Federal regulators have launched a probe into whether or not companies have improperly rounded up their earnings per share to the next highest cent, The Wall Street Journal reported.
Securities and Exchange Commission officials asked 10 or more companies to share information about accounting adjustments that could result in higher earnings, a source told the Journal. It was not clear which companies the SEC questioned.
The investigation was prompted by an academic paper that notes the number “4” rarely appears in the tenth place of companies’ reported earnings per share. If the number in the tenth place is “5” or higher, companies can round their EPS up to the next cent. Earnings per share of 13.4 cents would be rounded to 13 cents, whereas EPS of 13.5 cents could be rounded to 14 cents, the paper points out.
Researchers Nadya Malenko and Joseph Grundfest refer to the phenomenon as “quadrophobia,” or fear of the number four.
Companies have a strong incentive to report strong earnings, the Journal reported, especially those tracked by Wall Street analysts whose forecasts are used to measure a company’s performance. Investors typically buy shares of companies that beat analyst expectations and sell shares of those that miss.
The investigation is still in its early stages, someone familiar with the situation told the Journal. And since accounting rules offer some flexibility on when revenue or expenses are recognized, boosted earnings — in some cases — can be legal, according to the Journal.
“The rounding itself might not be fraud, but it signals a certain aggressive approach to accounting practices,” Malenko told the Journal. “It can predict more serious accounting violations.”