Earnings Management Among Firms During the Pre-Sec Era: A Benford's Law Analysis

Abstract

This paper examines the existence of financial statement manipulation in the U.S. during a time period when many of the current motivations did not exist. The study looks for types of manipulations that would be motivated by the pre-SEC operating environment. To examine this issue, a sample of U.S. firms from the 1915 Moody's Analyses of Investments is divided into industrial firms, railroads, and utilities. The railroad and utility companies faced rate regulation during this time period, providing incentives to manipulate the financial reports so as to maximize the rate received. Industrial firms were not regulated. These companies wanted to attract investors, motivating manipulations to increase income and net assets. To determine if manipulations are occurring, a Benford's Law analysis is used. This analysis examines the frequency of numbers in certain positions within an amount to determine if the distribution of the numbers is similar to the pattern documented by Benford's Law. Some manipulations consistent with expectations are found.

Rumors and Runs in Opaque Markets: Evidence from the Panic of 1907

“…Still, the adherence to and enforcement of the rule remained weak for many years, and the content of these reports varied significantly in their extent and accuracy (Archambault and Archambault (2005) and Sivakumar and Waymire (1993)). In particular, companies in sectors subject to rate regulation saw the greatest incentive to publish their accounts, but their regulation also created incentives to manipulate their earnings statements (Archambault and Archambault (2011)). New laws and exchange rules requiring audited accounts developed only after the Panic of 1907 (Sivakumar and Waymire (1993) and Sivakumar and Waymire (2003)).…”

Economic Aspects of the Missing Data Problem - the Case of the Patient Registry

“…A number of publications use the BL stated in Benford (1938) for exploring distributions and data set applicability in different contexts. Leemis et al (2000) confirm the relevance of Benford in survival distribution research, while Judge and Schechter (2009) discuss the usability for biased conclusions in survey data and the Archambault and Archambault (2011) explore the BL in management area.…”

“…the pharmaceutical registry), survival distribution research (Leemis et. al., 2000), biased conclusions in survey data (Judge and Schechter, 2009), management manipulation (Archambault and Archambault, 2011) or data fraud detection (Tam et al, 2007). Still, the disadvantages of BL are that investigation of categorical or dichotomous data is not possible.…”

The interplay between law and accounting in the conceptualization of depreciation in Spain (1885–1939)

“…Secret reserves were common in the British companies, which often created reserves by overstating liabilities or depreciation during years of high income and then liquidating the reserves during lean years (Arnold, 1991). These manipulations, achieved through depreciation, taxation and secret reserves, were used by 25 per cent of companies after 1915 (Archambault and Archambault, 2011). For instance, Kern (2000) provided evidence that depreciation varied between good and poor years for companies between 1908 and 1930, and Carlon and Morris (2003) linked depreciation to two points: unregulated companies disclosed that they charged depreciation when they had sufficient profits, and the amount of depreciation they charged was strongly related to their profit levels rather than to the size of their depreciable assets.…”