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The chilling effect of Sarbanes-Oxley; extending terrorism insurance; powering your company's computers; monitoring employee use of the Internet; a new twist on health-care coverage; a record year for M&A; and more.
CFO Staff, CFO Magazine
August 1, 2007
Risk, like luck, comes in two varieties: good and bad. The latter you hope to avoid, the former to capitalize on. Lately, however, there's been precious little capitalizing. Companies have been decidedly risk-averse for years, accumulating piles of cash and returning it to shareholders rather than investing it in new products or ventures.
Many critics of regulation have claimed that one reason for this uncharacteristic caution has been the "chilling effect" of the Sarbanes-Oxley Act. Now researchers at the University of Pittsburgh have put that theory to the test, and have concluded that it's true.
Or true-ish. Or maybe just a coincidence, but if so a big one. Leonce Bargeron, Kenneth Lehn, and Chad Zutter looked at companies in the United States and the UK and assessed them on both accounting variables (the levels and types of investments companies make) and stock-based variables (for example, returns, betas, and company-specific risk measures). They also looked at data on initial public offerings for both countries in an effort to see whether Sarbox has, as many speculate, driven companies to pursue IPOs overseas, and whether the companies that do so tend to be more risk-based (as measured by their research-and-development expenditures).
Once the data was crunched on more than 5,000 firms (split about 80/20 between the United States and the UK), the team concluded that risk-taking by U.S. firms has declined significantly in the post-Sarbox era. "We can't nail it down to Sarbox," says Bargeron, an assistant professor of business administration at Pitt (and a former CFO). "In isolation, any of our measures could be taken issue with, but together they create a preponderance of evidence that is striking."
Meanwhile, Sarbox was intended to have a positive impact on negative risks, the kind companies hope to avoid, by encouraging a more rigorous assessment of high-risk areas including finance and technology. But a PricewaterhouseCoopers study has found that almost one in five companies conducts no annual risk assessment, while a third conduct multiple assessments but rarely share the results across departments.
"The cost of overseeing risk and compliance goes well beyond Sarbox," says Miles Everson, a PwC partner, "and often runs to hundreds of millions of dollars a year." Many companies have rushed to create new positions or departments in response to specific demands, creating huge duplication of effort. "When was the last time a newly created job title wasn't named after a regulation?" he asks. "You have privacy officers, compliance officers, and new audit positions proliferating." By adopting a formal governance, risk, and compliance (GRC) strategy, he says, companies can get faster efficiency — and free up employees to explore the strategic risks that companies should be pursuing. — Scott Leibs
Who Will Pick Up the Terror Tab?
The Terrorism Risk Insurance Act (TRIA) will expire at the end of this year, and as Congress prepares to debate a second extension of the act (the first passed in 2005), the stakes have changed.
For one, more than 60 percent of U.S. corporations now participate, and despite the absence of any triggering event on U.S. soil, the uptake rate over the past 2 years has been strong, particularly in such sectors as utilities and higher education. Meanwhile, the Bush Administration, which backed off on demands that the private-insurance market absorb more of the risk when the act came up for renewal two years ago, may be far less flexible this time, as proponents push for a 10-year extension.
Enacted in 2002, TRIA established a federal "backstop" program that would provide partial compensation for insured losses in the event of a massive terrorist attack. The Administration said at the time that the act was a temporary measure to allow the private-insurance industry to develop its own forms of coverage. But that has been slow to happen, and Aaron Davis, director of National Terrorism and Property Resources for Aon Corp., says another extension of TRIA is imperative to keep the insurance industry from total collapse if a substantial terrorist attack is carried out on U.S. soil.
Since 2002, premiums have dropped more than 50 percent, which may provide ammunition to those who believe that TRIA puts too much risk on taxpayers and not enough on private insurers. Few doubt that TRIA will be extended in some form, but when debate resumes in the Senate after the August break, expect to see strong differences of opinion as to just how far the government will or won't go in backing up the insurance industry. One major point of contention: the new bill would reduce the payout trigger point from the current $100 million in losses to $50 million. In 2005 the Administration had wanted the trigger point raised to $500 million. — Laura DeMars
If you thought computer hardware and software were expensive, consider that the electric bill for a data center can eat up 25 to 44 percent of its budget. That raises concerns not just about the bottom line, but also about brownouts or blackouts. A recent study by Stanford professor Jonathan Koomey found that computer servers (including cooling and auxiliary equipment) now account for 1.2 percent of total U.S. electric consumption, a figure that's growing fast. (Power consumption by such devices doubled between 2000 and 2005, Koomey says.)
The situation is so bad that, in December, Congress asked the Environmental Protection Agency to study the power consumption of corporate and government data centers; the EPA was expected to issue its findings late last month (after this issue went to press).
