With great power comes great responsibility – or not?  According to one academic paper, firm-level electricity consumption data provides a novel window into financial misreporting among South Korean firms. We discuss how an investor can take this use case from theory to practice with a number of alternative indicators for firm productivity.

LAYING THE GROUNDWORK

Within academia, works that deal with financial misreporting often focus on identifying firm traits that signal an increased propensity towards fraudulent accounting. These purported warning signs range from plausible and practical to mildly fantastical. An investigation into the relevant research starts off on reasonably solid ground. It makes sense that misreporting would vary by geography, for instance. Corporate culture and performance incentives are influential? Yes, absolutely. Apparently, having your investors located slightly closer to home can also incentivize a firm to be better-behaved.

But then things start to get personal – from CEO facial masculinity to the impact of individual psychology or belief systems. Academics have posited that 21st-century Machiavelli’s are up to no good, whereas the religious among us apparently maintain saintliness even in their financial reporting.

‘Never was anything great achieved without danger’

said Niccolò Machiavelli as he added an extra zero to Accounts Receivable.

Identifying misreporting after the fact is a different kind of beast. The obvious approach involves analysis of firm-reported financial data itself. Beyond this, an investor may also look at non-financial measures (NFMs) such as order backlogs, or employee numbers. However, this is still ‘information that the company told you’, and the problem is that, in this context, we must assume that we can’t trust the company.

A newer, more alternative, channel of investigation has sprung up around identifying vocal and linguistic cues from senior management. The pressure for a CEO to have a steady voice on an earnings call has never been higher. But then again – overconfidence is also a red flag. Perhaps voice changing software will soon become commonplace in boardrooms.

WITH GREAT POWER COMES GREAT RESPONSIBILITY 

What if, there was an independent source of data, which is (1) not self-reported, (2) relatively impervious to firm-level variables, and (3) an indicator of real economic activities?