The WSJ reports today on a study that confirms what everyone has known for years: That many firms manage their earnings, pulling all manner of shenanigans to beat the street.
The way this form of fraud was detected was rather ingenious: The lower than mathematically expected incidences of the digit "4″ in corporate earnings releases. ("X.4″ to be precise) This simple statistical insight was due to an analysis of normal random distribution. "When the authors ran the earnings-per-share numbers down to a 10th of a cent, they found that the number "4″ appeared less often in the 10ths place than any other digit, and significantly less often than would be expected by chance."
By finagling the 0.4 to a 0.5, accountants then get to round up to the next higher number. Hence, 12.4 cents is "managed" to 12.5, which then becomes rounded to 13 cents per share.
They dub the effect "quadrophobia" — fear of fours.