Distorting Financial Performance Hurts Firms

FINANCIAL fraud and other shenanigans can wreak havoc on a company, harming investors, creditors, employees, vendors, and customers.

Financial shenanigans, as defined by Howard Schilit in a recent National Association of Corporate Directors paper, are actions or omissions intended to hide or distort the real financial performance or financial condition of a company.

There are certain types of companies that are particularly vulnerable to financial shenanigans, Dr. Schilit notes. These include small, fast-growing companies; newly public companies; privately held companies; and ``basket case'' companies.

The character of individuals within a company often provides a tip-off of trouble. Financial cheaters are often narcissistic, spending money ostentatiously to impress others. They also may lack discipline and integrity, Schilit finds.

Schilit divides financial shenanigans into several broad categories. These categories include: recording revenue too soon; recording bogus revenue; boosting income with one-time gains; shifting current expenses to a later period; and failing to record or disclose all liabilities.

Corporate directors are in a particularly good position to ``detect and correct'' shenanigans, Schilit writes. They can improve the company incentive structure to encourage individual integrity and strengthen its systems of control and monitoring.