The problem is you get what you pay for. If you pay food workers based on the number of insect parts they find and remove from line, they are going to bring in bugs from home to raise their pay (example in this weeks Business Week). The same holds true for executives. If you tie their pay to the stocks performance, they are going to drive the stock price up.
december: There are actually a number of problems. One set involves enforcing existing rules.
Another set may involve GAAP’s tendency towards laying down it’s rules with great specificity, in contrast with the Brit’s reliance on broad principles. (This is debatable of course.)
Finally, I was alluding to the fact that stock options paid to executives are not considered costs under GAAP. A noncorrupted FASB would arguably not allow such a misleading accounting framework. This is not a case of keeping up with the minutia: as I stated earlier, stock option grants reportedly sum to 2.5% of total reported profits over the past 5 years.
I agree that not counting stock options as a cost causes distortions. It encourages their use. It also means that the stock dilution isn’t reflected in earnings.
on a somewhat related note… is it possible for citizens to simply move their representitives to revoke the state charters of corporations that are sticking their big fat greedsticks up our collective ying-yang?
Let’s not forget that employee benefits have been gutted as a way of upping the reported profits. Frequently, this takes the form of gutting the pension plan - turning it from a defined benefit to a defined contribution “cash balance” plan. The main benefit, beyond anything else, is this: the company no longer worries about providing health insurance to their retirees. This wipes out one of the main sources of the value of a pension plan to an employee, of course. In my case, none of my fellow employees seem to realize that this could cost them a minimum of 10k per year when they retire in current dollars. What they’ll have to pay in the inflated (or devalued, take your pick) dollars of the future is anyone’s guess. The inevitable result will be a continued increase in the cost of Medicare to taxpayers.
Why is it so wrong to hope for some honesty in public statements? Other than it seems there rarely is. With working, night school, trying to keep up with politics, being baffeled by the stock market as I realize my 401K will be worthless the way things are going, finding time for a social life, and coming in here to get new ideals on old and new concepts alike, now I have to do detective work into companies accounting practices? Hell, keeping up with politics is almost a full time job in itself!
Why is honesty so hard in business? We seem to reward those who are deceitful.
{sinks back to lurkerdom}
I don’t think the problem is that options aren’t considered a cost. The problem is making sure executives are working in the best long term interest of the company and not just artificially driving the price up so they can cash out on the quick buck. Paying execs with options originally had the best intentions. Tie an executives compensation to the performance of the company. it sounds good on paper, but in practice it doesn’t seem to have worked that well.
Just the tip of the iceberg avalanche, pals and gals. The banks are next.
Mr. Lay strolls into MolochBank (a wholly owned subsidiary of MammonCo). It is better for Kenny Boy to borrow money than to spend its own (I know this sounds weird).
MolochBank politely inquires as to the net worth of Enron. To the mutual satisfaction of both parties, Enron’s bald faced lie is accepted at face value, and Kenny Boy qualifies for MolochBanks very very best interest rate.
Now, of course, MolochBank lists the loan as an asset, which is rather like regarding a tumor as a blush of health. When it plays in the money sandbox with its other buddies, it exchanges money at a favorable rate based on its assets.
Now, Poor Dumb Schmuck, an Enron employee with lots of stock socked away, secures a mortgage from MolochBank, using Enron stock as collatteral. If he resides in one of those Real Estate Boom markets, his house is probably over-priced. But no matter. He has ample collatteral and the bank is more than happy to underwrite the mortgage.
Now, Enron aint worth diddly squat. The loan that Enron secured will not be paid. The assets represented by that loan as being MolochBank assets go “poof!”.
At the same time, PD Schmuck has lost his job, his Enron stock is toilet paper, and the bank wants its money NOW! He is, to use the technical economic term, “Screwed, blued and tattooed”. He cannot pay his mortgage, so the bank takes the house. Which, you will remember, is not really worth the money represented by the mortgage.