So what's a company to do? A short list of partial solutions includes:
New energy-efficient servers can also help (see "What's Hot This Summer"), and recent industry initiatives such as The Green Grid consortium and the Climate Savers Computing Initiative promise to deliver better technology and smarter management techniques. — Karen M. Kroll
Enron and WorldCom may have given accounting games a bad rap, but one software company hopes that a more literal interpretation of the concept can prove useful. Last month Softrax Corp. went live with "Revenue Recognition Challenge," a free online accounting game in which players become the CFO of "Worldwide Faulty Enterprises." Players must decide how to report different types of revenue after unexpected situations arise, such as a flash flood that strikes the company's biggest candy factory, halting production for three months. If the revenue impact is reported correctly and your audit passes the standards of "Schmarbanes-Schmoxley," then Faulty's stock price soars and fireworks fly across the computer screen.
More than 7,000 people have played the game to date, and while some CFOs say the questions are on the easy side, Gottfried Sehringer, vice president of marketing at Softrax, says the primary aim is to give line managers and others a window into the complexities of revenue recognition and the impact it can have on business decisions.
Sean Whyte, vice president of finance and administration for Morega Systems Inc., says the game is both entertaining and thought-provoking, and that it demonstrates that "the reality of life and business is that there are so many unknowns out there."
Want to be a Faulty CFO for a day? See www.revenuerecognitionchallenge.com. — Kate Plourd
"We used to be the Big Eight and then we were the Big Four and now we're sort of the Big Eight again. There are eight firms that audit more than 100 public companies now, and we're working together to have a voice as a profession."
— Robert Kueppers, Deputy CEO, Deloitte & Touche USA
A Room of Their Own
First came virtual annual meetings, then "paperless" proxies, and now the Internet may play a role in shaping another aspect of company-shareholder communications: ongoing dialogue between shareholders and management, made feasible by dedicated chat rooms.
In May the Securities and Exchange Commission held a roundtable discussion on the concept, and the following month SEC chairman Christopher Cox told Congress that the commission is updating its rules to allow the use of the Internet in order to improve investor-management communications.
As currently proposed, a company interested in offering this venue to shareholders would alert them via various means (E-delivery or standard mail) and provide them with an individual ID number to log in. Participating shareholders would be known by that ID number and would also be identified by the amount of stock they own. "You don't want to get someone who owns only five shares saying, 'Let's fire the board,'" says Chuck Callan, senior vice president of regulatory affairs at Broadridge Financial Solutions Inc., the company that consulted with the SEC on the concept. Shareholders would be free to discuss anything among themselves and to pose suggestions to, and presumably ask questions of, management. In theory, management would benefit from the ability to find out how shareholders feel about proposals and issues on an ongoing basis.
In a letter to the SEC, Peter H. Mixon, general counsel for the California Public Employees' Retirement System, said that an "unproven chat-room concept" shouldn't replace traditional nonbinding shareholder proposals, and expressed doubt that companies would heed any proposals suggested in chat rooms. Proponents counter that chat rooms are in keeping with the trend toward granting shareholders more say in how companies are run, and will result in more-efficient annual meetings by deflecting less-urgent issues to offline (or, in this case, online) discussion. The SEC is now accepting public comments on the idea; there is no deadline or time frame for the next substantive move. — K.P.
A recent survey from the American Management Association found that over the past five years the number of companies that monitor employee Internet use has risen 13 percent. More than three-fourths of employers now track employee Web use to some degree, and dozens of software companies offer programs to monitor or restrict Web access.
But new research from Jeffrey Johnson and Kenneth Chalmers of Utah State University highlights the difficulties in determining whether Internet abuse is a problem. They looked at the computer logs for a multinational medical-device maker with more than 500 Internet users and found that while some employees did visit 25 categories of Websites that are almost certainly inappropriate (everything from gambling sites to those with "gruesome content"), in many cases a similar pattern emerged: most employees who visited such sites did so only a few times (in some cases, potentially by accident); a few visited often enough to raise some concern; and one or two seemed to spend so much time on those sites that management intervention was likely needed.
The researchers point out that site-blocking software may not be enough; in one case, an employee with a penchant for pornography simply switched to Spanish sites once sites in English were blocked (most such software uses keywords to determine which sites to prohibit). Johnson and Chalmers say that while studying Internet-usage logs provides an accurate window into Internet abuse, more work is needed to gauge the true effect on productivity and to develop effective corporate policies. — K.P.
Compensation: All Talk
Companies continue to discuss pay-for-performance, but that's about all they’re doing. Asked about how they shape compensation practice to drive business results, only 29% of 171 companies surveyed by Authoria said they use aggressive pay-for-performance programs. And a mere 15% said they consider their organizations to be very effective at aligning individual performance to corporate goals. The most common compensation practice cited was "communicating total rewards," that is, dazzling employees with the inventory of pay and perks they currently enjoy. Also high on the list: providing "more information to managers." But not, apparently, more information about pay-for-performance programs. — S.L.
