In
today's stock market, CEOs live from one doomsday to another -
the doomsday of quarterly reports. Faced by the unusually fearsome
pressures of today's competitive environment their focus is not
so much on "true and fair reflection" of company's financial
position but management of figures in a way that meets market
expectations.
After the report of lies told to the investors by Shell, a paragon
of corporate virtue, has come yet another high profile corporate
fraud fueled by market's morbid addiction to quarterly reports.
Three former executives of Computer Associates International Inc
(CA) have pleaded guilty to securities fraud, as federal prosecutors
continue to investigate the company.
According to New York Times report Ira H. Zar, the former Chief
Financial Officer, and Mr. David Kaplan and Mr. David Rivard,
both former Vice-Presidents of finance at CA have entered their
guilty plea. They are all cooperating with federal prosecutors
in Brooklyn. Mr. Zar pleaded guilty to three counts of securities
fraud and obstruction of justice. Mr. Kaplan and Mr. Rivard each
pleaded guilty to one count of conspiracy to commit securities
fraud and one count of conspiracy to obstruct justice.
Zar said he had met with two other senior Computer Associates
executives on January 6, 2000, to discuss the company's sales
for the previous quarter. The sales fell short of Wall Street
analysts' forecasts, so the men decided to continue to book new
sales as if they had taken place in the previous quarter, according
to the plea. To hide the backdated sales from auditors, employees
of Computer Associates deleted time stamps that showed when the
contracts had actually been faxed to the company.
Perpetration of fraud while reporting quarterly earning is treated
as fair game. Lynn Turner, Chief Accountant of the Security and
Exchange Commission of US from 1998 to 2001 who earlier was a
partner of Coopers and Lybrand had this to say about the accounting
practices of Wall Street:
"All the Big Five accounting firms have a group of accountants
kind of like a financial services group, and that group of accountants
works with Wall Street. In my prior life, we actually had a retainer
arrangement with each of the major wall Street investment banking
firms under which we could help them financially engineer or structure
hypothetical transactions for finding financing, keeping it off
balance sheet, making companies look better than, quite frankly,
they really were."
On 27 January 2003 Financial Times of UK published a letter from
Pierre Bollon Director General AFG-ASFFI (Association Francaise
de la Gestion Financiere) and Peter Montagnon, Head of Investment
Affairs, Association of British Insurers which stated:
"Our organisations represent a wide range of European institutions.
They attach great importance to transparency, but quarterly reporting
is not a high priority. It has not helped to prevent corporate
scandals in the US, and there is a risk that mandatory quarterly
reports will encourage short-termism as management becomes overly
focused on the next reporting deadline. What is vital for investors
is the certainty of knowing that price-sensitive news is transmitted
accurately and promptly to the whole market in an orderly way.
Without this, markets will lack integrity and impose a risk premium
that will add to the cost of capital. As investors, we believe
this should have much greater emphasis than quarterly reporting
in the unified single European financial markets. It is more difficult
to regulate for, but compulsory quarterly reporting is not a substitute
for reliable ad hoc announcement."
That quarterly reports can give a false sense of company's performance
and detract from a long view is evident from a research conducted
by an Indian fortnightly in collaboration with Stern Stewart,
the firm that developed the concept of Economic Value Added (EVA)
to rank the biggest wealth creators in India during the five-year
period from 1998-2003. Hindustan Lever & ITC, two icons of
India, who are perceived to be enormous wealth creators have actually
destroyed wealth. HLL destroyed shareholders wealth to the tune
of £ 1.8 billion and ITC destroyed shareholders wealth to
the tune of £928 million during the period 1998 - 2003.
A study conducted by Skinner and Lynda Myers of Michigan University
and reported in the Economist, looked at 399 firms with unusually
smooth and consistent earnings growth found that (i) they all
enjoyed high market valuations, (ii) there was evidence that they
were smoothening bumpy earnings (iii) they eventually ended in
an earning shock that had an unusually damaging effect on the
stock market.
Over-emphasis on quarterly reports has spawned a culture of concealment.
GE used to feature on university courses as a model of probity.
These days, it crops up in the seminars about earnings-manipulation.
While it is time to educate investors to discount the importance
of quarterly reports, there are lessons for CEOs that manipulation
of these reports can cause irretrievable damage to company reputation.
It was Richard Nixon who said you could disobey all the Ten Commandments
provided you abide by the 11th commandment - "thou shalt
not be found out". In the uncertain economy of Internet there
is only one certainty is "thou shalt be found out."
