We are beginning to understand the importance of verification, validation, and authentication of corporate claims about business performance. Everyone with an interest in our economic health and progress will demand sounder ways to find truth in time to make a difference. Smart, responsible corporations will help this process develop and become leaders in business authenticity. Investors now see the conflicts of interest and the outright lies about corporate financial performance: the defensive posturing of corporations, auditors, politicians, and Wall Street. Their first line of defense is to placate investors by creating the illusion of reform -- a lot of political talk followed by unenforceable rules. After all, much of the political business and financial establishment does not want reform. Disturbing the cozy relationship between Congress and the companies who contribute to political campaigns would upset a long tradition. Too much change would expose them and take them out of the game. Managed mendacity, systematically applied to the investing public, has become the new science of publicly traded corporations. The one thing corporate leaders know for sure is how to handle the investors. They know just how much information to provide and what kinds of information to hide, and they can rev up the engines of hype and misinformation at the drop of a hat. Lies and deception at their basest level help the inner circle achieve personal goals of greed and cover up their incompetence as executives. Gamesmanship has replaced business management competence as executives and their boards have focused on managing the stock first, and the business second, and strategic value last. This pattern of conduct is not what investors came to the market for and is the reason why many are now thinking twice about staying unless new methods of verifiable data on corporate performance are developed. The performance reports of Cendant, Waste Management, Sunbeam, Global Crossing, Tyco International, and Enron were certified as accurate by their auditors. But Cendant allegedly booked $500 million in fake revenue over three years. Waste Management defended itself in seventy class-action security fraud complaints and accounting scandals and became the most frequently sued company of 1998. Sunbeam was charged with accounting fraud for shifting $21.5 million from reserves to income to cover up massive discounts and inflated sales forecasts. Global Crossing was charged with Enronlike accounting fraud and inflated revenue reporting. Tyco International was investigated for hiding debt to make revenues look better. Enron and the others are just the tip of a deeply submerged iceberg. The root of some of these cases goes back for more than a decade. None of them received much attention until the Enron story began to develop and the markets declined for the second straight year. The sensitivities of investors have become sharply tuned, and Enron pushed the sensors to the full tilt. Enron and these other companies wanted to make revenue look stronger than it actually was during each reporting period. They shifted expense, debt, and sales forecast numbers from book to book to create the illusion of financial stability. They concocted their stories carefully, never stretching too much at a time. Their reports seemed reasonable, directionally right. Falsehood was concealed among accurate facts. The business leaders who were best at this deception were moneymakers on a "five-year" mission. Their goal was to manage an initial public offering, or take over a solid publicly traded company, push the stock to the sky, and cash out. In the process of making things look better than reality, insiders sold off at market high points to line their own pockets. If investors cannot validate the factual basis of revenue reporting, return on capital, and reports of cash flows, logically, they should not invest. But with all this deception and deliberate concealment, there is no way to validate all the reporting. This is the investors' "catch-22." It gets worse. If only there were a simple checklist of indicators, like the following, that would give a signal that something is amiss:
However, keeping up with the indicators of lies and deception is like trying to paint a moving train. Since the Enron accounting spill, corporations will move to other devices to play their games. They will be extremely careful in the future, and they will change their patterns. Any system as complicated as our system of investing cannot be simplified to a set of bullet points. Investors can't simply rely on a checklist, but need to ask some hard, even rude, questions. Why hesitate being tough-minded when it comes to protecting your financial life? RUDE INVESTORS Individual investors have been left to trust the professionals -- the fund managers, brokers, and advisers -- to ensure that their money is with the best possible companies. Individuals, however, must still be responsible for their own investments. We need to let the fund managers and professional investors know that we now expect them to do their homework and recommend companies who are not hiding behind technical compliance but are willing and able to disclose fully what they are doing. Here is a list of questions that can be used to start developing an understanding of companies. Basic Financial Verification
Corporate Ethics
Management
The Board of Directors
This list is just for starters, an example of the kind of questions that shift the burden to corporations to "show us" they are right. If you can't get answers that satisfy you, then you know, one, perhaps two, things are wrong. First, the investment "pro" you are dealing with doesn't have much in the way of useful information. What are you paying him for? Second, the company that can't or won't provide this information is suspect. As Enron unfolded, reporters noted that Warren Buffet commented that if he could not understand an annual report, perhaps the company did not intend for him to understand it.
Dr. Richard J. Schroth is a consultant and advisor on emerging technology and business strategy to many of the world's leading corporations. From the Book: How Companies Lie: Why Enron is Just the Tip of the Iceberg by A. Larry Elliott and Richard J. Schroth. Copyright (c) 2002 by Richard J. Schroth and A. Larry Elliott. Crown Business. Reprinted by permission of Crown Publishers, a division of Random House, Inc. |
Fifty percent of American households support corporations by buying
stock. But the level of trust people have placed in the corporate world
by making these investments has not been reciprocated by reliable
information about the financial performance and the actual financial
condition of the corporation. Both individual and professional investors
are becoming more cautious, with many reducing or withdrawing their
investments.
