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The Daily

Study Finds Earnings Misstatements in One Company Spawn Copycat Misstatements in Others

Chris Gaetano
Published Date:
Oct 26, 2015
LierA recent study has found that when one company is found to have stretched the truth in its earnings report, other companies watch how they did it and say "Huh, that's a good idea, why don't we try that?" according to the New York Times.

The conclusion came after an examination of 2,249 companies from 1997 through 2008. What the researchers found was that "controlling for industry and firm characteristics, firms are more likely to begin managing earnings after the public announcement of a restatement by another firm in their industry or neighborhood," according to the study abstract. Copycat companies were found by the study to be extremely precise in their mimicry, often duplicating the exact method the original company used to fudge their numbers, whether it was manipulating revenue, abusing the expense accounts, or messing with the inventory figures, according to the Times. 

The exception was if the discovery of the misstatement held some negative consequence for the company itself, such as an SEC investigation, a class action lawsuit, or even bad publicity due to its actions. In these cases, the researchers did not find a copycat effect from the initial misstatement. 

The researchers believe this copycat effect comes from the social norms that are established between companies. If one company misstates its earnings and nothing bad happens when it's discovered, the thinking goes, why shouldn't another company do the same? This thinking is further bolstered by the lack of copycat effect when the company does face some negative consequence for its actions: other companies watching this know the same thing could happen to them if they step out of line, and so are less inclined to manipulate earnings information. The researchers believe this means SEC action, litigation, and bad publicity can have a strong deterrent effect. 

One of the researchers compared it to littering in his native India: he said people litter there because everyone else litters, so why not litter too? In this same respect, according to the paper, companies see a competitor breaking the rules with nothing happening to them, so why not break the rules too? After all, deciding to take the high road could put you at a disadvantage against those who don't.