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Thinking Generally

This NYT article by Gretchen Morgenson on Oct. 17, 2015 suggests that presentation is as important as disclosure in communicating (or not) financial information (see also Enron for contrasts between presentation of a related party transaction in notes to the financial statements and disclosure of financing cash flows as operating cash flows in its financial statements, among other data materially misleadingly disseminated to the public). That is, where and how the data are published affects predominantly their interpretation by readers, especially those without sufficient experience in financial shenanigans, data aggregation risk, and commonly accepted methods of preparation of the data. Unsurprisingly, publishers and authors, even those hiding behind the corporate form and other legal fictions, have personal agendas, and the risk accompanying this hazardous condition is amplified where publisher and author are not independent in fact.

Part of the success of those dumping large amounts of data characterized by both presenting detail in too summary a format (see tables such as income statements) and disclosing detail in obfuscating layers of language (compare, plain English requirements and what passes as such in filings with the SEC) is due to deficiencies in training and education of the reader. While this may appear as blaming the victim, a shared condition of the event popularly known as fraud is that both the perpetrator and the victim often want (more or less) something for nothing. This is fertile ground for wrongful belief accepted as conventional wisdom.

Many analysts and others are educated and trained in statistics and related social science methods and techniques that overvalue the ability to generalize. That is, problems are identified and solved according to the strategy of thinking that takes what can be measured in one context and rigorously applies it to another context. For example, consider the reasoning underlying analysis based on benchmarks, industry norms, etc. that leaves those not conforming to the overarching influence of exaggeration, puffery, excessive optimism / pessimism, and other BS in its wake. Reasoning by analogy and the transfer of understanding and skill developed in one context and qualitatively applying it to a different context is normally given short shrift as something too soft and unscientific. In brief, the poets and novelists’ voices are muted under the virtually suffocating cover of spreadsheets and other predefined database outputs.

There are few, if any, tools better at generalization than the computer. Preparation and presentation of tables, figures, and other exhibits may wow the reader that glimpses the bar charts, graphs, and other outputs allegedly demonstrating the point of the presenter in a summary and conclusive matter, but the essential question – are we looking at the right data for the decision at hand – is often taken for granted. After all, past performance is not invariably a reliable indicator of future performance, and this is due both to changes in external conditions (for example, an earthquake off the coast of Japan) and/or changes in internal conditions (for example, a decision to discontinue a line of business). Additionally, no one has ever read a financial statement filed with the SEC containing the line item “fraud expense.” At best, one may observe a note about inventory shrinkage. Does this suggest that fraud generally is an immaterial part of entities’ financial reporting? In practice, fraud is neither routinely estimated nor assumed as an element of spreadsheet calculations – it is some other dude’s problem.

In brief, the issue may not be whether enterprise A reports a superior performance based on metric M than enterprise B, but what metric is really key for this decision? What data are excluded? How did the norm in fact become the norm; whose influence swayed? Management bias is realized in practice through related party and self-dealing transactions – some fair exchanges of value, some not. The legal opacity of many entities’ beneficial ownership (see straw man) makes the gatekeepers’ job, including independent registered public accountants, error-prone. Publisher, author, and inadequately undisclosed related parties may be closer than they appear.

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