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Reform: How the Corporate Landscape Is Changing

Everyone from Congress to the journalist next door has a reform proposal to promote. We assess the likelihood of passage as well as the potential impacts.
CFO Staff, CFO Magazine
October 1, 2002

Although congressional enactment of a law designed to improve corporate governance, Securities and Exchange Commission-­mandated certification of financial statements, and companies' voluntary adoption of new practices seem to have gone some way to relieve investors' concerns about the integrity of the U.S. capital markets, critics contend more fundamental change is required. The table below describes and assesses the potential impact of changes mandated or proposed by Congress and regulatory authorities and of further steps suggested by those pursuing further reform.

Problem Proposed solutionIntended effects ChancesPossible drawbacks
Reporting
Expense employee stock optionsInhibit large grantsStrongFights over expensing formula
Expand disclosure in annual reportsIncrease transparencyStrongInvestors overwhelmed with minutiae
Create stricter standards for Pro FormaIncrease transparencyDoneInvestors confused
Shift to real-time reportingIncrease transparencyWeakTechnical difficulties; compliance burden for smaller companies
Adopt principles-based accounting standardsRely more on judgmentAlmost nilIncomparability of results
Streamline FASB. Assure independent fundingEncourage faster, more independent decisionsDone/ StrongLess outside input to decisions
Tighten rules on off-balance-sheet financing and use of SPEs*Decrease ability to hide riskStrongCredit crunch
Tighten rules on revenue recognitionDecrease ability to manage earningsStrongLess ability to manage earnings
Clarify cash-flow statementsDecrease ability to manipulate operating cash flowStrongLess ability to manipulate operating cash flow
Require CFO to be a CPAImprove disclosureWeakCompliance burden; more training required
Make senior management certify financial statementsIncrease accountabilityDoneDifficult for recent hires
Protect whistle-blowers*Uncover fraud earlierDoneFrivolous lawsuits
Improve reconciliation of book and tax reportingImprove correspondence to economic realityUncertainLess ability to manage earnings
Audits
Separate auditing from consulting*Improve oversight, reduced potential conflicts of interestDoneIncreased cost or decreased quality of audits
Rotate auditors every five years*Improve oversightDoneDecreased quality of audits
Ban hiring of external auditors by clients for three years*Improve oversight, reduced potential conflicts of interestDoneHarder for auditors and clients to recruit talent
Create new auditor oversight board*Improve oversight depending on effectivenessDoneIncrease cost of audits
Laws and Regulations
Increase SEC resourcesImprove ability to review, investigate, and enforceDoneIncreased regulatory burden
Upgrade SEC's status to cabinet levelEnhance power, resourcesNilMore partisanship
Broaden definition of securities fraud*Increase accountabilityDoneDecreased willingness to take
risk; increased litigation
Increase criminal penalties for securities fraud and obstruction of justice*Deter crime depending on evidence requiredDoneFew convicted on criminal charges
Lengthen time investors have to file lawsuits for securities fraud*Increase executive liabilityDoneIncreased executive liability
Bar use of bankruptcy by executives to escape liability for securities fraud*Increase executive liabilityDoneIncreased executive liability
Investment Banking
Separate securities underwriting and researchReduce conflict of interestUncertain

Increased cost of capital; difficult to enforce

Protect research analysts from retribution*Reduce conflict of interestDone

Increased cost of capital; difficult to administer

Separate securities underwriting and lendingReduce conflict of interestDoneIncreased cost of capital
Compensation
Subject broad-based stock-option plans to shareholder vote*Reduce size of option grantsDoneIncreased compensation costs
Restrict employees' right to exercise options until departureAlign employee and shareholder interestsWeakUnattractive to employees
Award restricted stock instead of optionsAlign employee and shareholder interestsUncertain

Increased reported costs to company

Ban loans to senior managers from companies*Prevent excessive loan-grantingDone

Reduced executive stock ownership

Compensate CFO in cash based on metric other than stock performanceFocus attention away from short-term share priceWeak

Disruptive conflicts between CEO and CFO

Governance
Make audit-committee members independent*Improve oversight depending on expertiseUncertainScarcity of candidates
Give audit committee authority to hire and fire external auditors*Improve oversight depending on independenceDoneBureaucratic slowdown
Give board management authority over internal auditInhibit misreporting of resultsWeak

Confused administrative relationship

Make boards of directors independent*Improve governance depending on expertiseUncertainHarder to attract candidates
Separate CEOs and board chairmenImprove governance depending on composition of rest of boardWeak

Potential disconnect between development and execution of corporate strategies

Speed reporting of stock trades by officers and directors*Align management and shareholder interestsDone

Opportunity for late or erroneous information

Require audit committee to approve related-party transactions*Ensure transactions are in all shareholders' interestsStrong

Reduced compensation to board members

Limit board members' pay*Maintain independenceDoneHarder to attract candidates
Require disclosure of proxy votes by investment advisersEnsure fiduciary obligations are metUncertainDisruptive shareholder dissent




*Part of Sarbanes-Oxley Act or rules issued or formally proposed by such regulatory organizations as the SEC, FASB, NYSE, and NASD.




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