Ethical standards in different data communities

by Andrew Gelman on October 8, 2012 · 8 comments

in Methodology,Political Economy

I opened the paper today and saw this from Paul Krugman, on

Jack Welch, the former chairman of General Electric, who posted an assertion on Twitter that the [recent unemployment data] had been cooked to help President Obama’s re-election campaign. His claim was quickly picked up by right-wing pundits and media personalities.

It was nonsense, of course. Job numbers are prepared by professional civil servants, at an agency that currently has no political appointees. But then maybe Mr. Welch — under whose leadership G.E. reported remarkably smooth earnings growth, with none of the short-term fluctuations you might have expected (fluctuations that reappeared under his successor) — doesn’t know how hard it would be to cook the jobs data.

I was curious so I googled general electric historical earnings. It was surprisingly difficult to find the numbers! Most of the links just went back to 2011, or to 2008. Eventually I came across this blog by Barry Ritholtz that showed this graph:

That looks pretty fishy, indeed. Also a link to a news article from 2002 (shortly after Welch stepped down from running GE) that said:

GE used to feature on university courses as a model of probity. These days, it crops up in the seminars about earnings-manipulation. Everyone agrees that GE practises one form of earnings management: it times one-off asset sales to coincide with one-off write-downs or restructurings. . . . Beyond this, the amount of profits-smoothing that GE indulges in is a matter of speculation. GE also manages expectations about its earnings by managing its analysts. . . . managers who are in the habit of smoothing earnings have an especially strong motive to keep the good news coming, whether or not the business warrants it.

Yup. Also this from Marie Leone and Tim Reason:

[In 2009,] after a four-year investigation, GE settled accounting fraud charges with the SEC for allegedly misleading investors with improper hedge accounting and revenue recognition schemes. Specifically, GE was charged with violating accounting rules when it changed its original hedge documentation to avoid recording fluctuations in the fair value of interest rates swaps, which would have dragged down the company’s reported earnings-per-share estimates.

In addition, the SEC charged GE with concocting schemes to accelerate the recognition of revenue from its locomotive and aircraft spare parts business, to make the company’s financial results appear healthier than they actually were.

Without admitting or denying guilt, GE paid a fine of $50 million, and agreed to remedial action related to internal control enhancements. “GE bent the accounting rules beyond the breaking point,” noted Robert Khuzami, director of the SEC’s Division of Enforcement, in a statement.

OK, fine. This isn’t my area of expertise and, in any case, our circulation is on the order of 1/10,000th of Krugman’s, so why report it here?

What’s interesting to me are the different attitudes on statistical manipulation. The Bureau of Labor Statistics, Census Bureau, etc., take their data pretty seriously and I agree with Krugman that it’s hard for me to imagine them manipulating the numbers in any way. For one thing, don’t have much incentive to do so: as Krugman notes, they are civil service workers, not political appointees. And it’s not like better numbers would increase their budget line. (In contrast, I can understand the motivation for those military guys who faked the data on missile tests: success can lead to more funding.) Beyond this, it just doesn’t seem that this sort of fraud is part of the culture of government statistics in the United States.

In contrast, Leone and Reason report:

The SEC complaint relates several instances of round-robin email discussions among GE accountants, internal auditors, executives, and the company’s external auditor, KPMG, debating whether aggressive accounting would past muster with regulators.

So, it’s not about Welch being some sort of data sociopath; rather, data manipulation is part of corporate culture. And, indeed, these guys have lots of motivation to fake the numbers (i.e., “aggressive accounting”). The executives and accountants personally make millions of dollars from it. Millions of dollars in win, very little personal risk if you get caught (it was GE that paid the fine, right? Jack Welch is still at loose on Twitter): that’s what I call an incentive.

One reason this interests me is the connection to ethics in the scientific literature. Jack Welch has experience in data manipulation and so, when he sees a number he doesn’t like, he suspects it’s been manipulated. In academia, Steven Levitt has seen economists “work behind the scenes constantly trying to undermine each other” and been involved with a journal that suppressed unwelcome research results and so, when he has a paper rejected (by a different journal), he suspects the rejection was for illegitimate reasons. I don’t think such a thing would be done in the field of statistics, because I think we have more of a tradition of going with the data.

