though, and the evening news alone will show that corporate fraud occurs often enough. Researchers at Mays have found that there are definitely repercussions for aggressive accounting, and committing the crime means paying the price—but the highest price isn’t always paid from the pocket. While there are definitely repercussions from the SEC if caught, one of the largest drawbacks of aggressive accounting is actually a private one—the reputational penalty. According to Associate Professor of Accounting Michael S. Wilkins’ co-authored article, “The Reputational Penalty for Aggressive Accounting: Earnings Restatements and Management Turnover,” 60 percent of restating firms experience a turnover of at least one top manager within 24 months of a restatement. This new finding surpasses previous research that showed a 35 percent turnover among similarly aged, sized and industry-matched firms. Restatements occur when a company must revise and correct previous financial documents, usually because of an accounting irregularity or misrepresentation. Although restatement can result from honest error, the practice became notorious during the wave of corporate scandals in the early 2000s. According to Wilkins, a restatement can cost you more than job security; for some managers, losing their job means losing their career. For example, Wilkins finds that the rehire rate for managers of firms that have restatements is only about half that of firms without restatements—and the age and tenure of a CEO can be a double edged sword. It’s arguable that the longer a CEO has been in power, the more power they will have—making it easier for those with longer tenure to keep their job after a restatement. But on the contrary, age discrimination is a factor in the corporate world. While a CEO with longer tenure may have a better chance of keeping his job, if it’s lost, he might not find a new one. “A high management turnover coupled with a low rehire rate could influence managerial actions and incentives,” Wilkins said. This alone is enough to encourage lawful financial statements. And the knowledge alone of risk for such punishments may reduce the regulatory costs associated with monitoring and enforcing strict adherence to Generally Accepted Accounting Principles (GAAP). Wilkins’ research also shows that the primary culprits for aggressive accounting are younger firms who need to have access to capital markets. “Young firms are under a huge amount of pressure to meet earning targets,” he said. “This probably is one of the reasons why the SEC seems to scrutinize young firms’ financial statements a little more closely.” It’s hard to judge the intent of a firm when its financials are being restated, but what’s unquestionable is that there will be consequences for those who falter—and it’s likely that the price to pay will extend far beyond the monetary penalty from the SEC. Wilkins’ article appeared in the January 2006 issue of The Accounting Review. The article is co-authored by Hemang Desai of Southern Methodist University and Chris E. Hogan of Michigan State University. — Ashley N. Coker