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The President's $330 billion tax cut may win votes at election time, but it offers little help for businesses. Plus: E-mail as portrait painter, corporate exercises in utility, and the net tax debate.
CFO Staff, CFO Magazine
July 1, 2003
The Bush Administration is hoping that the third- largest tax cut in U.S. history, signed into law in May, will charm the economy out of its current funk. The Jobs and Growth Tax Relief Reconciliation Act of 2003 will slice taxes by $330 billion and provide $20 billion in aid to states.
While many economists expect the cut to jolt the economy in the short term, the long-term picture is fuzzier.
One of the criticisms is that the act does little to stimulate business investment directly. Instead, it puts the emphasis on consumer spending by accelerating tax reductions, increasing the child credit, and eliminating the marriage penalty. "It doesn't address the immediate problem," says Ken Goldstein, an economist at The Conference Board. "The slow economy is not because consumers haven't been spending. The real question is, how do you get businesses to invest?"
The act addresses this question only nominally. Just $10.1 billion of the total cuts are earmarked for companies, with an increased write-off for small businesses and accelerated depreciation on some equipment purchases. "There is not much here for medium and large businesses," say Timothy McCormally, executive director of the Tax Executives Institute.
Instead, Congress opted to trim the maximum capital gain and dividend income rate to 15 percent. Experts don't expect the changes to have a drastic impact on the dividend strategies at most companies, but businesses are hopeful that consumers will spend the windfall, providing a spark to the economy. "My view is that the economy was already in recovery mode; this practically guarantees it," says Daniel Laufenberg, chief U.S. economist at American Express Financial Advisors Inc.
David Wyss, chief economist at Standard and Poor's, counters that the big danger is that interest rates will spike and deficits will handcuff the economy just when baby boomers are putting a strain on Medicare and Social Security. He thinks that could lead to a return of the slow-growth, low-productivity period of the 1970s and early '80s. "My guess is that this is going to have to be fixed in five years," he says.
Congress will get that chance. The act uses a neat trick called "sunset provisions" that expire many of the changes in periods ranging from two to five years. But the maneuver has largely been viewed as a ploy to get the cuts Bush wanted at a cost that was palatable to moderate Republicans. The reality is that once cuts are in place, they are hard to roll back. "There are questions about the mechanism that Congress used to get the numbers to work out," says McCormally. "At a time when Congress has come down hard on companies for creative bookkeeping, you have to ask if there is not some creative bookkeeping being used here."
There they go again. A bill that would temporarily stop the Financial Accounting Standards Board from requiring companies to expense stock options got a hearing before a House subcommittee on June 3. Along with requiring greater disclosure of options, it mandates a three- year study of the effects of such disclosure before any new accounting standards governing options could take affect.
The bill's sponsors argue that mandating companies to expense options would effectively halt broad-based options plans for rank-and-file employees. "While I agree that accounting standards are best left to FASB," said co-sponsor Anna Eshoo (DCalif.) in prepared remarks, "promoting job growth and economic viability is a responsibility of the Congress."
FASB opposes the bill, which could stall its final rule on expensing stock options. "The moratorium," chairman Robert Herz noted in his testimony, "...would send a clear and unmistakable signal that Congress is willing to intervene in the independent, objective, and open accounting-standard-setting process."
In 1995, FASB backed off its proposal to expense stock options, bowing to similar pressure from Congress and lobbyists for the high-tech industry.
Email: Return from Senders
Looking for leaders — or slackers — in your finance organization? Check your E-mail.
Using an algorithm originally developed to identify groups of genes with related functions, researchers at Hewlett-Packard Labs analyzed the addresses of close to a million E-mail messages sent among 400 of the lab's workers over three months' time. The result? A remarkably accurate picture of the organization. Some 80 percent of the groups identified mirrored actual departments or proj-ect teams. More intriguing, the remaining 20 percent turned out to reflect strong but informal collaborations that don't appear on the lab's organization chart. The algorithm also correctly identified leaders — both those with management titles and de facto leaders of the informal groups.
Companies traditionally spend big bucks on surveys and consultants to identify so-called communities of practice, says Joshua R. Tyler, co-author of the study. E-mail analysis, he says, "is quick and cheap." Although still in the early stages, he says, the research might also provide "a way to discover the undiscovered stars."
