Another indicator of decline: Corporate dishonesty
Add this to the long list of ways to tell when the economy is headed for a recession: Companies report more misleadingly in the lead-up to a major recession, a new study finds.
According to a new peer-reviewed paper by researchers at the University of Missouri and Indiana University, the more companies lie in their financial statements, the more likely the economy is headed for recession in the next five to eight quarters.
The new measure could help economists more accurately predict whether a major economic downturn is ahead. While many experts currently predict that the economy will enter next year as a result of the Federal Reserve, predictions vary widely on whether we will get it and how bad it will be.
The researchers said in an email that this new model suggests that, while misstatements are on the rise, a recession is unlikely and instead we are in a period of slowing economic growth that is not bad enough to be called a recession.
“When companies misrepresent information, it can take years for them to be caught, if they are caught at all,” Matthew Glendening, an accounting professor at the University of Missouri and one of the study's authors, said in a press release. “Our model shows that the likelihood of financial statement manipulation helps predict the outlook for the economy.”
Note
Experts are sharply divided on whether a major recession is imminent or not. Some examples include selling men's underwear, library circulation, and whether or not the Phillies win the World Series.
The study is based on a metric called M-score, an analysis tool used to determine the likelihood of financial statement manipulation. The M-account model includes information on sales, expenses, and corporate debt, the ratios between them, and assigns a score that indicates the likelihood of the books being cooked. Researchers analyzed a database of corporate reports for thousands of publicly traded companies going back 43 years.
It found that the higher the combined M-scores of publicly traded companies, the greater the likelihood of a recession occurring in the next five to eight quarters. Smaller spikes in misstatements preceded smaller economic slowdowns. The researchers noted that corporate data manipulation is not just a predictor of recession, but actually harms the economy.
“Accounting issues and manipulated accounting data can have a negative impact on the economy,” Glendening said in a press release. “When financial statements are not adequately controlled and companies manipulate financial information, this can have potentially harmful consequences. This information is used not only by investors, but also by other firms. In many cases, firms make employment and investment decisions based on this information, which can be overly optimistic.”
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