“Financial shenanigans are acts or actions designed to mask or misrepresent the true financial performance or actual financial position of a company or entity.
Financial shenanigans can range from relatively minor infractions involving creative interpretation of accounting rules to outright fraud over many years. In almost every instance, the revelation that a company’s stellar financial performance has been due to financial shenanigans rather than management prowess will have a calamitous effect on its stock price and future prospects.
Depending on the scale and scope of the shenanigans, the repercussions can range from a steep sell-off in the stock to the company’s bankruptcy and dissolution.” (Source – Investopedia)
Best Books on the Subject
Howard Schilit’s Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports , Charles Mulford’s Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance and The Financial Numbers Game: Detecting Creative Accounting Practices .
Why Firms/Managers Indulge In It
- Firms need to raise capital at cheap rates and thus need to look better to credit rating agencies and lenders
- Shenanigans can have huge paybacks (higher profits, performance linked bonuses etc.)
- Companies omit things to prevent negative outcomes
- Omissions are made to dispel negative market perceptions (especially during bull markets)
- These are easy to do
- It’s unlikely the wrongdoers will get caught
- Firms under pressure to maintain high growth rate in earnings or revenues
- Firms that trumpet earnings projections and growth expectations
- Firms that need constant capital infusion to sustain growth or survive
- Managers with large part of compensation tied to stock options whose value depend largely on earnings growth than quality of those earnings
- Companies raising money through IPOs so that they look best before they make their public appearance
- Businesses with a lot of regulations
- Firms making a lot of acquisitions (most are done for bad reasons anyways)
- Real estate and construction companies (politicians, banks…all are involved in most cases)
- Banks and financial institutions (don’t get me started here!)
A Struggling Artist’s Impression
[Click on the images to download their larger versions]
Easy to Spot Shenanigans?
No. It’s difficult. Perpetrators of accounting frauds and shenanigans are reading the same books that you are, and some may also be reading this post.
- Be suspicious of firms in which you are considering an investment. Your investment in any stock could be subject to a major loss as a result of unethical or incompetent management.
- Recognize your limitations…because you cannot necessarily detect firms that use deceptive accounting or that waste cash because of the unethical or incompetent behavior of their managers.
- Diversify…so that you are not excessively exposed to any single investment whose value may ultimately be affected by misleading accounting or other unethical behavior on the part of the firm’s executives.