The study focused on internal E-mails, and excluded messages with wide distribution that were likely to be administrative — or jokes, in less-disciplined settings. "Privacy," adds Tyler, "is potentially the biggest obstacle preventing other organizations from trying to deploy this algorithm," although he notes that the study did not look at subject lines or content, only addresses.
Too bad, says Michael Schrage, co-director of the eMarkets Initiative at the MIT Media Lab. "This study is a nice first cut," he says, but argues that greater insight will come from analyzing E-mail content. He predicts CFOs will soon use E-mail technologies to gauge productivity and to audit who is communicating about sensitive financial information.
Indeed, some companies already filter outgoing E-mails for financial disclosures. "Over time," says Schrage, "auditing E-mail will become an integral part of the internal and external audit function."
The privacy issue is "bull," he says. "Anyone sending E-mails to fellow employees who believes that E-mail is protected is insane."
Securities Markets: New Rules for IPO Deal-makers
Can public confidence in the process of taking a company public be restored? That is the hope of the IPO Advisory Committee, a group formed last October by the New York Stock Exchange and the National Association of Securities Dealers. The committee's final report includes 20 recommendations for promoting transparency, ending allocation abuses, and improving information about initial public offerings.
And none too soon. The report was issued on May 29 — during a month in which only three companies filed plans for IPOs with the Securities and Exchange Commission. That's practically a flurry of activity these days, but a precipitous drop from May 1999, when some 65 companies filed plans to go public.
In the ensuing four years, the market has been hammered with reports of underwriters doling out hot IPO shares to potential clients ("spinning"), investors who agreed to pay excessive commissions on other transactions, and investors who promised to purchase more shares in the aftermarket, pushing up the price. The report took issue with all of these practices and will be considered a basis for new rule-making at the exchanges and the SEC.
One recommendation that could affect CFOs requires a company's code of ethics to include a policy regarding receipt of IPO shares by directors and executive officers. At the same time, underwriters would be prohibited from allocating IPO shares to directors and executives of companies with which they have an investment-banking relationship.
The report is "useful," says Alexander Ljungqvist, a finance professor at New York University's Stern School of Business, but falls short of full transparency into how banks build their "book" of investor bids and their allocations.
The committee suggested that banks provide such information to issuers. Ljungqvist, who advised the committee, argues it would be better to file book-building data with the SEC.Too Little Too Late
Utilites: Your Own Private Electric Co.
Electric grids provide power supplies and prices that may prove erratic and untrustworthy; the blackouts in California two years ago underscored the dangers of such dependency. So now companies, especially those that rely on power for their core businesses, are looking for alternatives.
Enter "distributed-generation" power suppliers such as American DG Inc., a Waltham, Mass.-based start-up that is affiliated with Tecogen Inc., a manufacturer and servicer of distributed-generation equipment. The company installs, owns, and operates "co-generation" systems that supply on-site electric power and heat, using natural-gas-fed engines based on automotive designs. American DG sells power back to the customer at a purported savings of 10 to 15 percent off electricity-grid prices.
Robert Marrow, president of Hermany Farms Inc., a Bronx, N.Y,-based milk-processing company, is enlisting American DG as an on-site supplier of heat for processes such as pasteurization and homogenization. The system will also provide extra electricity, to make sure the plant's milk pumps run smoothly if the local utility — Consolidated Edison — has trouble supplying consistent power during the dog days of summer. "I expect to save 25 percent on my total energy costs, or about $100,000 a year," when three co-generation systems are built this summer, says Marrow.
Still, users of cogeneration power and heat are not completely immune from price fluctuations. "The client is still at risk for energy-market and fuel-market [pricing] differentials," notes Mark Schroeder, principal of South River Consulting, a Baltimore-based energy-consulting firm. "It's like a collar on your costs."
A competitor of American DG, Plug Power Inc., has begun to install hydrogen-powered fuel cells in facilities ranging from homes to McDonald's restaurants. Plug Power sells its "grid-parallel" systems either to utilities or to end users rather than leasing them as American DG does. "It's yet to be determined which models will work best," concedes Dave Neumann, CFO of the Albany, N.Y.-based company. "But the most important part is providing another way to get reliable energy to the end customer."
Tax: Nexus and the 'Net
Should businesses have to collect sales taxes for states in which they have no physical presence? Riding the coattails of interest surrounding the soon-to-expire Internet Tax Non-discrimination Act, a growing number of cash-strapped states are pushing to get Congress to say yes.
