What are Financial Shenanigans
Financial shenanigans are actions designed to misrepresent the true financial performance or financial position of a company or entity. Financial shenanigans can range from relatively minor infractions involving merely a loose interpretation of accounting rules to outright fraud perpetuated over many years. In almost every instance, the revelation that a company’s performance has been due to financial shenanigans will have a calamitous effect on its stock price and future prospects. Depending on the 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:
- Schemes that overstate revenues and profits – These have a direct and positive impact on a company’s valuation. Often this results in greater rewards management via higher compensation and profits on company stock and stock options.
- Schemes that understate revenues and profits – These are typically done to smooth out net income over time to 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. 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. In the case of Enron and WorldCom, senior executives were convicted and spent time in jail for lying to investors and employees. 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.