Corporate Earnings: Who Can You Trust?
With financial markets in Tokyo, Seoul, and Moscow imploding, investors are flocking to the U.S., where they know certain bedrock principles still apply. Here, companies adhere to universally accepted accounting standards. Auditors scour the books to keep management honest. Regulators ensure that "sunshine" is applied through regular disclosure. And analysts parse the numbers on behalf of investors for information that will make them money.
Or at least that's the way the checks and balances are supposed to work. But lately, questions have begun to be raised about the integrity of the U.S. financial markets, too. Nothing on the order of what has been happening overseas, of course, but disturbing questions nonetheless.
The concern is being driven not just by accounting debacles, as witnessed at Cendant Corp. It's the gnawing sense that companies that should know better are regularly pushing the limit, accountants are AWOL, and analysts are too enmeshed with their investment-banking brethren to provide objective advice. Even investors bear some responsibility: They've been so eager to cash in on the bull market that they've frequently ignored or optimistically interpreted restructuring charges, acquisition write-downs, and other accounting ploys that camouflage what's really going on.
As risk has returned to the system with a vengeance, smart players are starting to apply more discrimination. Savvy institutional investors are seeking more independent analysis. Regulators are stepping up the public pressure on companies and accountants. Companies that shun accounting convention are being punished in the marketplace. And individual investors, singed by unpleasant surprises, are starting to educate themselves. Of course, the pressures that caused these problems to arise in the first place are not going to disappear quickly. And with markets as volatile as they are, no issue deserves more attention. BUSINESS WEEK devotes this Cover Story to examining the depth of the problem, identifying solutions, and educating investors in self-defense.