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| Corporate Power and Accountability By Louis Erlichman Canadian Research Director |
| This is the Age of Easy Information. Ask a question, and the Internet will immediately bury you with answers. When I started working for the IAM in the late 1970s, getting public financial information was an arduous and time-consuming exercise – searching through out-of-date directories, trips to libraries, waiting to receive annual reports in the mail. Now I can get piles of documents off the Internet virtually instantaneously, not to speak of opinions, investment advice and “spin”. The problem now is not how to get financial information, but how to use it. How do you sift through it, understand it and use it? And now, with recent accounting scandals, the another frequently-asked question is “How reliable is even the ‘hard’ financial data you get?” Corporate have always had different sets of accounts for different purposes. They have one set of figures for tax purposes, generally aimed at minimizing the tax they have to pay. They have internal accounting systems for use by management, or to create goals or incentives for corporate divisions. Then there are the publicly-filed accounts, aimed at shareholders and investors, and generally putting a positive spin on company prospects. Each of these accounts may have quite different ‘bottom lines’, because they are created for different reasons. The capitalist free-enterprise system is supposed to be based on open, transparent markets. Free access to information is at the core of the system. If people are going to make the rational investment decisions that lead to efficient markets, they need reliable information, and for fairness, everyone should have access to the same information. The stock market is the epitome of the system. Every day, anyone (who has the money) can buy or sell common stock, literally a share, of any public company -- called ‘public’ not because it is owned by all of the public or serves the public good, but because ownership is private but open. ‘Private’ companies are companies that are “closely-held”, whose stocks are not available for general sale. Stock prices are determined by supply and demand in the market. In theory, since they represent the ownership of a piece of the company, stock prices are supposed to reflect the value of the assets of the company and prospects for future profits. Often, however, stock prices have little relation to either company assets or profit expectations, but simply move because of an expectation that the price is going up or down in the short run, because of general expectations about the movement of the market, or, often, for no visible reason at all. In theory, market movements are presumed to be based on information, but, while financial information gets easier to obtain, it doesn’t make investment decisions any easier, not least because information is being created constantly for the specific purpose of affecting investment decisions and stock prices. Companies release information showing their prospects in a good or bad light, analysts and journalists and your next-door neighbour make buy and sell recommendations. The most solid and reliable financial information is generally considered to be a company’s audited financial statements. These are summaries of corporate accounts, published regularly by public companies, detailing assets and liabilities, profits and losses and a range of other corporate information. These accounts are “audited” by outside accounting firms, who look at the company’s internal statements and certify, after doing some sample tests, that, in their professional opinion, these statements fairly represent the company’s financial condition. The accounts are supposed to follow a set of guidelines laid down by the accountants themselves, called Generally Accepted Accounting Principles (GAAP). Audited statements are supposed to provide a solid basis for investors to make informed decisions, but even audited statements prepared under GAAP have to be read with a critical eye. The “hard” numbers in the statements are all history – what happened in the previous quarter, year or years, and can’t tell you what is going to happen in the future, which, in theory, is what the value of the company should depend on. And even the historical numbers can be questioned, since there is considerable leeway within the GAAP rules to make a big difference in profits or asset values. For example, let’s say an aerospace company has a multi-year project for an aircraft part, which requires a big upfront expense for research and development. In calculating costs and profits, the company can spread these expenses over the expected life of the project, in effect charging a certain share of the cost to each part as it is made and sold. It makes a big difference to “bottom line” profit whether the company assumes it will sell 200 or 1000 of these parts, over 5 years or over 20 years. If you assume more parts sold and a shorter payback period, you can allocate less R&D expense to each part and increase your apparent profit for a few years, but if sales fall short of projections, at some point you are suddenly going to be facing an unexpected loss. Recently, we have seen large, high-profile companies not only stretching the limits of GAAP, but leaping over the line, with the cooperation of the supposedly independent outside auditors. For management, there were enormous gains to be made by inflating profits or asset values, pumping up stock prices, and taking bonuses and big stock option profits. In any case, in a booming market, with most investors looking to get rich quick were not looking too closely at financial statements anyway. For accounting firms, for which auditing has become just a sideline for the more lucrative business consulting trade, collusion with crooked management seemed like good business. While there has been a lot of self-righteous talk in the business press (and from the U.S. White House) about excessive greed, this kind of activity is really endemic in the system, which is based on maximizing profit and personal gain. If some people lose, that’s all part of the game, and just makes winning all the sweeter. Frankly, the market-worshippers in the business world, and who have been running our governments in recent years, believe that rules to protect the public interest just get in the way of the ‘efficient’ operation of the markets. We need less regulation, they say, not more. It is up to each of us to judge whether something is a good investment, and it is our own fault if we believed the wrong information. C’est la vie – that’s the market. And if some executives made fortunes because they knew when to sell out, that’s just a sign of their business acumen. Insider trading is just one of the perks of being an insider (ask George W. Bush). It may not seem fair, but are these victimless crimes? Or are the only victims wealthy investors who should know better. Well, if you invested in the stock market, directly or in a mutual fund, and you lost money when inflated stock prices collapsed, then those ill-gotten gains came out of your pocket. And since most union members belong to pension funds that invest in the stock market, most of us have been cheated, directly or indirectly. Aside from that, none of us is insulated from the stock market. It’s a central part of our economic system. It affects the actions of corporations, governments and consumers. A stock market boom can fuel our economy and create jobs (though not as effectively as good government policies), while a stock market slump has implications in the real economy, cutting economic growth and jobs. What happens on the stock market can affect anyone’s livelihood, even if they have never invested. For better or worse, our economic system floats on institutions like the stock market. Particularly after long upward run in the stock market as we have seen over the last couple of decades, a big market downturn and the exposure of the shortcomings of the market are an important corrective to the notion that we can all painlessly get rich playing the markets. Ironically, a campaign is being waged, in Canada, the U.S., and many other countries to convert public pension systems to individual investor accounts, making our public pensions dependent on the state of our individual investment portfolio. While this would provide a huge bonanza for the investment industry, who would charge us for investing our money, it would also undermine the retirement income security of virtually every one of us. In Canada, over three quarters of seniors get more than half of their income from public pensions. While the current accounting scandals and stock market collapse have highlighted the folly of “privatizing” our public pensions, we cannot let down our guard. Privatization means lots of money for Bay Street and Wall Street, and they are not going to give up easily. After some earlier market downturns and scandals, notably at the end of the nineteenth century and in the 1930s, we saw some attempt to regulate the stock market to make the system somewhat fairer and more stable. Unfortunately, the power of the free-marketeers seems to be firmly entrenched. A few high-profile corporate scapegoats are being offered up as human sacrifices to protect their corporate brethren, but we are unlikely to see any long-lasting reform in the market or accounting standards coming out of this round of scandals. |
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