|  | | 2006 News and Press Releases | | |
HEADLINE NEWS:
Company's Reputation Is What Gets Fried When Its Books Get Cooked
Staff Writer
HT Media Ltd.. November 13, 2006
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EXCERPT: University of Washington issued the following news release: While fines imposed by regulators and courts on companies that falsify records may seem substantial, a new study finds the largest monetary penalties suffered by these companies are the result of a damaged reputation when news of their misconduct was reported. The study, led by Jonathan Karpoff, a professor of finance at the University of Washington Business School, reveals than on average, companies that have cooked their books lose 41 percent of their market value after news spreads about their misdeeds. "Cooking the books can be extremely costly," he said. "Firms lose real value when they are caught inflating their earnings, but the legal penalties turn out to be only a small part of the total losses experienced by these firms. The largest losses accrue because firms that cheat lose customers and face higher financing costs." Karpoff and co-authors D. Scott Lee and Gerald Martin of Texas A&M University examined the penalties imposed on 585 companies that were disciplined by the Securities and Exchange Commission and the Department of Justice for financial misrepresentation from 1978 though 2002, and which were tracked through November 2005. They presented their findings, "The Cost to Firms of Cooking the Books" recently at a conference held at the University of Chicago's Center for Research in Security Prices.
The researchers found that while the penalties imposed on firms through the legal system are relatively small, averaging $23.5 million per firm, the penalties imposed by the market in terms of damage to a firm's reputation are colossal. According to Karpoff, damage done to a firm's reputation as a result of intentionally falsifying financial statements, commonly referred to as "cooking the books," is more than 7.5 times the amount of all penalties imposed on it through legal and regulatory systems. That is, for each dollar that a firm misleadingly inflates its market value, on average, it loses this dollar when its misconduct is revealed, plus an additional $3.08. Of this additional loss, $0.36 is due to expected legal penalties and $2.71 is due to lost reputation. Reputational penalty is defined as the expected loss in the present value of future cash flows due to lower sales and higher contracting costs. Even before the implementation of the Sarbanes-Oxley Act in 2002, intended to improve corporate governance, penalties for cooking the books were substantial, Karpoff said. But the loss to a businesses' reputation is by far the biggest penalty it faces, he added. |
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