Analyst: Aggressive Accounting Flags Short Opportunities

Companies that practice aggressive accounting offer lower future stock returns and under-perform the market, an analyst said Thursday. Deutsche Bank's David Elledge said research from Messod D. Beneish of the University of Indiana suggests that aggressive accounting practices also suggest a propensity for fraud. http://www.researchgate.net/profile/Messod_Beneish/publication/228259621_Fraud_Detection_and_Expected_Returns/links/00b4951e4337961b64000000.pdf Elledge tested Beneish's thesis, identifying high-risk companies using rankings prepared by MSCI Inc.

. https://www.msci.com/ About 15 percent of stocks are rated "conservative," half are "average," a quarter are "aggressive" and 10 percent are "very aggressive" using the model, according to Elledge. Elledge used the rankings to build a short-sales portfolio of the 15 percent "most aggressive" companies according to the ratings, and a long portfolio with the 20 percent "least aggressive" firms. "The steady, cumulative signal is quite promising" in the U.S., Elledge said of the method, although it has proven less successful when applied in Canada, the U.K. and Japan. Elledge also evaluated Benford's law as a method for evaluating fraud propensity. The so-called law concerns frequency distribution of digits in data, particularly the first number in a series, and has been used in fraud detection for many years. http://www.journalofaccountancy.com/Issues/1999/May/nigrini U.S. enforcement actions related to accounting fraud decreased steadily from 2007 to 2013, but spiked 46 percent in 2014, Elledge said.