Study Proves Companies Manage Earnings

Which is like a study proving that people breathe.  Mark Hulbert in the New York Times:

A NEW study has found compelling evidence that companies often tinker with their earnings to make themselves look more attractive…

The new study–“Earnings Momentum and Earnings Management,” (PDF) by James Myers, Linda Myers, and Douglas Skinner–doesn’t claim to “prove” anything, of course, just to provide “prima facie evidence of” a practice that the most junior accountant or analyst would tell you happens every day. 

Of course companies manage earnings!  Our accounting system involves as much subjectivity as Impressionism.  Why would companies not store acorns in fat quarters and raid the stores in lean ones?  Especially when, as the study also shows, companies that manage earnings have better stock returns than companies that don’t.

How much better?  The study analysed two groups of companies that grew earnings for five years in a row (itself unusual).  The first group managed earnings so well that earnings appeared to increase for 20 straight quarters.  The second group increased earnings each year, but had quarters in which earnings declined.  The stocks of the first group outperformed the stocks of the second group by 6 percentage points per year.

The bad news for earnings-managers is that when their consecutive winning streaks finally end, their stocks get hammered.  Why?  In part because, after 20 straight quarters of apparent infallibility, the companies have inadvertently persuaded themselves and their investors that they’re as safe as Treasury bills.  And when this illusion is shattered, there are hard feelings all around.