Study Finds Footnotes Increasingly Fertile Grounds for Earnings Distortion

Chris Gaetano
Published Date:
Dec 2, 2019

A recent study has found that public firms are increasingly using the footnotes to distort earnings and present a rosier picture than reality suggests, according to Institutional Investor

The practice concerns how firms classify earnings. Core earnings are generally known as things which represent persistent profit centers connected with a firm's long-term operations. Transitory earnings, on the other hand, represent one-time or temporary events not connected with the main business, such as litigation or regulatory events. The researchers found that firms are increasingly disclosing non-operating short-term earnings events but only doing so in the footnotes or the MD&A. Those not reading the fine print could come away with the impression of a more sustainable cash flow than might actually be the case. 

What's more, this practice is growing: between 1998 and 2017 there was a 34 percent increase in the average number of earnings adjustments that management claims to be from non-operating events. This has led to a situation where, in 2018, earnings in the S&P 500 were estimated to be distorted by an average of 22 percent. The analysis indicates that a growing share of corporate income is derived from unusual or one-time events which are disclosed only in the footnotes or the MD&A, which is not always apparent to analysts looking at the income statement. 

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