Date: 5/18/09
Revenue Recognition Problems in the Communications Equipment Industry
1 – In late 2000, Lucent announced that revenues would be adjusted downwards by $679 million as a result of revenue recognition problems. Yet the firms market capitalization plummeted by $24.7 billion. Why do you think the market reacted so negatively to Lucent's announcements of the problems?
There is usually a grey zone between aggressive accounting, which is the use of legitimate accounting methods to achieve business purposes, and fraudulent financial reporting, which is the intentional misrepresentation of financial information for business purposes. In this particular case, the company shipped products to distributors when it knew that they may not be able to sell the products (indeed, many of the distributors had a weakened financial position). Therefore, even though these aggressive practices might technically be classified as sales under accounting rules, they distorted the reality of the situation and, ultimately, were fraudulent.
As per the downward adjustment of the company's revenues we can clearly see that company improperly booked those $679 million in revenue. Such announcement was made public little by little in the month of December. The semi-strong efficient market theory states that current market prices reflect all publicly available information, including quarterly reports and SEC filings. So I guess the market realized that Lucent was forging its figures and made a necessary correction in its stock price to reflect the newly reduced earnings per share.
Furthermore, in management's drive to realize revenue, meet internal sales targets and/or obtain sales bonuses they improperly granted and/or failed to disclose various side agreements, credits and other incentives. Eventually the market realized that this move was done to induce Lucent’s customers to purchase the company’s products. The result of