Why do companies lie?

Should regulators be responsible for verifying the truth of financial statements

Should regulators be responsible for verifying the truth of financial statements? Italian regulator Consob thinks not. That's what the agency said after being accused of dragging its feet on the Parmalat fiasco. Regulators are responsible for making sure companies disclose information, not whether that information is true, Consob officials told the New York Times.

It's a good point, really. Regulators don't have the resources to verify the honesty of all the financial reports they receive from public companies. Therefore, the responsibility to tell the truth about its financial health falls on a company's shoulders - which doesn't seem like such an outrageous request. It's like asking airline pilots to report a heart condition because their health could place passengers in jeopardy. Similarly, corporations put investors' savings at risk by not reporting financial troubles.

So why are some companies having such a tough time giving it to us straight? A record number of US firms revised their annual financial statements in 2003, going from 183 in 2002 to 206 in 2003, according to a study by the Huron Consulting Group. It's possible that many of the executives preparing and approving these financials made honest mistakes. New requirements under Sox on corporate vigilance may also explain the elevation in restatements.

The most common reason for restating financials, according to the Huron study, is connected to the dollars companies put aside to pay for the anticipated costs of restructuring, liability, uncollected debts or other expenses. That's sort of refreshing given the most common reason for restating financials in the past has been revenue recognition.

Still, every day we read about companies that purposely mislead investors. Computer Associates recently received a Wells notice from the SEC, warning that the company will likely face civil charges for booking sales contracts before they were finalized. And Parmalat, with its imaginary $4.1 bn bank account, is an example of financial dishonesty taken to extremes.

The question is: why do companies lie? Is the short-term performance pressure companies are under preventing them from telling the truth? Or are corporations simply not living up to their responsibility to tell the truth in their financials? It's likely a bit of both. An investment culture that continues to reward short-term performance coupled with a corporate culture that encourages stretching the truth in the name of short-term gains inevitably leads to earnings restatements and corporate fraud. So it will take a major cultural shift to avoid another big scandal and make companies take seriously their responsibility for truth in financials.

But what do you think? At IR magazine we want to know what our readers think about the state of corporate reporting - and the state of our reporting. We want your feedback for a 'Letters to the Editor' page we're launching next month. So please send your comments, suggestions, gripes and queries to: letterstoeditor@irmag.com.


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