Memories of Enron, WorldCom, Tyco, Parmalat and other egregious corporate accounting scandals of the early 21st century may have receded, but the expensive problem of fudged financial figures appears only to have been swept under the corporate rug.
A report by the accounting firm Ernst & Young found that corporate “bribery and corruption are widespread, with 39% of respondents to (a recent) survey reporting that bribery or corrupt practices occur frequently in their countries. The situation is significantly worse in rapid-growth markets.”
Not that things are squeaky clean on this side of the Atlantic, either. According to GMI Ratings — which was named “The Best Independent Corporate Governance Research Provider” of 2012 by Thomson Reuters and SRI-Connect.com — if investors owned every publicly traded North American company in equal amounts, fraudulent accounting practices would cost them 3% per year. Given the impact of compounding, shaving 3 percentage points off a portfolio’s annual performance would have major significance over the long run.
What might motivate a CEO or CFO to risk career — and perhaps his personal freedom — by cooking the corporate books? The same thing that drives most illegality: money. GMI notes that incentive-based compensation packages have been growing faster than traditional salaries, “exacerbating the temptation to misinform or mislead shareholders in order to obtain substantial short-term rewards.” The soggy global economic environment also has magnified the problem by intensifying competitive pressures on businesses and their leaders.