Every year, my mailbox gets cluttered up with huge proxy statement packets filled with a bunch of crap I won't read. And every year, I vote against the Big 4 accounting firm recommended by the Board. Why? Because it's the only way to stick it to the man now that I've sold out, obviously. In […]
[R]esearch finds auditing fees charged to companies to be significantly related to the their financial performance for as long as five years into the future: the higher the fees this year, the lower firms’ performance next year and beyond. In the words of the journal report by Jonathan D. Stanley of Auburn University, “Primary results indicate a significant inverse relation between audit fees and the one-year ahead change in clients’ operating performance… Further analysis reveals that the primary results extend to changes in operating performance observed up to five years after the fee is disclosed; are more pronounced for future negative versus positive chances; and [are] applicable to future changes in earnings unaccounted for by analysts’ forecasts.” Asked if these findings are likely to be of value to average investors, Prof. Stanley answers in one word: “Definitely.” [AAA]
Speaking at The Wall Street Journal’s annual CFO Network meeting in Washington D.C., Schapiro readily admitted that there isn’t a big push from either multinationals or shareholders to move to international financial reporting standards.
In response to a question from Bank of America’s CFO, Chuck Noski, Schapiro said, “We have not heard from a lot of shareholders that we have to go (to IFRS). We’ve heard the contrary… ‘Why would we take this step toward international accounting standards?’” [CFOJ]
Convoluted corporate financial reports are just as unreadable for professional stock analysts as they are for the average investor, according to a new study.
The study, published in the current issue of the American Accounting Association journal Accounting Review, tested the readability of tens of thousands of company filings over 12 years and found that analysts’ earnings forecasts for firms with less readable reports “have greater dispersion, are less accurate, and are associated with greater overall analyst uncertainty.” Ironically, however, the syntactic and linguistic complexity of these reports generated greater demand from investors for analysts’ commentary and greater reliance on their forecasts. [AT]
Yesterday, prior to today’s excitement regarding Satyam and PwC, PCAOB Chairman James Doty spoke at the The Council of Institutional Investors 2011 Spring Meeting and he had some interesting things to say about the audit profession, specifically that auditors don’t always remember that “protecting investors” ≠ “client service”:
Time and time again, we’ve seen services that might be valuable to management reduce the auditor’s objectivity, and thus reduce the value of the audit to investors. While management may need the services, they just don’t have to get them from the auditor.
Audit firms call this “client service,” and it makes things terribly confusing. When the hard questions of supporting management’s financial presentation arise, the engagement partner is often enlisted as an advocate to argue management’s case to the technical experts in the national office of the audit firm. The mortgaging of audit objectivity can even begin at the outset of the relationship, with the pitch to get the client.
Consider the way these formulations of the audit engagement that we’ve uncovered through our inspections process might prejudice quality:
• “Simply stated we want management to view us as a trusted partner that can assist with the resolution of issues and structuring of transactions.”
• We will “support the desired outcome where the audit team may be confronted with an issue that merits consultation with our National Office.”
• Our audit decisions are “made by the global engagement partner with no second guessing or National Office reversals.”
Huh. Doty doesn’t name names but you could easily interpret those statements as one made by a client advocate, not a white knight for investors. He continues:
Or, to demonstrate how confusing the value proposition could be even to those auditors who try to articulate it:
• We will provide you “with the best, value-added audit service in the most cost effective and least disruptive manner by eliminating non-value added procedures.”
(What is a “non-value added procedure”? Whose value do you think the claim refers to? If a procedure is valuable to investors but doesn’t add value to management, will it be scrapped?)
In other words, “we promise that we won’t be pests” and “value” will be a game-time decision. And finally:
Or, consider this as a possible audit engagement formula for misunderstanding down the road:
• We will deliver a “reduced footprint in the organization, lessening audit fatigue.”
(What is “audit fatigue”? Does accommodating it add value to investors? How should investors feel about a “reduced footprint”?)
Yes, what is “audit fatigue”? Is that what happens to second and third-year senior associates every February/March? Or is this better articulated by “we know audits are annoying and our hope is that we won’t annoy you too much.”?
