Misreporting in financial statements in a centrally planned economy: The case of Czechoslovak state-owned enterprises in late socialism

Abstract

Communist economies of the former Eastern Bloc were driven by systems of central planning. The central plan set detailed goals to be achieved by the state-owned enterprises, which often struggled to meet them and obtain bonuses or avoid the related sanctions. In line with the principal-agent theory, we study the behaviour of managers of the Czechoslovak state-owned enterprises in this specific environment and investigate the possibility of using creative accounting methods and other methods to cover failures in meeting those plans. Statistical analysis based on accounting records from the 1970s and 1980s recovered from state archives indicates that meeting the central plans targets was often achieved through false reporting. This conclusion is further supported by two series of 75 and 80 interviews with former managers of socialist state-owned enterprises. We expect our findings to hold for other centrally planned economies, as managers’ original motivations were distorted by features which were inherent to the centrally planned system itself.