VideoThere's no telling exactly what will dispel the crisis of confidence dogging the markets for corporate equity and debt. The crisis only deepened in June when WorldCom, the former high-flying telecommunications company, disclosed that it had overstated its cash flow for the previous five quarters by almost $4 billion. With the S&P 500 and Nasdaq Composite indices dropping to five-year lows, the stakes for CFOs obviously are huge. But CFOs themselves surely can extinguish doubt by improving their financial reporting practices and, at least in some cases, by frankly acknowledging the need for improvement in the first place.
Some companies are taking steps in that direction, however haltingly. Among them are Cisco Systems, General Electric, IBM, Krispy Kreme, Priceline.com, and Sears, Roebuck. And a new survey of senior financial executives at publicly traded companies by CFO magazine points to others. Almost 60 percent say they have disclosed more information to investors during the past 3 months, and a similar proportion plans to disclose more during the next 12 months. On the other hand, the remaining 40 percent saw no need to disclose more.
However, the survey also suggests that many companies must do much more. Over half (54 percent) of the 141 respondents say they report pro forma results in quarterly earnings releases, but 18 percent of those that use pro forma don't reconcile those results to U.S. generally accepted accounting principles (GAAP), even though the Securities and Exchange Commission has advised companies to do so. Even more troubling, 17 percent of all respondents report being pressured to misrepresent their results by their companies' CEOs during the past five years.
Of all respondents, 5 percent say their reporting practices have violated GAAP. Those abuses most often involve reserves and revenue recognition.
How likely is it that the offending companies will clean up their acts? Both our survey results and anecdotal evidence suggest that companies are changing their practices so reluctantly that they risk undercutting whatever trust such moves might regenerate.
Under Suspicion
The need for improvement, and for acknowledging it, seems indisputable. Although the economy shows signs of recovery, the capital markets continue to labor under a cloud of suspicion, much of it directed at the integrity of corporate financial statements.
Some CFOs concede that they have a responsibility to help restore trust. "Because of Enron, companies are really held to a higher standard in terms of what they're reporting," says Randy Casstevens, CFO of Krispy Kreme Doughnuts Inc., a doughnut retailer and franchiser based in Winston-Salem, North Carolina. "We want to do whatever we can to increase public confidence in us."
A big question, however, is whether companies are capable of that in the absence of new rules and regulations. Says Casstevens: "It will take a combination" of action in the private and public arenas to restore confidence.
The CFO survey of corporate financial reporting suggests that other financial executives are resisting the kind of change that might go some ways toward alleviating investor suspicion. Of the respondents to our survey who take debt off the balance sheet through special-purpose entities (SPEs), almost 80 percent say they have no plans to consolidate any of it. And that's so despite the fact that almost 42 percent guarantee the investments of outside investors in such deals. Under existing accounting rules, the assets of SPEs must be consolidated when outside investors' stakes are protected in that fashion.
Slow to Change
Resistance is also clear in individual cases. Consider IBM Corp. Although criticized for years for counting gains on asset sales as reductions in its overhead, artificially inflating its reported profit margins, the company fought tooth and nail to continue the practice. According to press reports, it even resisted demands from the SEC to cease and desist. The company finally acquiesced in the 10-K it issued last spring, excluding one-time gains from SG&A costs and reporting them on a separate line on its income statement. That change, along with the exclusion of intellectual property income from R&D expense, revealed that the company's actual overhead costs in 2000 were $17.5 billion, 12 percent higher than the $15.6 billion it reported in its previous 10-K.
IBM's CFO, John Joyce, told Business Week magazine that the changes would better display the company's financial strength. Others suggest that Big Blue has belatedly come to appreciate the virtues of transparency, which, all things being equal, should reduce its cost of capital. "They got religion," says Charles Mulford, an accounting professor at Georgia Institute of Technology. Yet IBM's change of heart looks to have been coerced — hardly the sort of conversion likely to impress skeptics.
Another company that has improved its reporting practices is Priceline.com. Analysts credit the online travel discounter with making it easier to compare the pro forma results it reports in press releases with its results according to U.S. GAAP. As recently as last year, for instance, David Kathman of Chicago-based Morningstar says he had to hunt for the information necessary to compare Priceline's results under GAAP with its pro forma numbers, to which the company called investors' attention in the first few lines of its earnings press release. In contrast, the data needed to come up with GAAP-based numbers, says Kathman, "was buried in a table." But now Priceline's GAAP-based numbers are given almost equal prominence.
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