While the act primarily addresses taxes on Internet access charges — not sales — the bill has become a catalyst for the long-running debate about how and when companies must collect state and local taxes. "It's not just going to be about extending the legislation," which is set to expire November 1, says Jeff Friedman, tax partner with KPMG LLP. "We expect to see bills and amendments introduced to expand the protections for E-commerce, and possibly to redefine nexus," potentially making a company's physical location irrelevant to its tax obligations.
Currently, most companies do not have to collect sales tax for states in which they do not have a presence, thanks to a 1992 U.S. Supreme Court decision that said managing the myriad and ever-changing rules on all state and local taxes would be too burdensome.
In an effort to get that decision overturned, however, this spring 13 states passed laws to adopt the agreement drawn up by the Streamlined Sales Tax Project (SSTP), which aims to standardize definitions of taxable goods across states and limit each state to two sales- tax rates, thereby defusing the burden argument. According to Neal Osten, a director for the National Conference of State Legislatures, project backers are hoping to get a bill before Congress by next fall seeking authority for states to require all out-of-state sellers, including Web-based ones, to collect sales tax.
"Businesses would benefit from the simplification," says Douglas Lindholm, president and executive director of the Council on State Taxation, which represents 550 multistate corporations on tax issues. However, he says, the reform should include congressional action to stop states from using the same logic to pad their income-tax bills. "If you set physical presence aside as a standard for sales-tax purposes," says Lindholm, "the big unanswered question is, what is the nexus standard for business- activity taxes?"
States adopting the SSTP agreement.
|Source: National Conference of State Legislatures|
Business-continuity Planning: SARS: A Preview of Things to Come?
Back when companies actually feared Y2K, Convergys Corp. put in place a business-continuity plan that designated "incident commanders" at each of its more than 40 sites to handle emergencies. Now those same commanders are tackling a new, and possibly more virulent, threat — Severe Acute Respiratory Syndrome (SARS).
The Cincinnati-based company, which provides customer-care services, has conducted various scenario-planning exercises for emergencies such as a SARS outbreak, even making preparations to route customer service and other business away from sites in the event of a crisis. "SARS got our attention," says director of risk management Carol Fox.
SARS has gotten the attention of many companies. To date, the disease has spread to 32 countries and resulted in 784 deaths. And although only 68 American cases have been diagnosed, U.S. companies haven't been immune. In fact, many are not only curtailing travel to the hardest-hit regions but also rethinking their risk-management strategies to address communicable diseases.
After all, it's no longer difficult to conceive of bioterrorists launching an attack with smallpox, botulism, or plague. SARS itself may make a comeback next winter. And while "it's true that there is a low probability of any one company being affected," says Lee Zeichner, president of Falls Church, Va.-based Zeichner Risk Analytics LLC, "the potential [is] that it could affect the core business operations and impact revenue and earnings." Consequently, increasing preventive measures, he says, "is just good planning."
What's different about these new business-continuity plans is their focus. In the past, "most plans called for second sites and backup systems," says Anne Nicoll, a principal at Mercer Human Resource Consulting in Toronto. "The new thinking is around the people-based issues: what do you do when your employees can't work together in groups?" She says companies are beefing up their remote networking facilities so employees can work from home, and splitting workforces into "clean teams" so that if one group is quarantined, there's another group that's not affected.
In fact, says Nicoll, "it's not necessarily actual infections causing the disruptions. It's the needed preventive actions." For example, while 60 new cases of SARS were reported in Toronto in late May, more than 6,000 people were given "isolation directives."
The greatest risk to plan for, however, is that key suppliers, especially those in Asia, will be forced to close temporarily due to SARS. "Our suppliers have been informed by the Chinese government that if there is a potential case of SARS in anyone in the plant, they would have to shut it down," says Michael Umana, CFO of Saucony Inc. In response, the Peabody, Mass.-based athletic footwear and apparel maker has been increasing its supply of key materials for its core styles and looking for backup suppliers elsewhere. "All of our efforts are on sourcing alternatives," says Umana.
Of course, crucial to any business-continuity plan is adequate insurance coverage. But policies typically "cover only interruptions caused by physical damage to a facility," says P.J. Crowley, vice president at the Insurance Information Institute in New York. To date, there is no SARS-specific coverage, but that doesn't mean insurers are ignoring the issue. In fact, claims from an outbreak could be "devastating" to the industry, says Crowley, with the largest potential impact on workers' compensation lines.
