Question

Why do you think corporate CEOs and upper management negligently or fraudulently provided information to investors? Do you believe that corporate CEOs and upper management have been pressured to provide false or misleading information because their success is measured on how well their able to maximize shareholders wealth and increase profitability?  How can the SEC prevent or deter this behavior?

Answer 1

CEOs and upper management negligiently or fradulently provide information to investors to induce investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of securities laws. This is also called as Stock fraud or Investment fraud. The companies manipulate their accounting practices to paint a good  picture of the financials of the company to actually provide higher bonuses for executives or attracting investors. It reflects a financially stronger company by inclusion of fictitious asset costs or artificial revenues. Understated liabilities and expenses are shown through exclusion of costs or financial obligations. Both methods result in increased equity and net worth for the company. This overstatement and/or understatement results in increased earnings per share or increased profit resulting in more stable or strong picture of the company's true situation.

In my opinion , it will be inappropriate to say that CEOs are pressured to provide false or misleading information as they are the only one reaping benefits by showing false information and attracting investments. They are doing this by there own will. Even if they do so to attract investors or to comply with loan regulations or to attract investors we cant say that they are pressured. We can infact say that they put pressure on CFOs to present good picture of the company in many cases. There are three primary reasons why management manipulates financial statements. First, in many cases, the compensation of corporate executives is directly tied to the financial performance of the company. As a result, they have a direct incentive to paint a rosy picture of the company's financial condition in order to meet established performance expectations and bolster their personal compensation.

Second,it is a relatively easy thing to do. The Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude and interpretation in accounting provisions and methods. For better or worse, these GAAP standards afford a significant amount of flexibility, making it feasible for corporate management to paint a particular picture of the financial condition of the company.

Thirdly, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client.As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep the client happy – and keep its business.

SEC can prevent or deter this behaviour by taking the below mentioned steps:-

1. Investors education: Such practices can't be actually stopped until the investor himself is educated and well aware. SEC should open an online portal and taken some steps to educate the investors and solve there doubts.There are a host of factors that may affect the quality and accuracy of the data at an investor's disposal. As a result, investors must have a working knowledge of financial statement analysis, including a strong command of the use of internal liquidity solvency analysis ratios, external liquidity marketability analysis ratios, growth, and corporate profitability ratios, financial risk ratios and business risk ratios. Investors should also have a strong understanding of how to use market multiple analysis, including the use of price/earnings ratios, price/book value ratios, price/sales ratios and price/cash flow ratios in order to gauge the reasonableness of the financial data.

2. Imposing heavy penalties to curb such practices on whomsoever found indulged directl or indirectly including auditors if they provide unqualified opinion even if the Financial statements are materially misstated.