Wednesday, October 12, 2011

Evidence Enron not an anomaly?

This numerical regularity [of digit ordered frequency] is known as Benford's Law, and specifically, it says that the probability of the first digit from a set of numbers is d is given by [equation]....
In fact, Benford's law has been used in legal cases to detect corporate fraud, because deviations from the law can indicate that a company's books have been manipulated. Naturally, I was keen to see whether it applies to the large public firms that we commonly study in finance,

Deviations from Benford's law have increased substantially over time, such that today the empirical distribution of each digit is about 3 percentage points off from what Benford's law would predict. The deviation increased sharply between 1982-1986 before leveling off, then zoomed up again from 1998 to 2002. Notably, the deviation from Benford dropped off very slightly in 2003-2004 after the enactment of Sarbanes-Oxley accounting reform act in 2002, but this was very tiny and the deviation resumed its increase up to an all-time peak in 2009.

So according to Benford's law, accounting statements are getting less and less representative of what's really going on inside of companies. The major reform that was passed after Enron and other major accounting standards barely made a dent.
(h/t Mark Thoma)


Shaun Hingston said...

That is really cool. Thanks.

Mario said...

It's a crazy world out there. And I am intending to get into Auditing too!!! haha!!!

Great stuff Tom.

What do you guys think of this!!!

In Argentina, apparently they are using a barter system with a "creditos" currency. Check it out (6 min video). Note though I am not sure how old this video is though.

googleheim said...

argentina is doing fine. the barter is only for people who don't like to work. they've got soy and their real estate is priced in USD and their cars are as well.

greece is bartering in towns like Volos.

China has a high Benford number with their currency being undervalued. JUST compare the Yuan fixed against a properly modeled Yuan which would have been allowed to float - say over the past two years.

The differential would show that China is cooking the books.

Noam Chomsky and the Austrians meet at the deficit terrorist level - tax payer advocates without any brains.