Predicting the Next Enron

Via the Wall Street Journal, here’s further evidence that companies “tweak” quarterly earnings numbers. Joseph Grundfest and Nadya Malenko analyzed almost half a million earnings reports from 1980-2006. They discovered that when companies want to appear more successful than they are, they often massage their per-share earnings numbers upward by a tenth of one cent. The evidence? The number 4 appears significantly less often than expected in the post-decimal digits of earnings reports. In the U.S., per-share earnings are reported as pennies, so bumping that post-decimal digit from a 4 to a 5 results in the overall number being rounded up by a full penny. Grundfest and Malenko call the practice quadrophobia. While the tweaking may be legal in some cases, the authors also found that “quadrophobes are more likely to restate financials and to be named as defendants in SEC Accounting and Auditing Enforcement Releases (AAER).” Or, as Grundfest told the Journal, quadrophobia serves as “a leading indicator of a company that’s going to have an accounting issue.”[%comments]