Accounting & Tax

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 i...
CFO StaffOctober 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 solution Intended effects Chances Possible drawbacks
Reporting
Expense employee stock options Inhibit large grants Strong Fights over expensing formula
Expand disclosure in annual reports Increase transparency Strong Investors overwhelmed with minutiae
Create stricter standards for Pro Forma Increase transparency Done Investors confused
Shift to real-time reporting Increase transparency Weak Technical difficulties; compliance burden for smaller companies
Adopt principles-based accounting standards Rely more on judgment Almost nil Incomparability of results
Streamline FASB. Assure independent funding Encourage faster, more independent decisions Done/ Strong Less outside input to decisions
Tighten rules on off-balance-sheet financing and use of SPEs* Decrease ability to hide risk Strong Credit crunch
Tighten rules on revenue recognition Decrease ability to manage earnings Strong Less ability to manage earnings
Clarify cash-flow statements Decrease ability to manipulate operating cash flow Strong Less ability to manipulate operating cash flow
Require CFO to be a CPA Improve disclosure Weak Compliance burden; more training required
Make senior management certify financial statements Increase accountability Done Difficult for recent hires
Protect whistle-blowers* Uncover fraud earlier Done Frivolous lawsuits
Improve reconciliation of book and tax reporting Improve correspondence to economic reality Uncertain Less ability to manage earnings
Audits
Separate auditing from consulting* Improve oversight, reduced potential conflicts of interest Done Increased cost or decreased quality of audits
Rotate auditors every five years* Improve oversight Done Decreased quality of audits
Ban hiring of external auditors by clients for three years* Improve oversight, reduced potential conflicts of interest Done Harder for auditors and clients to recruit talent
Create new auditor oversight board* Improve oversight depending on effectiveness Done Increase cost of audits
Laws and Regulations
Increase SEC resources Improve ability to review, investigate, and enforce Done Increased regulatory burden
Upgrade SEC’s status to cabinet level Enhance power, resources Nil More partisanship
Broaden definition of securities fraud* Increase accountability Done Decreased willingness to take
risk; increased litigation
Increase criminal penalties for securities fraud and obstruction of justice* Deter crime depending on evidence required Done Few convicted on criminal charges
Lengthen time investors have to file lawsuits for securities fraud* Increase executive liability Done Increased executive liability
Bar use of bankruptcy by executives to escape liability for securities fraud* Increase executive liability Done Increased executive liability
Investment Banking
Separate securities underwriting and research Reduce conflict of interest Uncertain

Increased cost of capital; difficult to enforce

Protect research analysts from retribution* Reduce conflict of interest Done

Increased cost of capital; difficult to administer

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Separate securities underwriting and lending Reduce conflict of interest Done Increased cost of capital
Compensation
Subject broad-based stock-option plans to shareholder vote* Reduce size of option grants Done Increased compensation costs
Restrict employees’ right to exercise options until departure Align employee and shareholder interests Weak Unattractive to employees
Award restricted stock instead of options Align employee and shareholder interests Uncertain

Increased reported costs to company

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

Reduced executive stock ownership

Compensate CFO in cash based on metric other than stock performance Focus attention away from short-term share price Weak

Disruptive conflicts between CEO and CFO

Governance
Make audit-committee members independent* Improve oversight depending on expertise Uncertain Scarcity of candidates
Give audit committee authority to hire and fire external auditors* Improve oversight depending on independence Done Bureaucratic slowdown
Give board management authority over internal audit Inhibit misreporting of results Weak

Confused administrative relationship

Make boards of directors independent* Improve governance depending on expertise Uncertain Harder to attract candidates
Separate CEOs and board chairmen Improve governance depending on composition of rest of board Weak

Potential disconnect between development and execution of corporate strategies

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

Opportunity for late or erroneous information

Require audit committee to approve related-party transactions* Ensure transactions are in all shareholders’ interests Strong

Reduced compensation to board members

Limit board members’ pay* Maintain independence Done Harder to attract candidates
Require disclosure of proxy votes by investment advisers Ensure fiduciary obligations are met Uncertain Disruptive shareholder dissent

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