9 Someofthesefirmsusetheseentitiesaslegitimatedevices
to reduce their cost of debt and then provide information
abouttheirexistenceintheirfinancialstatements,butothers
use them to hide their indebtedness from the public.
3.Earningssmoothingandmanagement.Firmshaveuseda
varietyoftechniquestosmoothearningsoverperiods.Inthe
1990s,Microsoft routinelyunderestimateditsearningsfrom
upgrades to both operating and applications software,
buildingupareserveitcoulddrawoninthosequarterswhere
its true earnings threatened to fall short of earnings
expectations. Intel reported the price appreciation on the
equityinvestments ithad in othercompanies asprofitand
usedtheseadditionalearningsto meetmarket expectations.
During the stock market boom of the 1990s, some firms
reported some of their excess pension fund assets as profits.
10 Whatharmisdonebythesepractices?Forbetterorworse,
investorswholookatearningsstabilityasameasureofequity
riskaremisledintobelievingthatthesefirms(andotherslike
them) are less risky than they truly are.
Does this mean that we should eliminate all discretionary
powergrantedtofirms?Wedonotbelieveso,sincethereare
clearly one-time expenses and income that should be
separated from operating expenses and income. Can more
effective policing by auditors prevent this type of abuse?
Perhaps,butweseriouslydoubtit.Inotherwords,nomatter
howstrictlyanaccountingruleiswritten,therewillbesome
firms that are more aggressive than others in their
interpretationoftherule.Theironyisthattighteningtherules
and adding new ones only increase the gulf between
aggressive companies that still find loopholes and
conservative companies that follow the rules as written.