Why did accounting irregularities become a major concern for companies and investors?

"Although our attention was focused on big-name accounting scandals in the late 1990s and early 2000s, an epidemic of accounting irregularities was also taking place in the wider corporate arena. The number of companies restating annual financial statements grew at an alarming rate, tripling from 1997 to 2002. In the wake of the numerous corporate financial scandals, Congress and the accounting profession took major steps to prevent future accounting irregularities. These measures targeted the basic ways, cited by a report from the AICPA, that companies massaged financial reports through creative, aggressive, or inappropriate accounting techniques, including:\n\n• Committing fraudulent financial reporting\n\n• Stretching accounting rules to significantly enhance financial results\n\n• Following appropriate accounting rules but using loopholes to manage financial results\n\nWhy did companies willfully push accounting to the edge—and over it—to artificially pump up revenues and profits? Looking at the companies involved in the scandals, some basic similarities have emerged:\n\n• A company culture of arrogance and above-average tolerance for risk\n\n• Interpretation of accounting policies to their advantage and manipulation of the rules to get to a predetermined result and conceal negative financial information\n\n• Compensation packages tied to financial or operating targets, making executives and managers greedy and pressuring them to find sometimes-questionable ways to meet what may have been overly optimistic goals\n\n• Ineffective checks and balances, such as audit committees, boards of directors, and financial control procedures, that were not independent from management\n\n• Centralized financial reporting that was tightly controlled by top management, increasing the opportunity for fraud\n\n• Financial performance benchmarks that were often out of line with the companies’ industry\n\n• Complicated business structures that clouded how the company made its profits\n\n• Cash flow from operations that seemed out of line with reported earnings\n\n• Acquisitions made quickly, often to show growth rather than for sound business reasons; management focused more on buying new companies than making the existing operations more profitable\n\nCompanies focused on making themselves look good in the short term, doing whatever was necessary to top past performance and to meet the expectations of investment analysts, who project earnings, and investors, who panic when a company misses the analysts’ forecasts. Executives who benefited when stock prices rose had no incentive to question the earnings increases that led to the price gains. These number games raised serious concerns about the quality of earnings and questions about the validity of financial reports. Investors discovered to their dismay that they could neither assume that auditors were adequately monitoring their clients’ accounting methods nor depend on the integrity of published financial information."