Missouri, Indiana professors trace talk of recession to misleading financial statements

Researchers from the University of Missouri (MU) and Indiana University believe an early warning sign about an impending recession could be traced to misleading financial statements submitted by companies. 

The study, which was recently accepted for publication in The Accounting Review, noted that high levels of possible financial statement manipulation could not only predict GDP growth downturns, but also improve recession prediction anywhere from five to eight quarters in advance, according to a news release.

"Accounting matters, and manipulated accounting information can negatively impact the economy,” Matthew Glendening, an accounting professor at MU, said in the release. "When financial reporting is not adequately monitored and companies manipulate financial information, it can have potentially damaging consequences. 

"Not only do investors use this information, but other firms do so as well," he added. "In many cases firms make employment and investment decisions based on this information, which can be way too optimistic.”

Glendening, fellow Missouri accounting professor Ken Shaw, and co-authors Daniel Beneish and David Farber, both Indiana University accounting professors, teamed to conduct the research. Through their work, the authors developed this new way to predict U.S. recessions, the release stated. 

Researchers used the M-Score to evaluate how often financial statement manipulation was happening in the economy, according to the release. The M-Score was developed in the late 1990s by Beneish. It measures the probability of financial statement manipulation and is considered one of the most economically viable ways for investigators to determine whether or not those records have been altered. 

These researchers found that the M-Score can be used to help predict the economy's status and when companies misreport financial information. It can take years before those adjustment are caught, if it's ever noticed. According to the release, the goal was to find information that can be used to educate people and by regulators and managers.