Another Recession Indicator: Corporate Dishonesty

Add to the long list of ways to explain whether the economy is leading to the recession: companies record more misleading reports in a leading time for a major recession, found in a new study.

According to a new colleague-reviewed paper by researchers at Missouri and Indiana University, the more companies lie on their financial statements, the more likely the economy is leading to the recession in the next five to eight quarters.

The new measure can help economists to make more accurate prediction whether a major economic shock is ahead. While many experts have currently resulted in prediction of the Federal Reserve’s anti-inflation interest rate increase in a mild recession next year, forecasts vary widely about whether we will receive one and how bad it would be.

This new model shows that misleading statements are on increasing, there is no possibility of a slowdown, and instead we are for a slow economic development period which is not bad enough to be called a recession, researchers said in an email.

“When companies call the information wrong, they may take several years before they are caught, if they are caught at all – and there are not many,” said Matthew Glending, a professor of accounting at Missouri University and one of the authors of the study in a press release. “Our model suggests that the possibility of financial statements manipulation helps predict the approach of the economy.”

The study depends on a metric called M-score, an analysis tool that is used to determine the possibility that a financial statement is manipulated. The M-score model includes information about sales, spending and corporate debt, the ratio between them, and provides a score that indicates the possibility that books have been cooked. Researchers analyzed a database of corporate reports for thousands of public trading companies returning from 43 years.

It was discovered that the higher M-score of publicly trading companies, the greater the possibility of recession in the next five to eight quarters. Short jump in misleading statements was before the minor economic recession. Researchers reported that corporate data manipulation was not only a prophet of recession, but actually causes the economy.

“Accounting cases, and manipulated accounting information can negatively affect the economy,” Glending said in a press release. “When financial reporting is not adequately monitored and companies manipulate financial information, it can have potentially harmful consequences. Not only investors use this information, but also do other firms. In many cases, the firms make employment and investment based on this information, which can be very optimistic.”

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