Business press plays "watchdog" role, says Harvard study

By Carole Winkler

The press plays a valuable “watchdog” role in the capital markets by being the first to publicly identify accounting fraud in a significant number of cases, a Harvard Business School study revealed.

Associate professor Greg Miller studied 263 cases of accounting fraud and determined that 29% were identified by the press before the SEC or the company announced an investigation.

Further, in 36 percent of those early identifications the reporter conducted original financial analysis to break the story.

“In each of these articles, it is the reporter making the case for accounting impropriety based on analysis of public and private information. No other information intermediaries (i.e., analysts, auditors, or the legal system) are cited,” wrote Miller.

Academics previously believed that Wall Street analysts uncovered accounting fraud and the press merely disseminated the information.

Small investors appear to benefit most from the new information. “[On article days] trade volume increases by 375% while average number of trades increases by 429%. Although there is an increase in trades of all sizes, there is a statistically significant shift upwards in the proportion of small trades (less than 1,000 shares). Combined, these data suggest that the articles…[are] most informative to small traders (who are likely individuals),” Miller wrote.

“Greg's paper is the first in accounting to look at the press and the role it plays in providing information to investors and regulators about earnings quality,” said Maureen McNichols, a Stanford Business School accounting professor who coaches board audit committees. “Some classic cases are Sunbeam and Enron. In each of these, a reporter's careful evaluation of financial statements raised questions about earnings manipulation that led to investigations by the company's board of directors.”

Miller had trouble convincing his fellow academics at first.

“There was an awful lot of pushback,” Miller said. “We’ve been writing about analysts for 20 years. People have this kind of belief fixed in their minds and they would say, ‘Well, how do you know they haven’t really gotten this from an analyst who just didn’t go public?’ I’d say, ‘Well, how do you know all the analyst stuff you wrote didn’t really come from the press?’”

Charles Bobrinsky, Ariel Focus Fund co-manager and Ariel Capital Management’s vice chairman and director of research, said, “The Wall Street Journal and Forbes in particular have developed credibility in uncovering corporate misbehavior, the Journal through its network of sources and Forbes through its contrarian attitude and dedication to investigative research.”

The 75 articles that first identified fraud in Miller’s study were written by 54 different authors and published through 40 news outlets. “The Wall Street Journal and Dow Jones News Service have the greatest number of publications, with 14 each, followed by The San Francisco Chronicle, with 6,” wrote Miller, right. Marketwatch's Herb Greenberg was the only journalist to author multiple articles.

Professor Miller’s findings come as newspapers’ advertising revenues and circulation figures have deteriorated, making them valuable takeover candidates.

In the past, shrinking revenues of other stock market information providers have had devastating consequences for shareholders.

HBS Professors Paul Healy and Krishna Palepu cite the decline of the willingness to pay for audits and shrinking brokerage commissions as being among the root causes of the accounting scandals of the late 1990s and early 2000s. Lower audit fees gave rise to consulting and also commoditized this crucial service, reducing the process to a mere checklist mentality. The best and brightest students switched to more lucrative careers such as investment banking or consulting, reducing the auditing talent pool. Lower brokerage commissions caused conflicts of interest for analysts as investment banks pressured them into writing overly rosy reports to help close underwriting deals.

“We believe that liquidity, which has been the goal of most market reforms of the past decades, is a necessary but not a sufficient condition for an efficient market,” wrote Palepu and Healy in a 2003 Harvard Business Review article titled, “How the Quest for Efficiency Corroded the Market.” “The availability of high quality information is just as important. Rules and regulations that promote liquidity at the expense of information damage rather than reinforce the market’s ability to set the right price.”

Miller also believes that the press provides a deterrent against future fraud. “In class I call this the "Wall Street Journal rule" - don't do anything that you would be worried about seeing on the front page of the Wall Street Journal.”

Copies of Miller’s paper can be obtained by calling (617) 495-6157 or e-mailing Jim Aisner at the Harvard Business School at jaisner@hbs.edu.

Posted July 30, 2007