Financial Statement Impact: Earnings Per Share
Premier Anesthesia is a high tech health services provider that transformed itself from a private company to a public company in 1992. At the end of 1992, its price to earnings ratio was 45.0, based on estimated 1992 earnings. Its quarterly earnings for the first and second quarter of 1992 were, respectively, three cents and six cents a share. Curiously, its year to date EPS at the end of the second quarter of 1992 was 11 cents per share (WSJ, December 8, 1992, p. C1). The company’s market price more than doubled during the last half of 1992 (from less than $6.00 per share to more than $14.00 per share).
Required
a. Comment on the discrepancy between the reported earnings per share data.
b. Comment on Premier Anesthesia’s spectacular share prices relative to its earnings.
Additional Data
A reporter, Mr. Craig Torres, reported that “much of Premier’s interest earnings come from high interest loans to a group of clinics” owned and controlled by Premier’s chairman and largest stockholder (WSJ, December 8, 1992, p. C1). These loans carried interest rates ranging from 12 to 24 percent. Premier also booked management fees from the clinics as operating income. Mr. Torres suggested that “Premier’s earnings come not from the hospital world, but from collecting interest income.” The article was headlined as “Premier Anesthesia’s Earnings Are Bloated by Interest Income” and “Premier Anesthesia’s Earnings Get a Big Boost from Large Injection of Loan Interest Income.” Approximately
42 percent of the firm’s earnings were derived from these related party loans.
a. Find one to two articles (using the library or Internet) on “related party” issues. Summarize the key issues as they reflect financial reporting and ethics.
b. Describe how a company can earn interest income from another company, particularly one that it controls. Comment on the ethical issues of such loans and the reporting of such income, particularly given the market’s response to Premier Anesthesia’s earnings. Also comment on the interest rates, given that the prime rate during this period was around six percent.
Additional Data
Mr. Torres also reported that no buyer had been found for the clinics, so the loans were essentially “bridge” financing until Premier Anesthesia could acquire the clinics. He reported that “Some analysts suspect Premier is deliberately delaying the deal’s closing to keep collecting interest income, and thus to avoid losing an important source of earnings in its first year as a public company” (WSJ, December 8, 1991, p. C2).
a. Reassess your conclusions about the sources of Premier’s earnings and about the ethics of its earnings management tactics.
b. What might you recommend in similar circumstances? Why?