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Wednesday, October 01, 2014

Are US Companies Lying About Earnings?

In the past few years of so-called ‘recovery,’ we've seen a strange combination of rising corporate earnings and falling real wages. And, profit margins are at record highs as well. This is all while the economy is debatably not growing at a rate commensurate with such earnings rises. Something is fishy here. Are corporations lying about earnings?

One of the big changes which would tend to cause this misinformation is that corporate leadership's pay rate is determined largely by increases in share prices. And, share prices increase with rising earnings. So, it's in the interest of corporate management to boost earnings to up their take-home pay. Andrew Smithers has a description of this:

The massive rise in bonuses paid to managements, which depend on the data the companies publish, has encouraged companies to boost profits in the short-term as bonuses often depend on short-term changes in earnings per share or return on equity. Even when they are more directly related to changes in share prices, these often respond to similar changes in the published data. Parallel with this rise in incentives to misrepresent profits has been an increasing ability to do so, with the change from "marked to cost" to "marked to market" accounting.
The result might be compared to the increase in theft that we might expect if windows and safes had to be left open by law, and items stolen were declared to be the lawful property of the thieves.