The FEI Research Foundation, the research affiliate of Financial Executives International (FEI), today released the results of a study of the quality of financial reporting. The study tracked two key metrics over time -- the number of earnings restatements and the corresponding market value losses following those restatements.
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The average annual number of restatements since 1995 was three-quarters of one percent (0.75%) of the average annual number of reporting companies, indicating that the overall quality of financial reporting is high. In addition, the market value losses following restatements represent less than one-tenth of one percent of the total equity market value since 1995. Furthermore, the bulk of the market value losses following restatements were tightly concentrated around a small number of cases. For instance, in 2000, 95% of the market value losses stemmed from the restatements of 10 companies.
FEI undertook the study in order to objectively assess the extent of perceived problems in financial reporting. In addition, the study tries to establish a context for the frequency of the problems and the effect of restatements on investors.
Key Study Findings
From 1977 to 2000, there were 1,080 restatements of earnings, with the number of restatements at significantly higher levels in years 1998, 1999 and 2000. In 1998, there were 100 restatements; 1999, 207; and 2000, 157. The average annual number of restatements per year from 1990 to 1997 was 49.
The most common reason for restatements was revenue recognition, which have accounted for one-third of all restatements since 1977. Cost issues (typically relating to inventory valuation) and loan-loss provisions were the second and third most common causes. (Full results, including a list of restatement causes, are available online at the FEI''s web site at http://www.fei.org/).
Another common restatement cause during the past three years was accounting for acquired "In-Process Research & Development" (IPR&D). IPR&D was the subject of a 1998 SEC initiative to revise its accounting treatment. This caused 9 restatements in 1998 and a dramatic 57 in 1999. However, the market reaction to these IPR&D restatements was typically small. When IPR&D restatements are excluded, restatements involved just two-thirds of one percent (0.67%) of the average annual number of public companies.
In tracking stock price changes following earnings restatements, the study found that market value losses in total were small relative to the entire market. Further, market value losses were sharply focused.
For example, from 1998 through 2000, eight cases represented 77% of the total market value losses (not including IPR&D cases). (See full results for listings of the companies in years 1998, 1999 and 2000 that experienced the 10 greatest market value losses following their restatements.)
In total since 1990, annual market value losses following earnings restatements represented less than two-tenths of one percent of the market capitalization of all stocks. In actual dollars, the total market value losses were, for example, $17.7 billion in 1998, $24.2 billion in 1999, and $31.2 billion in 2000. Excluding IPR&D causes, the market value losses were lower in 1998 and 1999: $17.3 billion and $16.4 billion, respectively. (See full study for market value losses 1990-2000.)
In response to the study, FEI President and CEO Philip Livingston said, "This data confirms that we enjoy high-quality financial reporting in the United States, with a very small rate of restatements. To illustrate, the market value losses that followed restatements represent just 1.6 percent of the $4.7 trillion in market gains from 1997 to 2000. Certainly there should be no free pass for companies who don't report accurately and in compliance with regulation, and violators should be punished to the full extent of the law. This data also confirms that the major cause of earnings restatements -- revenue recognition -- is an issue that needs to be addressed by regulators, accountants, and companies to create clarification, simplification, and consistent interpretation."
The FEI Research Foundation contracted the data collection and analysis from Min Wu, a graduate student at NYU's Stern School of Business. Ms. Wu searched Lexis-Nexis and Dow Jones Interactive for all mentions of "restatements" from 1977 to 2000. Restatements due to irregularities or errors that were reported voluntarily by the companies, forced by company auditors, or enforced by the SEC were included in the database, while the research excluded instances of accounting methodology changes, stock splits, dividends, inflation accounting and discontinued operations.
About the FEI Research Foundation
The FEI Research Foundation is a non-profit affiliate of Financial Executives International. Its mission is to identify and sponsor research to benefit the corporate finance profession. The Foundation offers print and web-based research studies and survey results, teleconferences, conferences, and an online customized search service, "Ask the FEI Librarian." The foundation relies on voluntary contributions from the business community to carry out its work.
Financial Executives International, the leading advocate for the views of corporate financial management, is a professional association of 15,000 CFOs, treasurers and controllers. FEI enhances member professional development through peer networking, career management services, conferences, publications, and special reports and research. For more information, visit our web site at http://www.fei.org/.
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SOURCE: FEI Research Foundation
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