- Cleary Gottlieb’s Neal Whoriskey makes a good point – there’s been a minor groundswell of coverage from both regulators and journalists looking at companies that have been more aggressive with revenue accounting recently. Whoriskey’s piece cites numerous headlines generated off companies that have set up incentive programs to pull revenue forward from future quarters. For context on the thought process, a McKinsey survey suggests that 47% of company executives facing a possible earnings miss that don’t have a self-described “long-term culture” would “take some action to close the gap” between actual and expected earnings. The piece also mentions some specific tactics that have drawn the ire of regulators, specifically citing “price rebates, discounted prices, free products, and extended payment terms.” The Autocorrect staff is not in the business of giving accounting advice, but we do think these stories are a good reminder for all levels of public companies; we’ll just leave it at that.
- Possibly our favorite story for the week comes with a hat tip to Bloomberg’s Matt Levine, who dedicated the lead of his recent daily column to a group of Stanford University researchers analyzing the strategy of a massive insider trading scheme. From 2011-2015, a small criminal enterprise was able to access 150,000 earnings press releases for a wide range of public companies prior to their broad distribution, with full details as to the headline EPS numbers in advance, making as much as $100m in ill-gotten profits. However, the research piece, entitled The Signal Quality of Earnings Announcements: Evidence from an Informed Trading Cartel, looks at the data from the point of view of the criminals – “if you had the press releases, could you come up with a better trading strategy?”
First off, 77% of the trades entered using the illicit information actually generated a profit – not much better than two coin flips. Further, the researchers note that the traders missed out on 70% of the most profitable trades that could have resulted from their advance knowledge; earnings announcements in the most profitable decile would have yielded 11.5% per trade, but the criminals only traded on events producing 5.15% per trade. Autocorrect readers know the answer here – the headline number on a press release is often the least important value therein. Guidance, discussions of market conditions, management confidence in business segments or geographies, and general context are all important inputs, and much more difficult to digest by an untrained (or illicit) eye. And, that’s why we have a financial community in the first place.