Transparency & investor protection Implications for accounting - PowerPoint PPT Presentation

Transparency & investor protection Implications for accounting and auditing Barcelona, October 18, 2013 Oriol Amat UPF

Programme 1.Introduction 2.Assessing solvency and forecasting bankruptcy 3.Misleading information 4.Conclusions 1

1.Introduction Objectives of an exchange supervisor: -Investor protection -Solvency listed companies and brokers (8.000 companies) -Markets in Financial Instruments Directive (MiFID) -Avoiding market abuse -Insider trading -Price manipulation: Misleading information Irregular orders 2

2.Assessing solvency and forecasting bankruptcy -Sample: 80.000 companies (good and bad) -40 ratios -Ratios with more predicting power: x 1 = Current assets/ Current liabilities x 2 = Equity/ Assets x 3 = Net profit/ Assets x 4 = Net profit / Equity -Discriminant function: >0: Good Z = -3,9 + 1,28 x 1 + 6,1 x 2 + 6,5 x 3 + 4,8 x 4 <0: Bad 3 Source: Amat, O. et al (2012): Análisis de operaciones de crédito, Profit, Barcelona

Example: Supermarket company in bankruptcy 2009 2002 2003 2004 2005 2006 2007 2008 x1 CA/CL 0,71 0,69 0,66 0,65 0,61 0,57 0,61 x2 Equity / Assets 0,34 0,34 0,33 0,32 0,30 0,31 0,28 x3 Net profit / Assets 0,07 0,08 0,06 0,02 0,01 -0,03 -0,04 x4 Net profit / Equity 0,16 0,18 0,14 0,04 0,03 -0,09 -0,12 Z - 3,9 + 1,28 x1+ 6,1 x2+ 6,5 x3+ 4,8 x4 0,306 0,441 0,02 -0,79 -1,08 -1,91 -2,25 4

3.Misleading information 2 Jun: ‘A’ , 80 Outlook negative Long-term issuer credit rating: ‘A+’, Outlook stable 600 70 15 Sep: Lehman 500 files for 60 bankruptcy; S&P 50 assigns SD 400 (selective default) 40 rating 300 30 200 20 100 10 0 0 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Lehman 5 yr senior CDS spread in bps (left hand scale) Lehman share price (right hand scale) Lehman Brothers (bankruptcy losses: 639.000 million $) 5 Source: Guy Carpenter, Standard & Poor’s, Bloomberg data

Accounts manipulation Accounting Real practices transactions Legal Earnings Anticipating or management delaying real expenses or income... Illegal Accounting Illegal treatments transactions... not allowed 6

Accounts manipulation and earnings management Changes in a company’s net profit according to the accounting Changes in a company’s net profit according to the accounting criteria of several countries (2008) criteria of several countries (2008) More used More used More More Less Less criteria criteria conservative conservative conservative conservative criteria criteria criteria criteria Spain Spain 100 100 -23 -23 166 166 Germany Germany 133 133 -31 -31 140 140 U.K. U.K. 162 162 71 71 194 194 USA USA 167 167 86 86 211 211 7

Accounts manipulation and earnings management Example of profit smooting Example of profit smooting 300.000 Real net profit Reported net profit 200.000 100.000 0 1 2 3 4 8

Signals of manipulation Financials statements -Changes in valuation rules -Differencies between net profit and cash flow from operations -Too much debt Ratios -Important changes in ratios compared with industry -Z formula to forecast manipulations Other signals -Change of auditor -Problems with debt covenants -Too much complex operations with third parties -Problems in the Board of Directors or in the Auditing Committee -Personality of leaders: language in meetings… 9

4.Conclusions -The challenge of predicting bankruptcy -Accounting regulations: increasing room for earnings management -The challenge of predicting earnings management -Key role of auditors and accountants 10

Example of differences between earnings before taxes and cash flow from operations 2011 2010 EBT +64,7 +49,6 Depreciation -153,6 -16,6 and accruals CFO -88,9 +33,0 11

Example: Rights Thierry Henry May 14, 2010, Barça and Giants sign a private contract selling the player for 0 euros. The value of the asset was 13 million euros. UEFA and the player accepted the deal after June 30, 2010. Reason for provision at Reasons for not June 30, 2010 provisioning at June 30, 2010 12

Example of big bath Accounts restated Accounts restated New board New board 2002 2003 2004 2005 2006 2007 2008 2009 2010 Earnings +7,2 -63,8 +1,4 +36,7 +32,9 +6,8 +10 +6,6 -77,1 according to the auditors Some days before the change in the Board, an auditor’s report draft reported 13 a profit of 11