This post comes to us from Mark Bagnoli, Professor of Accounting at Purdue University, and Susan Watts, Professor of Accounting at Purdue University.
In our paper, Oligopoly, Disclosure, and Earnings Management, which is forthcoming in The Accounting Review, we theoretically examine whether firms bias their disclosures (manage earnings) to gain a competitive advantage in their product market. Our specific motivation comes from the claims of C. Michael Armstrong who was the CEO of AT&T from 1997 to 2002. In statements made by Armstrong, he argues that accounting fraud at Worldcom was the cause of AT&T’s perceived strategic failures, its inability to compete with Worldcom and, in the end, the decision to break up the company. He specifically suggests that Worldcom’s fraudulently reported revenues, margins and costs drove AT&T’s layoffs, cost cutting and a very unprofitable price war that left AT&T unable to service the debt he incurred to revive the company. This view is supported by William Esrey who was Sprint’s CEO during that time. We interpret Armstrong and Esrey’s argument as suggesting that a rival’s earnings management affected competition in the product market, led to a misevaluation of their relative performance and caused dramatic, potentially non-optimal changes in their business strategy.