Mini-Meds Offer Some Relief
Six years ago, only 13 percent of employees at Ratner Cos., an operator of 1,000 salons under such names as Hair Cuttery and Salon Cielo, took advantage of the company's medical plan. Today, 78 percent have coverage, under a limited benefit plan from Century Healthcare.
Driving that nearly eightfold increase was a switch to a so-called mini-med policy, or limited medical-benefits plan. Think of mini-meds as the flip side of catastrophic coverage: instead of forcing employees to pay out-of-pocket for smaller expenses while guarding them against huge outlays in the event of serious illness or accident, mini-meds instead pick up the tab for low-cost, routine forms of health care such as doctors' visits, immunizations, X-rays, and emergency-room charges, but impose strict annual caps on payouts.
One rationale for this kind of coverage: many analyses show that most participants in health-care plans use less than $2,000 annually in health-care benefits. But the growing popularity of mini-meds is primarily driven by the desire to keep health-insurance premiums low while extending some form of coverage to hourly or part-time workers, who often go unprotected. Monthly premiums for single coverage range from about $50 to $200 per month, says Derek Peterman, CEO and founder of Century Healthcare, an administrator of limited-benefit plans. As one sign of the growing popularity of such plans, insurance giants Aetna and Cigna have recently entered the market.
Employers considering a limited-benefit plan should check that it complies with the Health Insurance Portability and Accountability Act (HIPAA), covers state-mandated benefits, and offers discounts of 30 to 60 percent off the prices charged by network providers, say Rich Williams, vice president of operations with SRC, an Aetna company and provider of employee-benefits programs. Explaining to employees just what services are and aren't covered is crucial; many may be new to health coverage and not realize that benefits are limited. Employee participation rises dramatically when the employer picks up at least half the cost of premiums, says Williams. — K.M.K.
$1 Trillion and Counting
If the second half of 2007 matches the first half, this will be a record year for mergers and acquisitions. North American dealmaking crested the $1 trillion mark at the end of June, a full 10 weeks earlier than in 2006. Globally, deals approached the $3 trillion level, an astounding 55 percent jump from the same period last year, according to Dealogic (which reported that Wall Street advisers racked up more than $11 billion in fees through June, a 23 percent rise over the same period in 2006).
The top 10 transactions in the first half of 2007 featured a familiar mix of foreign companies purchasing U.S. assets and midsize private-equity buyouts, according to MergerMarket. The biggest private-equity deal of the year (through June) was the $32.6 billion buyout of Canadian telecommunications giant BCE by a multiparty investor group. Also, Thomson Corp. of Canada agreed to pay $18.2 billion to acquire UK financial-news service Reuters Group.
Private-equity deals accounted for more than $400 billion of North America's first-half total. Among the notable ones in May and June: Home Depot selling HD Supply to a private consortium for $10.3 billion and Madrid-based energy concern Iberdrola buying Energy East for $8.5 billion. — Roy Harris
An Alternative to the Alternative
If you're among the millions of Americans who pay more in federal income taxes each year because you're prey to the alternative minimum tax, help may be on the way. Created nearly 40 years ago, the AMT was originally targeted at a mere 155 ultra-wealthy households that paid little or no income tax, because of deductions and exemptions. Last year, more than 3.5 million taxpayers felt the sting of the AMT (which was never indexed for inflation) and by one estimate the AMT could affect an additional 19 million households this year, some earning as little as $50,000.
As the Senate and House mull various fixes, the Tax Foundation, a nonpartisan tax research group, is offering its own proposal. Its plan, says the foundation, would reduce taxes on most incomes of less than $200,000 annually without reducing overall tax revenue. "We want to restore the AMT to its original, limited role of preventing a few high-income people from combining so many deductions and exemptions that they owe little or nothing," says foundation president Scott Hodge. The foundation's proposal calls for eliminating deductions for state and local income and sales taxes as well as real estate taxes. It would also repeal the exemption for municipal-bond interest. In return, the AMT would not kick in until incomes reach $300,000 for individuals and $450,000 for couples, and most tax rates would be cut. According to the proposal, those with adjusted gross incomes under $200,000 — who currently pay 49.5 percent of total income taxes — would pay only 46.8 percent of total taxes. Most taxpayers with incomes under $200,000 would realize a tax cut, but some (12 percent of those with an AGI of less than $75,000 and 31 percent of those with an AGI of between $75,000 and $200,000) would face a tax hike.
"We view this AMT fix as a bridge to 2011, when the Bush tax cuts expire," Hodge says. "By then, we hope to have a tax system that permits more-moderate tax rates overall by taxing previously untaxed income." — Art Detman