Now, money borrowed using MammonBank stock as collateral is no longer an asset…
Well, you see where this goes. Here’s your handbasket. You know the destination.
msmith: I don’t think the problem is that options aren’t considered a cost.
If payments to employees are not costs, what are?
Remember, this is estimated at 2 1/2 percent of total profits. This distorts economy-wide capital allocation as companies which make large pay outs to their executives and employees (Tyco, Microsoft) release numbers with misleadingly high reported earnings.
The problem is making sure executives are working in the best long term interest of the company and not just artificially driving the price up so they can cash out on the quick buck. Paying execs with options originally had the best intentions. Tie an executives compensation to the performance of the company. it sounds good on paper, but in practice it doesn’t seem to have worked that well.
With all due respect, you are not dealing with the tradeoffs. Yes, management theorists initially advocated stock options. Unfortunately, they anticipated neither the mendacity of corporate America nor the toothlessness of shareholder oversight within the existing institutional structure.
Option payments, as currently structured, encourage executives to, “artificially drive up the stock price and cash out”, as you put it.
Aligning shareholder and managerial interests is trickier than was anticipated in the early 1990s.
december: Permit me to offer a half-defense of FASB, on the basis of hearsay. (Dopers are invited to correct me here.) My understanding is that FASB has representatives from both the Big 5 4? accounting firms as well as various academicians. On technical matters, it does an ok job. But the accounting collective’s clients (that is, those who hired them, not shareholders) cared passionately about obscuring the true costs of their salary payments. So FASB was divided on that issue. When Silicon Valley lobbied Congress and secured threats to compromise FASB’s independence, however, the issue became a no-brainer: capitulation to the Big 5’s clients followed in 1998(?). On this issue.
Tabeitha inquires, "Why is it so wrong to hope for some honesty in public statements? Other than it seems there rarely is. "
Interestingly, we are witnessing the corruption of the US capitalist system in real time. Recall that prior to 1998, the reported profit numbers (based on GAAP) tracked the government’s profit numbers (based on tax payments) pretty well.
I suspect that relentless pressure to deliver a growing bottom line to Wall Street (never mind the fine print) led first to corner cutting, then wholesale deception. Those who protested that it simply wasn’t possible to deliver the sort of results that Wall Street rewarded were transferred from their post or shown the door.
The Sunday NYT had an amusing article about the travails of Worldcom’s competitor, AT&T. First, they decided, a la AOL-Time Warner, that synergy was the way to go: consumers would be able to buy all their telecommunication needs at One place. Within a couple of years (my recollection) AT&T changed their mind: they would divest, chopping themselves up into 3 parts. Just the sort of exercise that Wall Street liked.
At the time, I couldn’t figure out what they thought they were up to (not that I really cared). In retrospect, it appears that they were trying to keep up with the Worldcoms of the world and failing miserably. Interestingly enough, one Michael Keith pleaded with his boss that it just wasn’t possible for his division to deliver the results expected of him. He got demoted in 12/99 after only 9 months.
As elucidator noted, distortions in one part of the economy typically have knock-on effects on the remainder. Bad decisions and inefficiencies follow. (Nonetheless, elucidator ignores certain redundancies built into the system; there is insufficient evidence for me to endorse his cyclic forecast.)
Admittedly, this piece of evidence, again from the Economist, isn’t as strong as that in the OP. But, I’ll add it for completeness.
The number of restatements of American corporate results following accounting errors increased in the 1990s. Interestingly, there was a big change in 1998, the same year that our 2 profit measures began to diverge.
Again, I am reading off a chart (Source: Economist 7/6/02; data from Financial Executives International)
Year(s)…Number of restatements
1990-1993…25-50 each year
1994-1997…50-60 each year
1998…100
1999…205
2000…155
2001…No data
Doom, I say! Dooooom!
There shall be great weeping and gnashing of teeth!
The Children of Enron shall be cast into the snows of Aspen, and the Hamptons shall know them not!
Woe unto the Servants of Enron, for the Day of Counting comes
And they are sore wroth, for thier asses are in slings.
Dooooooom!