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On September 28, 1998, Chairman of the U.S. Securities and Exchange Commission
Arthur Levitt sounded the call to arms in the financial community. Levitt asked for,
immediate and coordinated action to assure credibility and transparency of financial
reporting. Levitt speech emphasized the importance of clear financial reporting to those
gathered at New York University. Reporting which has bowed to the pressures and tricks
of earnings management. Levitt specifically addresses five of the most popular tricks used
by firms to smooth earnings. Secondly, Levitt outlines an eight part action plan to recover
the integrity of financial reporting in the U.S. market place. What are the basic objectives
of financial reporting? Generally accepted accounting principles provide information that
identifies, measures, and communicates financial information about economic entities to
reasonably knowledgeable users. Information that is a source of decision making for a
wide array of users, most importantly, by investors and creditors. Investors and creditors
who are responsible for effective allocation of capital in our economy. If financial
reporting becomes obscure and indecipherable, society loses the benefits of effective
capital allocation. Nothing illustrates the importance of transparent information better than
the pre-1930 era of anything goes accounting. An era that left a chasm of misinformation
in the market. A chasm that was a contributing factor to the market collapse of 1929 and
the years of economic depression. An entire society suffered the repercussions of
misinformation. Families, and retirees depend on the credibility of financial reporting for
their futures and livelihoods. Levitt describes financial reporting as, a bond between the
company and the investor which if damaged can have disastrous, long-lasting
consequences. Once again, the bond is being tested. Tested by a financial community
fixated on consensus earnings estimates. The pressure to achieve consensus estimates has
never been so intense. The market demands consistency and punishes those who come up
short. Eric Benhamou, former CEO of 3COM Corporation, learned this hard lesson over a
few short weeks in 1996. Benhamou and shareholders lost $7 billion in market value when
3COM failed to achieve expectations. The pressures are a tangled web of expectations, and
conflicts of interest which Levitt describes as almost self-perpetuating. With pressures
mounting, the answer from U.S. managers has been earnings management with a mix of
managed expectations. March of 1997 Fortune magazine reported that for an
unprecedented sixteen consecutive quarters, more S&P 500 companies have beat the
consensus earnings estimate than missed them. The sign of a quickly growing economy
