When Arthur Levitt was the chairman of the Securities Exchange Commission (SEC), he gave a speech at New York University (NYU) that became known as the "Numbers Game" speech. He spoke presciently about companies and their efforts to use earnings management, a process in which they use accounting rules and financial manipulations to meet goals or make their earnings seem smooth. Mr. Levitt said, "Too many corporate managers, auditors, and analysts are participants in the game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation... Managing may be giving way to manipulation; integrity may be losing out to illusion. \({ }^{324}\)

Earnings management has been business practice for so long, so often, and by so many that many businesspeople no longer see it as an ethical issue but an accepted business practice. Fortune magazine has even offered a feature piece on the how-to's and the importance of doing it. It remains an unassailable proposition, based on the financial research, that a firm's stock price attains a quality of stability through earnings management. However, the financial issues in the decision to manage earnings are but one block in the decision tree. In focusing on that one block, firms are losing sight of the impact such activities have on employees, employees' conduct, and eventually on the company and its shareholders.

Issues on financial reporting and earnings management are at the heart of market transparency and trust. Understanding the issue of earnings management is important as you begin to study the cases involving companies that used this process, perhaps to an extreme. What is earnings management? How is it done? How effective is it? How do accountants and managers perceive it from an ethical perspective?

The ultimate ethical question in all financial reporting and accounting practices is "Do these numbers provide fair insight into the true financial health and performance of the company?" Further, the example given illustrates that numbers alone, even if concluded to be fair, may not be sufficient because only MD\&A can provide a full and complete picture of what the non-GAAP measures mean, why they were used, and how they should be interpreted. The juxtaposition of GAAP and non-GAAP measures, now mandated by law, has also been a critical component to the effective use of both sets of numbers. The presentation of both provides checks and balances for the excesses in financial reporting during the 1990s as the non-GAAP measures became the standard for financial reports........................

Discussion Questions 1. Describe the risks in earnings management.
2. What are the motivations for moving around expenses and revenues in quarters and years?
3. Don't shareholders benefit by earnings management? Who is really harmed by earnings management?
4. Put earnings management into one of the ethical categories you have learned 5. Make up a headline description of earnings management.
6. How do you respond to a CFO who says, "Everybody does earnings management. If I don't do it, I am at a disadvantage."