Why do companies feel they need to manipulate their income? Is it "wrong" for management to maximize the stockholders' wealth?
It’s a common practice all over the world, that companies try their level best to place figures that only show the brighter side of the picture to the readers in their financial statements. This is evident from the fact that different companies belonging to different sectors release their financial statements at different times in the year, when their performance is at a peak, since the performance of most companies is season dependent, e.g. soft drinks and juices sell more during the summers than they do during the winters. Similarly, there are other such practices in accounting whose sole purpose is to make the financial statements look better and this is usually described by a term in accounting ‘Window dressing’ or ‘creative accounting’.
There can be several motives that a company, i.e. their board of directors and their accountants may have, some of which are described below.
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- A company that faces a high security analysts' profit forecast, because most people will invest on the advice of the security analyst (Simon, 1998)
- In most part of the world publically listed companies are required to report their financial statements quarterly so they have more scope to report good results in the interim financial statements knowing these will not be subject to the same detailed scrutiny as the yearly financial statements
- Incase of a recently taken over company, it is a common practice for the existing Board of Directors to get fired, so they try to manipulate their incomes and produce a significant loss, so that they may be able to blame the previous managers for it. This practice is also called big bath accounting
- Incase a company is converting its state from being privately listed to becoming publically listed, to attract shareholders for their first Initial public offering (IPO)
Incase of a public company, increasing shareholder value would mean driving the stock price as high as possible. According to me it isn’t wrong for companies to try to maximize shareholder wealth, as these people (investors) are the driving force behind any company and are part owners of the company. The management usually receives sufficient stock options to make sure their interests are in-line with the interests of the shareholders and together they give a boost to the company’s performance.
Read about B ig Bath accounting
Simon, Jon (1998, May, 01). Why do companies use creative accounting?. Retrieved April 25, 2008, from http://www.accaglobal.com/archive/sa_oldarticles/49847
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