Criterion Research Group claims to have discovered a quantifiable way to predict which public companies will get sued.
Neil Baron, chairman, said public companies with high accruals on their balance sheets are more likely to have class-action lawsuits brought against them than companies with low accruals. In accrual accounting, a company records a sale or expense before cash has changed hands. It can also record a capital expenditure, such as construction of a new factory or production plant, on its balance sheet before it actually pays cash for it.
Mr. Baron's firm is offering investors access to its online database, which divides the universe of 5,200 public companies into 10 deciles, with the first decile containing the 520 companies with the lowest accruals and the 10th containing the 520 with the highest. Criterion's model is based on research conducted by Richard Sloan, professor of finance at the University of Michigan Business School, and Scott Richardson, finance professor at the Wharton School of Business. Mr. Richardson is also on retainer with the firm.
Between 1996 and 2004, companies in the 10th decile had six times more accounting-related class-action lawsuits brought against them than companies in the first, Mr. Baron noted. Also, in a 40-year back testing of the firm's model, ended Dec. 31, 2001, companies in the first decile, on an average annualized basis, notched 18 percentage points in returns above those in the 10th decile.