New York (July 6, 2004) -- Companies that are most aggressive in booking the non-cash component of their earnings are four times as likely to be sued by their shareholders, according to a study by Criterion Research Group LLC, an independent research firm covering corporate equities and debt.
The study, based on class action suits filed from 1996-2003, found that companies in the highest accrual category are four times more likely to be sued by shareholders than companies in the lowest accrual category. Accruals are essentially estimates of future cash flows and expenses that impact current earnings.
Criterion examined the financials of companies filed for the year of the so-called class start date, which is the beginning of the period during which financial statements were allegedly erroneous. Criterion also found that class actions, on average, are filed one and one half years after the class start date, and are generally brought within three years of that date.
"By any measure our findings have underscored the age-old Wall Street adage: 'Earnings are opinion, cash is fact,'" said Neil Baron, co-founder and chairman of Criterion Research.
Criterion said the findings are in line with earlier studies it conducted that showed that companies with the highest accruals have historically realized poorer forward earnings, had poorer forward stock returns, and experienced more earnings restatements and Securities and Exchange Commission enforcement proceedings. A study it released last month found that nearly 60 percent of the material earnings restatements announced this year involved companies that were in the two highest accrual categories for the years restated.
Criterion noted that companies that settled recent class actions and were in the two highest accrual categories included Rite Aid, Waste Management, and MicroStrategy. It said companies currently in its highest accrual category include Yahoo Inc., General Motors Corp., eBay Inc. and Halliburton Co.
— WebCPA staff
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