{ 8 comments }

RobW October 8, 2012 at 11:11 am

Interesting post but two points stand out: 1) given the talk among large swaths of the GOP to reduce the size of government (and yes, there is absolutely no evidence they have any real desire to cut spending; nevertheless, they TALK about it), wouldn’t it not be out of the realm of possibility for civil servants in the BLS to thank, *Gee, you know. Bet not too many normal people would miss us if we were downsized, maybe we better do our part for the party that’s not talking crazy.* You don’t consider this even if just to point out it’s unlikely. 2) Your point about how this type of manipulation isn’t done (in political science? – not clear from the context), relies mostly on the a line of argumentation that *we* wouldn’t do this but *they* would. This isn’t very persuasive because there seems to be no inherent reason why there would be less incentive, academic or otherwise, not to engage in such behavior. So if it’s a matter of incentives, you haven’t shown that these don’t exist in our field.

Andrew Gelman October 8, 2012 at 11:33 am

Rob:

1. Yes, I agree that there are some incentives for cheating, even for civil service workers. But I think these incentives are much less than in the business world (as illustrated by that KPMG quote above). I was actually thinking about this when writing the point but didn’t want to get into a long parenthetical. It does make sense that, given that Welch was actively involved in data manipulation, that he would think others do it too.

2. By “we” I was thinking of statisticians rather than political scientists, in this case. I wouldn’t have thought that economists had such incentives to suppress evidence of research problems, until I saw the Levitt quote. I think statistics is different, though, not because we are better people but because we focus on methods rather than empirical conclusions, and methods are harder to fake.

Scott Monje October 8, 2012 at 11:55 am

You focus on the distinction between corporate culture and government culture regarding data manipulation because of the differences in incentives, which makes sense, but doesn’t the marked difference in reported earnings between the Welch era and the Immelt era suggest at least variations within the corporate culture and possibly a personal role by Welch? Or is it that the corporate culture allows for greater variation?

Bernard Winograd October 8, 2012 at 12:13 pm

As a retired senior corporate executive, I can tell you that GE was widely believed to have pushed the limits on earnings presentation. It is hardly a universal phenomenon, however, and you can see that Immelt does not practice it. In fact, this is a behavior that is motivated by a false theory of how the markets value companies, one which holds that volatility in reported earnings makes them less predictable and therefore less valuable. This appears to be true in part because analysts routinely prefer to follow stocks that are easy for them to model, and analysts are often mistakenly identified by management as a proxy for the views of the market. The academic evidence is to the contrary, but try telling that to an executive who thinks he knows what his source of capital wants….is this unethical or just a game with dysfunctional incentives?

Mark October 8, 2012 at 3:01 pm

I agree with your comment regarding the integrity of the BLS data reporting but your post did spark a related thought about why I would not feel the same about all government agencies.

As you pointed out, with corporations there is an SEC capable of investigating and enforcing and specific accounting standards applicable which must be complied with. With the federal government few of these accepted accounting practices are used and the types of accounting (or non accounting) practices used by the government would create legal liabilities for corporations (for instance, the non-funded federal employee pensions). In addition, Congress is very adept at excluding itself from the legal requirements it imposes on others.

The problem is compounded by the common legislative practice of shifting burdens of proof in new laws and the federal court’s deference to agency decision making processes. When you tell somebody that the burden of proof is not on them and their regulations will be upheld unless they are insane (or in legal terminology, arbitrary & capricious) you encourage poor analysis & rulemaking and the manipulation of data. I spent several decades in the corporate world in a heavily regulated environment dealing with government agencies and they knew very well who held the whip hand and that they did not need to be as rigorous as us in their work. They could get away with using data in ways that we never could. By the way, my comment is not meant as an indictment of the people at these agencies; how they act is a natural response for anyone in those circumstances – whether in government or not – the problem is that our approach to governance in the past few decades encourages sloppiness because people know they can get away with it.

Brian Rudzewicz October 8, 2012 at 3:25 pm

Your ultimate sentence, ” I don’t think such a thing would be done in the field of statistics, because I think we have more of a tradition of going with the data,” brought something to mind.

The same could be said of the field I studied, Physics, yet a number of people have left the American Physical Society because of what they saw as manipulation of data and research in support of Global Warming alarm. Harold Lewis’ resignation letter from UC Santa Barbara spells this feeling out quite well:

http://www.dailytech.com/Top+Physics+Professor+Resigns+From+Post+Denouncing+Global+Warming+Fraud/article19879.htm

It is amazing what people are capable of doing for political reasons.

Evan Harper October 8, 2012 at 4:07 pm

My, what a strikingly relevant and informative contribution.

Scott Monje October 10, 2012 at 3:11 pm

Needless to say, the American Physical Society disagrees.

http://www.aps.org/about/pressreleases/haroldlewis.cfm

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