How to Tell if Your Budget Has Been Manipulated
Marco Trombetta and Claudia Imperatore, a newcomer at the Department of Accounting, have used an algorithm to describe the reaction of accounting quality during a financial crisis. Their analysis is based on a sample of 5,964 U.S. companies during the period that goes from 1996 to 2011. They used two different models to examine how earnings manipulation behaviors are affected by financial distress, which acts as the independent variable. "In order to measure the financial crisis we created a stress index based on eleven market variables. To calculate earnings management we have adopted already existing metrics. We used quarterly accounting data to calculate accruals, that is the part of the operating income that is not associated with cash flow and therefore it can be deliberately used to match a target".
The results are featured on "The dynamic of financial crises and its non-monotonic effects on earnings quality", a study published by the Journal of Accounting and Public Policy. The relationship is non-monotonic: earnings management decreases when the intensity of the crisis is low, while it increases when the crisis is severe. Algorithms, Imperatore says, are commonly used to distinguish the part of the accruals that can be attributed to a correct adjustment of the financial report from the outcomes of manipulation. "This research area has existed for decades. Over the past eight years, we've seen the rise of the qualitative analysis of financial reports. New algorithms inspect the textual part of financial statements to measure the optimism or pessimism of those who drafted them, and they extract the most complicated phrases to test the level of readability. Using complex language is a way to hide the contents of a balance sheet".
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