During the past two years, the majority of companies making financial restatements have used stealth disclosures to avoid the far-more transparent Form 8-K that signals accounting errors to investors and affects market reactions to company stock, according to a new study published by the American Accounting Association.
That’s especially pertinent because the more that top executives’ pay is linked to company stock prices, the more these, shall we say, murky disclosures are used, according to The Association between Executive Pay Structure and the Transparency of Restatement Disclosures, written by professors Brian Hogan of the University of Pittsburgh and Gregory Jonas of Case Western Reserve University.
The study, which appears in the September issue of the journal Accounting Horizons, examined 1,178 corporate restatements issued from August 2004 to December 2013.
“By avoiding the high-transparency disclosure of restatements, executives can attempt to soften the effect of negative market reaction on company stock, provide more time to manage stock sales to their advantage, reduce the risk of being terminated, and minimize damage to their reputations,” the professors state.
Yet, there are undertones of C-suite conflicts, too. Prior studies indicate that CFOs more often face job loss and “labor market penalties” than CEOs do, the report states.
“With greater equity rewards at stake, CEOs may be more willing to take the risk of a low-transparency restatement disclosure,” the professors state. “Conversely, CFOs, having relatively less equity-based pay and the risk of more severe penalties, may be less willing.”
Thus, as the difference between the pay of CEOs and CFOs increases, so does the likelihood of a high-transparency restatement disclosure, such as an 8-K filing with the US Securities and Exchange Commission (SEC).
The professors don’t let regulators and stakeholders off the hook, either.
“By maintaining a presumption of innocence and appearance of forthright reporting, executives might reasonably expect to mitigate the likelihood and magnitude of SEC enforcement actions, as well as position themselves more favorably to defend against lawsuits,” they state. “However, our results suggest that executives with a higher proportion of equity-based pay are less likely to choose a high-transparency restatement disclosure.”
So, either penalties aren’t severe enough or are too infrequent to deter low-transparency restatement disclosures, they conclude. The professors believe there was less ambiguity in the SEC’s original intention more than a decade ago to require 8-Ks for restatements. Now, restatements can be disclosed in “less obvious” ways, depending on the judgment of companies and their auditors.
Their advice? Investors should check proxy statements and the pay difference between the CEOs and CFOs.