Common Terror: Permissible Error in Financial Statements - Teradyne Case Study - Why a $24 Million Accounting Error Need not be Corrected

Abstract

In 2002, the SEC, citing a need for transparency, promulgated new disclosure rules pertaining to corporate stock repurchase programs. As a result, companies since 2004 have been required to provide monthly reports on the volume and pricing of their stock buybacks. Under the new reporting protocol, Teradyne's monthly report for October 2007 erroneously excluded 1.738 million shares reacquired for $24.151 million at $13.90 apiece. The company decided no correction to the misstatement was necessary. The apparent lesson from the Teradyne case is: 1) Either a $24 million error is insignificant 2) Or the mandated 10Q/10K tables showing monthly corporate stock repurchases need not be accurate. In a world in which equity transactions such as stock repurchases, in conformance to 15th century tradition, are deemed never to cause a profit or loss, it makes sense both that $24 million be disregarded as insignificant and that corporate stock repurchase reports tolerate inaccuracy. But, if such reasoning seems out of joint, perhaps Teradyne should correct its error? More appropriately, accounting for equity transactions should be broadly revisited. In the market for corporate stock repurchases which, at its peak in 2007, exceeded a $700 billion annual rate, insult to common shareholders may be done a penny at a time (excessive fees, benefits to option holders, disregard of pricing, risk of insider trading) but, in the end, is tantamount to death by a thousand pinpricks and burial unnoticed in a pauper's grave. For instance, a recent study suggests losses to investors from U.S. corporate buybacks are now approaching $2 trillion (a benefit sellers reap at the expense of faithful investors). In the mayhem of financial ruin, the equanimity of accounting statements, in their total disregard of equity transaction losses, is a final indignity borne by shareholders. Common TERROR, a commentary on Teradyne's ethereal view on permissible error in financial statements, highlights that rules of equity accounting are overdue for overhaul. The solution is simple: Treat equity transactions the same as any other asset or liability with gains/losses included in the income statement. Tolerance for misstatement will vanish.