Financial Shenanigans

DEFINITION of 'Financial Shenanigans'

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.

BREAKING DOWN 'Financial Shenanigans'

Financial shenanigans can be broadly classified into two types:
  1. Schemes that overstate revenues and profits – the benefits in this case are obvious. Artificially boosting earnings per share (EPS) and growth rates has a direct and positive impact on a company’s valuation, which generally rewards management through higher compensation and profits on stock options.
  2. Schemes that understate revenues and profits – this is typically done to smooth out net income over time periods and make it appear less volatile. These shenanigans, while undesirable, are less serious than those that overstate revenues and profits.
Companies have numerous avenues to engage in financial shenanigans if they so desire. These include recognizing revenues prematurely, recording sales made to an affiliate or recording sales of unshipped items, capitalizing rather than expensing research and development costs, reclassifying balance sheet items to create income, amortizing costs or depreciating assets at a slower pace, setting up special-purpose vehicles to hide debt or mask ownership, and so on. In most instances of far-reaching and complex fraud, financial shenanigans were not detected even by a company’s auditors and accountants.
In the United States, 2001-02 saw the unearthing of a significant number of financial shenanigans at companies such as Enron, WorldCom and Tyco. Enron and WorldCom’s senior-most executives pushed their companies into bankruptcy and paid the price by getting jail time. The spate of corporate skullduggery during this period led to the passage of the Sarbanes-Oxley Act in July 2002, which set new and enhanced standards for all U.S. public company boards, management and public accounting firms.