They would also raise interesting questions. Can workers' comp claims be filed for employees who are healthy but can't work because they are quarantined? "Companies know how to handle employees getting sick. But what do you do when they're not sick, but can't work?" asks Nicoll.
SARS has brought these issues to the forefront, says Gilbert Ponniah, vice president of finance at Hewlett-Packard Services in Asia, who recently grappled with the crisis. Mostly, though, the spread of SARS, he says, has reinforced the notion "that the world, our region, is more interconnected than we ever imagined."
Forecasting: Everywhere a Sign
Charles Nelson keeps his eye on China's weather, but not because the CFO of Arizona Chemical Co. is planning a trip there. Rather, he's looking for signs that products that compete with his company's adhesives could flood the market. When the weather is dry, the Chinese tend to harvest more gum rosin, an alternative to the company's tall-oil-based products. When it's wet, they're generally busy plant-ing rice, and Arizona Chemical enjoys better pricing power.
With economic conditions so hard to read these days, plenty of companies are looking at a broader array of indicators, including some unconventional ones. "Sometimes near neighborhoods can give a skewed view of what's going on," says Nelson. "You also need to look at distant neighborhoods to get the overall picture."
Especially if managers want to see the trends that could pose a threat down the line. Paul Saffo, a director at the Institute for the Future, says CFOs don't spend enough time considering outside factors. "In periods of rapid change, peripheral vision is the name of the game," he warns. "Nothing important happens at the center."
In the semiconductor industry, for example, companies must react fast to an upturn. For this reason, Bob Halliday, CFO of Varian Semiconductor Equipment Associates Inc., tracks a number of leading indicators, including enrollment in training classes for chip- making. He says an increase is a good indication that chipmakers may expand production, increasing the demand for Varian's equipment. "The majority of profits in our industry are made on the front end of a ramp-up, so reaction time is everything," he explains.
Yet University of Baltimore professor Hossein Arsham cautions against looking too far afield for leading indicators. He says it's easy to focus on data that doesn't have a strong correlation to business outcomes. "Often," he suggests, "decisions are made first and then information is sought to support that conclusion."
Pension Accounting: Looking for a New Benchmark
So what will replace the now-defunct 30-year Treasury bond as the benchmark for measuring pension obligations?
It's a question that's getting a lot of attention on Capitol Hill and from the business lobby, especially since the current interim measure will expire by year end. It's also a question that finance chiefs would like answered, since so many plans are currently underfunded. "The longer we go without a replacement measure, the more pressure there is on companies because they can't predict their future cash flows," says Mike Johnston, a retirement practice leader at Hewitt Associates.
In May, the Bush Administration admitted that the current benchmark is inadequate. It opted not to make a permanent decision on how to value pension liabilities at that time. Instead, the Administration may extend the current 2002 law that allows employers to use a slightly higher discount rate to value their pension liabilities — which shrinks the mandatory funding obligations. Or it may still issue a proposal for long-term funding changes, including use of a yield curve.
By and large, companies — which faced a total pension shortfall of $220 billion at the end of 2002 — have lobbied hard for an alternative that is contained in a bill sponsored by Rep. Rob Portman (ROhio) and Rep. Benjamin Cardin (DMd.) that would replace the current method with a benchmark that is based on long-term corporate bonds. The benefit of moving to such a benchmark, says David Zion, an accounting expert with Credit Suisse First Boston, is that "you'd have consistency between funding requirements and pension accounting." More important, says Howard Silverblatt, an equity analyst with Standard and Poor's, by raising the discount rate, "you could literally wipe away a company's [pension] deficit overnight."
Breaking the impasse is crucial, says Johnston. In Hewitt's recent survey of 174 finance executives, 8 percent said they are already considering freezing or terminating their plans. A similar study of midsize firms by SEI Investments put that figure at 22 percent. "It would be a travesty not to get this fixed," says Johnston, adding that even a long delay would "leave enough companies up in the air that they would take drastic action."
Pension woes are forcing midsize U.S. firms to consider fixes.
|Actions Taken or Under Consideration||%|
|Adjust investment strategy||54|
|Close defined-benefit plan||22|
|Convert to defined-contribution plan||16|
|Replace defined-benefit plan||15|
|Source: SEI Investments|