Because corporate financial statements are often opaque, and sometimes deceptive, two Stanford University professors have analysed oral presentations by thousands of US company chiefs and believe they know when they are lying.
'It's hard to know whether there's been accounting manipulation or not, just looking at the books,' said David Larcker, a professor at Stanford Graduate Business School and a co-author of the study.
'There are certain models that people use but they don't work that well,' he said.
Larcker and Anastasia Zakolyukina developed models for predicting deception in quarterly financial statements that draw on linguistics. They describe their findings in an unpublished paper entitled 'Detecting Deceptive Discussions in Conference Calls'.
Examining over 29,600 transcripts of conference calls between 2003 and 2007 in which corporate leaders presented their quarterly results, the authors found that certain word choices and the way phrases are formulated can reveal deception.
Rather than use precise language in their talks, CEOs and financial directors with something to hide tended to opt instead for generalities. They used more words that conveyed extremely positive emotions, and made fewer references to value being created for shareholders.
The personal pronoun 'I' was replaced by the first person plural 'we' in talks that later were found to be deceptive. 'The use of first person singular pronouns implies an individual's ownership of a statement, whereas 'liars' try to dissociate themselves from their words due to the lack of personal experience,' the study said.
Boasting is a common sign of duplicity. The use of 'extreme positive emotions words significantly associated with deception,' said Larcker, who advises skepticism when expressions like 'things are fabulous' are thrown about.
To validate their theory, the researchers compared the CEO's presentations against restatements of financial results by their companies over the course of the following years through 2009.
Larcker said about 10% of CEOs presented overly optimistic results that later had to be corrected. Where there has been a large accounting restatement, he said, 'the assumption that we are making is that these guys probably knew about it when they were talking about it during their conference'.
He cites the case of former Lehman Brothers chief financial officer, Erin Callan. In a presentation in 2008 just months before the investment bank went under, she used the word 'great' 14 times, 'strong' 24 times, and 'incredibly' eight times. 'By contrast, she used the word 'challenging' six times and 'tough' only once,' the study noted.
'This had the effect of conveying a positive tone without providing specific factual data to support her message', the report said added.
There is also the case of Enron, the energy trading company that collapsed in scandal in 2001. A short time before the company's implosion, Enron CEO Kenneth Lay was interviewed by National Public Radio. 'I think our core businesses are extremely strong. We have a very strong competitive advantage,' he said during the interview.