Taking this (the whole speech is worth a read) and everything else that happened today into account, it will be interesting to hear what Mr Doty has to say at tomorrow’s hearing.
Professor Russell Lundholm may not have intended it to turn out this way but may have inadvertently revolutionized the accrual anomaly and not so incidentally points out that no one else seems to have figured this out. “It’s about the composition of earnings and what percent were due to accruals,” he said about his recent paper, published in the January/February American Accounting Association’s Accounting Review.
Think about it this way: a company with a lot of cash…has a lot of cash. It’s obvious that cold, hard cash can be used by a company at any point. Accruals, on the other hand, aren’t always as easily converted into a pile of dollar bills that can be shoved into a truck and sent to debtors or suppliers for items the company needs. Forgive me for going out on a limb here but it then seems obvious that a company low on accruals (or accounting tricks) should reasonably underperform. That’s not the point of the work, though. It’s about looking at earnings minus accruals:
Employing corporate data spanning 19 years, the authors — [Russell] Lundholm, [Nader] Hafzalla (now deceased), and Matt Van Winkle of Voyant Advisers, LLC of San Diego — compare results computed via the traditional method and via the new method for both operating accruals and total accruals. For both operating and total accruals the new method yields significantly better returns, with the sharpest difference being seen for operating accruals (net income minus cash from operations); there, the traditional model yields an annual return that is about 6.5% greater than that of a portfolio of similarly-sized firms, and the new model produces an abnormal annual return that is about 11.7% greater than that of similarly-sized firms.
People have figured out this strategy but the new bit is that Lundholm, Hafzalla and Van Winkle look at it as a new equation: is picking out a stock dud as easy as figuring out who has a bunch of accruals?
Lundholm points to examples where a high level of accruals preceded poor stock performance.
Accruals at Monsanto Co, the world’s biggest seed producer, were 58 percent of earnings for the previous four quarters when the company reported results on January 6, 2010, according to Lundholm. That was in the top 10 percent of all U.S. companies.
Since then, its shares have dropped 13 percent, while the S&P 500 index is up about 16 percent.
Recommended reading in relation to this subject, Lundholm’s paper in its entirety: Percent Accruals by Lundholm, Hafzalla and Van Winkle. We’ll take all the accounting revolutions (or revelations) we can get.
“Swift and vigorous prosecution of those who have broken the law is at the heart of the agency’s efforts to restore investor confidence.”
– SEC Chair Mary Schapiro in testimony before a Senate appropriations subcommittee Wednesday defending the SEC’s request to be self-funded.
Servants of the capital markets, in your day to day activity have you been thinking about the investors out there that depend on you? What they need? What they want? Do you really know them? If not, the Chief Accountant would like you to start, pretty please:
Securities and Exchange Commission Chief Accountant James L. Kroeker told leaders of the accounting profession that independent auditors will be expected to consider the interests of the “investing public” — not just their audit clients — when performing their duties.
The mission of his office will be to “put investor protection at the forefront in all that we do,” he said in an address to the American Institute of CPAs’ National Conference on SEC Developments.
Under his watch, “you are likely to notice we will be more proactively seeking to understand and discuss the views of investors.” Accountants “should not be surprised when we ask you whether you have considered the perspective of the investing public.”
He does think that majority of you are a-okay and “are honest hard-working professionals who simply want to ‘do the right thing,'” but dang it, are you sure you’re thinking about investors? All the time? Like, right this second? That’s your job, you know. The OCA just
wants to jump your shit remind you.
And if you’re not thinking about investors, you’ll be dealt with professionally but don’t confuse that with a regulatory rollover. Expect something more along the lines of wishing you were never born:
“You should not confuse professionalism with a notion of leniency. Those who fail to live up to their responsibilities and those who cause harm to investors or our capital markets can expect that we will take appropriate action.”
Got it? The SEC dream team will deal with you that don’t start taking this shit seriously. You see those crazy-eyes? You think he’s joking? Now get back to it, with investors on the brain.
SEC Chief Accountant Tells CPAs to Consider Investors [Web CPA]