General Electric Company (GE) is a large United States-based conglomerate, with operations extending from a large variety of industrial equipment and services, to healthcare, to TV and entertainment, to commercial finance. The sheer complexity and industry diversity of GE makes it particularly difficult for even financial analysts to fully understand the company, since it is unlikely, If not impossible, for anyone to be an expert in all the industries in which the company operates. As a result, it is very difficult for investors to predict GE's future performance. This puts a strong onus on GE management to assist investors in this regard.

Table11.

3 shows reported earnings for GE for the years indicated. What is striking is the steady increase in reported earnings. Only in 2005, when net income was pulled down by a large loss on discontinued operations, is there a small break in this impressive pattern of earnings growth.

GE has long been regarded as using earnings management to smooth its reported earnings to a pattern of steady growth. Some of the techniques with earnings management potential that it has used are:
Changes to the expected rate of return on pension plan assets.

Sales of divisions. Such sales generally lead to large non-recurring gains.

Restructuring charges. These are charges to current earnings o provide for expected costs of restructuring the operations of one or more of its many divisions. It is claimed that GE manages the amounts and timing of these charges so as to offset large nonrecurring gains, such as from sales of divisions. The objective is to avoid reporting higher earnings than can be sustained in future years.

Buying profitable businesses. GE is constantly acquiring new subsidiary companies. If needed to prevent reporting an earnings decrease, management of the timing and identity of such acquisitions can achieve an immediate contribution to consolidated reported earnings in the year of acquisition.
Conservative accounting. Rapid amortization of, for example, leased aircraft by GE’s commercial finance division enables large profits to be recorded when the aircraft are eventually sold. The timing of such sales can be managed by GE.
Allocation of purchased goodwill upon acquisition of subsidiary companies. When GE acquires a subsidiary, it may decide, or be required, to dispose of segments of the acquired business. The flexibility under GAAP of allocation of the excess of amount paid for a subsidiary company over the fair value of assets acquired enables GE to record a gain on such dispositions, by allocating a relatively small amount of amount paid to any subsidiary segments that it intends to dispose of.
The important point about the array of earnings management techniques available to GE is that they can be used in concert to report a smooth earnings sequence. Table11.

3 suggests that GE has been quite successful in this regard.

Required

a. Evaluate restructuring charges as an earnings management device. Relate your answer to the claims of Hanna (1999) about misuse of restructuring charges.

b. Under securities markets efficiency, share prices always fully reflect all public information about a firm’s securities. Given its complexity, would GE’s share price always reflect all public information about GE? Explain why or why not.

c. Is earnings management by GE good or bad? Explain.

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Reported Net Year Income 2006 $20,829 Table 11.3 General Electric Company Reported Net Income, 1993-2006, incl. Reported Net Income $10,717 Year 1999 2005 16,711 1998 9,296 2004 17,160 1997 8,203 2003 15,002 1996 7,280 2002 14,118 1995 6,573 2001 13,684 1994 4,726 2000 12,735 1993 4,315 Source: Annual Reports, General Electric Company.