Tesco results analysis: Why earning mis-statements are like London buses

 
Jessica Morris
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Earnings misstatements, like buses, come in groups (Source: Getty)

Earnings mis-statements are like London buses, it turns out: you wait ages for one, before two turn up at once.

Or that's according to a new study, anyway, which concluded that when one company is found to have mis-stated its earnings, its competitors in that industry could be incentivised to follow suit, leading to even more earnings mis-statements.

But it also found that if the mis-reporting company faces lawsuits or regulatory actions, its peers shun practices that lead to earnings misstatements, because the possible costs are perceived to be too high. No kidding...

Accounting issues rose to the top of the UK news agenda last year after supermarket Tesco found it had overstated its first-half results to the tune of £250m.

The company had been overly ambitious when predicting the sales of products in its UK food business, reducing the cash rebates received from suppliers who pay out when certain sales targets are met.

Read more: One year in, Tesco boss has no room for excuses

The study, entitled "Evidence on Contagion in Earnings Management", looked at accounting restatements by businesses over a 12-year period.

It was conducted by three academics and published in The Accounting Review.

"If the target restating firm, upon discovery of misrepresentation, faces little or no regulatory enforcement then a peer firm is likely to conclude that the costs of managing earnings are low. Lower expected cost of misconduct implies managers of peer firms may rationally choose to adopt these practices as the benefits of such behaviour outweigh the costs," it said.

"However, contagion is only likely to arise if the perceived costs borne by the misreporting firm are low. If the misreporting firm is subject to litigation or [US] Securities and Exchange Commission enforcement, peer firms are likely to shun questionable practices, leading to the phenomenon we refer to as deterrence."

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