Detecting Earnings Manipulations: Time think about european SMEs. A call for a Joint International Research Project

A large part of the world economic system is in a state of crisis. The financial system has paid very close attention to this problem, developing specific models to predict insolvency. All of the rating systems related to the Basel Accords use these kinds of models. The insolvency prediction models represent a broad research area, which many researchers have been delving into for many years. These models are largely based on accounting data. As a consequence, the effectiveness of any model depends on the accounting data quality. The accounting data quality is menaced by accounting manipulation actions carried out by mangers. Considering many accounting scams, all over the world, it is evident that sometimes managers cope with the crisis by doctoring their accounting data. That is the reason why, in this period of dire straits, many rating systems have shown strong limitations. According to Healy-Wahlen (1999), earnings management occurs when mangers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. On the same wavelength, the Association of Certified Fraud Examiners (ACFE) maintains that a company is engaged in earnings manipulation when it asks itself “How can we best report desired results?”, instead of “How can we best report economic reality?”. Accounting manipulation reduces the signals of risk that one can perceive analyzing the financial statements (Stolowy-Breton, 2004). Creditors and investors, in particular, are affected by this behavior. Givoly et al., in 2010, pointed out that, considering the analysts tips as a proxy for investors’ choices, the managed earnings components distort analysts’ subsequent earnings forecasts that appear to be unwarranted given the firms’ subsequent operating performance. Long story short, accounting manipulation causes a new risk component, the informative risk, in addition to the operational and financial risk (Stickney et al., 2007). It entails that accounting manipulation increases the cost of capital and impinges upon the companies’ fundamental value. So, this risk should be taken into account in any kind of company evaluation.