In a
perfect world, investors, board members, and executives would have full
confidence in companies’ financial statements. They could rely on the numbers
to make intelligent estimates of the magnitude, timing, and uncertainty of
future cash flows and to judge whether the resulting estimate of value was
fairly represented in the current stock price. And they could make wise
decisions about whether to invest in or acquire a company, thus promoting the
efficient allocation of capital. Unfortunately, that’s not what happens in the
real world, for several reasons. First, financial statements necessarily depend
on estimates and judgment calls that can be widely off the mark, even when made
in good faith. Second, standard financial metrics intended to enable comparisons
from one company to another often fall short, giving rise to unofficial
measures that have their own problems. Finally, executives routinely face
strong incentives to manipulate financial statements. In recent years, we’ve
seen the implosion of Enron, the passage of the Sarbanes-Oxley Act, the 2008
financial crisis, the adoption of the Dodd-Frank regulations, and the launch of
a global initiative to reconcile U.S. and international accounting regimes.
Meanwhile, the growing importance of online platforms has dramatically changed
the competitive environment for all businesses. In this article, the authors
examine the impact of those developments and consider new techniques to combat
the gaming of performance numbers. [ABSTRACT FROM AUTHOR]