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When requesting a correction, please mention this item's handle: RePEc:bla:jbfnac:vyip A recent study looking at restatements from over 2, companies found that there was a strong tie between whether one company manipulated earnings and the percentage of firms in its region or industry that had announced restatements in the past year. Simply put, when executives see their competitors engaging in accounting trickery, they tend to follow suit.

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The good news? The bad news is that….

Executives rarely face much blowback when they misstate earnings, either from regulators or the investing public. On the regulatory side, enforcement is so weak that they rarely even have to give back the bonuses they earned from false earnings.

How crazy is that? So much for being aligned with shareholder interests.

Buy-side analysts and short-sellers tend to be better at detecting these red flags, but too often they get shouted down when trying to raise the alarm. This has led to a bizarre culture where executives manipulate earnings to reward themselves with bigger bonuses, and everyone knows this is happening, but when anyone tries to call them out on it they get accused of being greedy and self-serving.

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The activist investors who might be best positioned to curb executive bonuses rarely do anything about them. Pershing Square founder Bill Ackman actively encouraged the aggressive acquisition accounting at Valeant that helped executives nearly triple their compensation in , and he has been a staunch supporter of the executive team at Jarden JAH that uses an exec friendly form of adjusted earnings to help executives boost their own pay at the expense of shareholders.

Ideally, this situation will change at some point, and the correct enforcement mechanisms will be in place to prevent earnings manipulation.



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It takes a lot of work to reverse all the loopholes that executives exploit to serve their own purposes. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Click here to download a PDF of this report.

The Income Statement I- Intermediate Accounting I- L3- Professor Levine

Eric February 26,