Chief financial officers are willing to sacrifice real cash flow for the sake of meeting a desired earnings target, or to avoid a bumpy earnings path, according to a survey of CFO's in the US carried out by John Graham, professor of finance at Duke University, North Carolina.

The majority of finance managers surveyed would abandon a project that was net present value positive if it meant falling short of the current quarter's consensus earnings. Similarly, most would give up economic value in exchange for smooth earnings. They are prepared to cut discretionary research and development spending, advertising and plant maintenance - expenditures fundamental to running a successful company.

He also found that the managers' interest in meeting, or beating, earnings benchmarks is more about boosting stock prices and helping their career prospects than about any incentives related to debt covenants, credit ratings, political visibility and employee bonuses.

Such flagrant intent to burn economic value in order to meet financial reporting goals surprised Graham, who did not expect such candid admissions. "We were surprised at the result because when you're running a survey it's pretty easy to lie," he says. Even more worrying was his finding that these executives felt comfortable about sacrificing economic value in order to smooth earnings or hit a target. "They feel they are choosing the lesser evil because missing earnings numbers means getting severely punished by the market."

He can sympathise. So many companies are manipulating the numbers to hit or beat earnings forecasts that the market has come to expect such behaviour.

"The severe stock market reaction to small EPS (earnings per share) misses means that the market believes most firms can always find the money to hit earnings targets. So if they don't, it is interpreted as evidence of hidden problems," Graham says.

"The market reacts too strongly, and I don't know how you change that. One possible way to break this habit is to get some good, strong companies to say they missed their earnings and explain that, while they could have sacrificed profit to hit the right number, they didn't do it because that's not the right way to run a business."

Previously, when CFOs wanted to deliver the earnings number that the market expected, they changed the accounting numbers on their financial statements. This led to such disasters as Enron and WorldCom. Now, instead of changing the accounting numbers, CFOs are deciding to pass up real investment opportunities. Graham says: "They're afraid to monkey around with their books. Instead, they are taking real action, and it's very disconcerting. What these finance executives are doing is maybe not illegal, but I would argue this is worse for shareholders."

Remarkably, given the overwhelming emphasis on cash flow in the finance literature, Graham found that cash flow does not receive enough attention from CFOs.

"We asked them about discounted cash flow and EVA (economic valued added), but quickly discovered that accounting earnings matter more to managers than cash flow for financial reporting purposes."