Benford’s Law and the Decreasing Reliability of Accounting Data for US Firms

Benford’s Law and the Decreasing Reliability of Accounting Data for US Firms

Among the episode’s astounding revelations was that babies count on a logarithmic scale.

A second earth-shattering fact is that there are more numbers in the universe that begin with the digit 1 than 2, or 3, or 4, or 5, or 6, or 7, or 8, or 9. And more numbers that begin with 2 than 3, or 4, and so on. This relationship holds for the lengths of rivers, the populations of cities, molecular weights of chemicals, and any number of other categories. What a blow to any of us who purport to have mastered the basic facts of the world around us!

This numerical regularity is known as Benford’s Law, . . . In fact, Benford’s law has been used in legal cases to detect corporate fraud, because deviations from the law can indicate that a company’s books have been manipulated.

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So according to Benford’s law, accounting statements are getting less and less representative of what’s really going on inside of companies. The major reform that was passed after Enron and other major accounting standards barely made a dent.

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As noted by William Black in his great book on the S&L crisis The Best Way to Rob a Bank Is to Own One, the most fraudulent S&Ls were the ones that looked most profitable on paper. That was in fact an inherent part of the scam.

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