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How To Know When Your Boss Or Company Is Hiding Something

How To Know When Your Boss Or Company Is Hiding Something
StrategyStrategy2 min read
When things are going badly at a company, it's not always easy to know. Because they want time to turn things around, are trying to squeeze personal profit out of the company, or fear scaring off investors, people will try every trick in the book to hide problems.

A new NBER working paper from David Yermack of NYU's Stern School of Business with Tanja Artiga González and Markus Schmid of the Swiss Institute of Banking and Finance titled "Smokescreen: How Managers Behave When They Have Something To Hide," takes a look at what exactly mangers do when they try to cover up poor performance or personal wrongdoing.

The authors focus on the governance and disclosure of companies accused of being part of price-fixing cartels by the government, but suspect that these behaviors can be found in many companies that are up to no good.

Here are a few of the major warning signs to look for that are connected with increased levels of wrongdoing:

  • Board members leave frequently, and either aren't replaced or are replaced very slowly.
  • Board members are often either extremely busy outsiders, or foreign.
  • Auditors rarely change.
  • Earnings are aggressively managed through the use of accruals and deferred revenue.
  • Financial reports are frequently restated after the fact.
  • The number, size, names and definitions of business segments frequently change.
  • Stock options are exercised more rapidly, possibly because managers fear exposure.
There's a pattern in all of these. These sorts of firms do as much as they can to hide what they're doing from external and internal eyes.

Behavior around the board is a great example. A new board member means a new set of eyes. Therefore, companies are slow to replace people on the board, or pick people who are busy or far away.

By frequently changing business segments and restating results, it's difficult to compare results year to year. These aren't things that are always easy to see. Many are patterns of "signal jamming" that emerge over a long time.

Because this behavior comes from the top, it's hard to pin down. But it's essential to keep an eye out for it.

Find the full paper here.