2010
Quadrophobia: the strategic rounding of earnings data
I just stumbled across a fascinating article by academics Joseph Grundfest and Nadya Malenko that examines the “first post-decimal digit of EPS” (earnings per share) data of nearly 489,000 quarterly earnings records for 22,000 companies over a 27-year period.
In a data set this large, the last digit of EPS measured to the one-tenth of a cent (for example, the number “6″ in $0.516) should be evenly distributed between 0 and 9. But Grundfest and Malenko find that is not the case. Rather, they found that the number 4 appeared only 8.5% of the time (instead of the expected 10% of the time), and the numbers 2 and 3 are also under-represented. All other numbers were over-represented.
This suggests that some publicly-traded firms are expending effort to manage revenues and costs in such a way that allows them to “round up” their earnings (e.g., from $0.516 to $0.52) rather than “round down” (e.g., from $0.514 to $0.51), improving their apparent earnings and making it more likely they’ll meet Wall Street expectations (or exceed those expectations by one cent).
Not only does this represent an economic inefficiency (in that it requires an expenditure of resources without any increase in “real” economic value), but Grundfest and Malenko find that firms that suffer from so-called “quadrophobia” are also more likely to be subsequently charged with accounting violations.
The obsession that Wall Street has with short-run earnings continues to be a destructive force. We need to develop alternative measures that help to focus investors’ attention on long-run value creation. That’s one of the reasons that the emergent field of human capital analytics is so important.
Tagged long-term perspective