During the past two years, companies making financial restatements have racked up a dubious record: more than three-fourths have made what are sometimes referred to as “stealth” disclosures.

EraserThat means they have chosen to disclose restatements in a way other than the most transparent one — the one that sends the clearest signal of prior accounting errors to investors — namely, filing a Form 8-K with the Securities and Exchange Commission.

Should this be a concern? In 2003, the year before the SEC’s landmark strengthening of restatement-reporting requirements, one-third of restating companies filed 8-Ks. By 2005, two-thirds did. The current trend represents a dramatic reversal, however.

True, the commission permits companies to employ some less-transparent means of restating if the dollar amounts involved are not material. But are companies avoiding 8-Ks for reasons other than materiality?

New research suggests that some are doing just that. A paper in the September issue of the American Accounting Association journal Accounting Horizons analyzes close to 1,200 corporate restatements and finds that the more top executives’ pay is dependent on their companies’ stock price, the greater the likelihood of stealth disclosures.

The research also suggests that CFOs are actually likely to be even more of a barrier to this practice than regulators, given that their compensation is generally less dependent than that of CEOs on stock performance.

“Lower-transparency restatement disclosures are associated with less-unfavorable market reactions than 8-K disclosures,” wrote the study’s authors, Brian Hogan of the University of Pittsburgh and Gregory Jonas of Case Western Reserve University. “By avoiding the high-transparency disclosure of restatements, executives can attempt to soften the effect of negative market reaction on company stock, provide more time to manage stock sales to their advantage, reduce the risk of being terminated, and minimize damage to their reputations.”

Yet, the interests of CEOs and CFOs where restatements are concerned may diverge markedly, the study notes: “Prior literature shows that CFOs face more severe penalties than CEOs in the form of job loss and labor market penalties. … With greater equity rewards at stake, CEOs may be more willing to take the risk of a low-transparency restatement disclosure. Conversely, CFOs, having relatively less equity-based pay and the risk of more severe penalties, may be less willing.”

Therefore, as the disparity in the equity-based pay proportions between these two executives increases, the likelihood of a high-transparency disclosure of a restatement increases as well.

Conventional wisdom for executive pay has been to increase the equity component to better align management interests with shareholder interests. However, to the extent greater equity-based pay supports low-transparency disclosures, pay-structure alignment between CEOs and CFOs “may not always be in the best interests of stakeholders,”

The professors reached these conclusions through an analysis of 1,178 corporate financial restatements issued from August 2004 — when the SEC implemented an 8-K filing requirement that was softened shortly thereafter — through December 2013.

Instances where Form 8-K was filed were defined as highly transparent. Low-transparency disclosures mostly entailed simply correcting items in misstated prior financial statements without taking special steps to signal the changes to investors. In addition, a smaller number of low-transparency cases consisted of formal amended filings, which can pertain to a multitude of company issues other than financial ones and may attract no more than a cursory look from investors.

The professors analyzed the relationship of these different disclosures to the percentage of CEO and CFO pay that was composed of stocks or stock options. In doing so, they controlled for a large number of factors that affect disclosure choice, such as magnitude of misstatements, the number of periods misstated, the quarter in which a restatement was issued, and whether it was initiated by management or an external auditor.

They found that at companies that issued high-disclosure restatements, an average of 45% of CEO pay and 38% of CFO pay was stock-related, while at low-disclosure companies the comparable figures were 46% and 43%. In other words, companies were less likely to issue high-disclosure restatements where the divergence between equity-based pay of CEOs and CFOs was greater.

Further, in analysis that took controls into account, the percentage of executive pay that was stock-based proved to be significantly related to disclosure transparency, with higher percentages for both CEOs and CFOs translating to lesser transparency.

The professors questioned the effectiveness of the current regulatory regime as it pertains to restatements.

“By maintaining a presumption of innocence and appearance of forthright reporting,” they wrote, “executives might reasonably expect to mitigate the likelihood and magnitude of SEC enforcement actions as well as position themselves more favorably to defend against lawsuits. However, our results suggest that executives with a higher proportion of equity-based pay are less likely to choose a high-transparency restatement disclosure.”

Thus, they concluded, “either the regulations and stakeholders do not mete out penalties of sufficient severity, or the penalties are assessed too infrequently, to be a deterrent to low-transparency restatement disclosures.”

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