Stronger Than Dirt

The litany of corporate accounting scandals is wide-ranging, some might say ingenious. Efforts to repair the damage -- and to guard against scandal...
Marie LeoneOctober 17, 2003

Juval Aviv hunts down stolen money — $10 billion over the last 10 years, or about 86 cents out of every dollar he seeks. As CEO of Interfor Inc., the retired commando and former operative for Mossad, the Israeli intelligence agency, works primarily for pension funds and bondholders who need to track and recover funds pilfered by white-collar criminals.

Not all these missions are cloak-and-dagger exercises, but Aviv maintains that he’s has uncovered enough phantom contractors, kickback schemes, secret commissions, and embezzlement plots to fill several John Le Carré novels. Lately, business has been good.

For the corporate cleanup industry, times are good all around. According to new research from the nonprofit Turnaround Management Association, 77 percent of its 6,400 member companies had to turn away clients this past year, slightly down from last year’s 83 percent. Most business referrals came from big stakeholders, such as banks and other lenders, as well as law firms.

Only 13 percent came directly from company management (though Aviv points out that businesses may “use the cover of a law firm” so that reports are covered by attorney-client confidentiality). But for companies that aren’t focused on cash recovery, where are they focused?

Sometimes More Seems Like Less

In the two years since Enron’s collapse, a host of companies have followed it into Chapter 11, or infamy, or both. Taking up the banner of corporate reform, new laws and regulations — to say nothing of commercially available “solutions” — were introduced faster than CFOs could empty their in-boxes. Yet many of these efforts — especially those intended as preventive measures, not as fixes — often seemed to do little more than cloud the issues.

Most reform measures, says Harvard Business School professor Quinn Mills, dance around the main problem — conflict of interest. Even those measures that do “a nice job” never address core incentive and behavioral problems, laments Mills, who adds that “in America’s largest corporations, the CEO has too much power and ability to enrich himself and close associates.”

Some of the new rules, such as the Sarbanes-Oxley financial literacy requirements for audit committee members, he considers “bureaucratic idiocy.” Indeed, one finding of a recent CFO survey of senior financial executives — examined in the magazine’s September cover story “Sticker Shock” — is that only 30 percent of respondents said that the benefits of Sarbanes-Oxley compliance outweigh the costs.

A more direct approach to addressing conflicts of interest, says Mills, would be to split the roles of chairman and chief executive officer, so the same person won’t serve two masters — management and shareholders. But at most companies, he quips, “One sure way to get thrown off the board is to propose that the CEO not be chairman.” (This measure, and many others that follow, apply just as well to businesses in good corporate health — but trying to be healthier — as they do to businesses on the mend.)

He also makes a case for rethinking stock options. While acknowledging that option grants are an important incentive, Mills joins many economists in suggesting that options should be decoupled from the company stock price. If options were indexed against the performance of peer companies, an industry, or the economy in general, he maintains, executives would be encouraged to focus on performance rather than stockmarket volatility.

Finally, Mills is an ardent proponent of an independent CFO and head of human resources. The two executives who control finance and compensation, says Mills, should be hired by, and report to, the board rather than the CEO. Appointing a corporate governance officer can be worthwhile, adds Diane Frankle, a partner with Palo Alto-based law firm Gray Cary, but only if the CGO has the authority to revise policies and provide governance training.

Mills has a ally in Stephen Roulac, a San Rafael, California-based financial and management consultant who likens good corporate governance to the U.S. Constitution. “Separation of powers” promotes appropriate decision making, declares Roulac. To that end, he offers a three-step process for corporate “decisions of consequence.”

First, an individual or group originates and advocates an idea. Next, a second group conducts an internal evaluation of the plan, including the associated budget, capital resources, financial risk, and business processes. Finally, a third group — an independent board or committee — produces a quantitative and qualitative assessment.

Too time consuming? Perhaps Roulac’s proposal is an example of how, in theory, most executives agree with corporate governance reform, but in the implementation, things get sticky. One former CEO, now a board member at a financial services company, agreed with Mills’s idea that CFOs should report directly to the board. He added, though, that “it’s not necessary at my company, because our culture doesn’t foster conflict-of-interest problems.” Self-examination, too, can be a sticking point.

Get It Together — or Break It Up

To integrate, or not to integrate — that is a question which, rightly, should be asked very early on. Say, sometime during M&A planning. But better late than never, says Joe Phelps, who sees fertile ground for improvement in Time Warner’s organizational structure. Phelps, the CEO of Santa Monica, California-based marketing communications firm the Phelps Group, would seek to eliminate the accounting problems associated with intercompany barters by eliminating competition between the company’s internal profit centers: broadcast, cable, film, magazines, online.

Phelps says that by becoming a one-stop shopping conduit built around major accounts and not major Time Warner business units. the parent company could outbid competitors with broad-based media packages. The company would also be able to free itself from internal turf battles — and their attendant accounting games.

Joel Goldhar would go to the other extreme. A professor at the Stuart Graduate School of Business at Chicago’s Illinois Institute of Technology, Goldhar contends that the only way to keep Time Warner out of trouble is by splitting it into separate operating companies linked only by external marketing agreements. There have been whispers from Wall Street — but nothing more — about spinning off the AOL division.

As for companies that are already in dire straits, “The most important thing to remember about bankruptcy is that there are no second chances,” says Paul Brown, CFO of Portland, Oregon-based PSC Inc., a supply-chain management company. If a company fails to emerge from Chapter 11, he explains, liquidation is the alternative.

Key ingredients in Brown’s formula — in addition to clear direction, active management, and candid communication — are getting control of cash flow and not allowing any “sacred cows.” Of the five companies that Brown has been called on to help survive bankruptcy, he’s met with success four times. The one failure, he maintains, was a sacred cow — the CEO’s favorite business segment, which he was unwilling to jettison to salvage the rest of the company. Eventually, says Brown, “cash flow problems just rolled over the company and sunk it.”

Building — or Rebuilding — Confidence

Rebuilding credibility with investors is best handled by management, not sell-side analysts, says Peter Ausnit, a San Francisco-based financial marketing consultant. He admonishes executives who issue terse financial press releases and opaque financial filings that barely meet minimum SEC and stock-exchange requirements. This lack of transparency, Ausnit maintains, is the reason that Wall Street became an intermediary between companies and investors.

Executives may be reluctant to release too much information into the public domain for fear of surrendering a competitive advantage — or even of piquing the SEC’s interest in the company’s accounting. Regulation Fair Disclosure also has to shoulder some of the blame for chilling communications between companies and investors, according to John Isaf, a senior vice president at Magnet Communications. But on issues that really matter, counters Ausnit, management always communicates with investors directly. Just take a look, he says, at the full-page advertisements that appear in daily newspapers when a merger needs investor support or a proxy fight breaks out.

One company that seems in step with Ausnit’s suggestion is the nicely named Progressive Corp. Two years ago the Ohio-based insurer became the first publicly held company to issue operating results every month. This summer Progressive captured another public-company first when management announced intentions to release earnings-per-share data every month. Indeed, after earnings warnings in 1999 and 2000 sent Progressive’s stock price on a rollercoaster ride, executives snuffed out the volatility, they maintain, by feeding investors more information, more frequently. Officials at the company also say that additional transparency makes any thoughts of “smoothing” results much less inviting.

The transparency of financial footnotes also could use some sprucing up, says Northeastern University business school professor David Sherman. For example, he supports adding earnings ranges to footnotes that clarify subjective accounting judgments. “You can’t take accounting judgments out of the process,” says Sherman, but earnings ranges can spell out the impact of accounting treatments and provide a rationale for choosing one method over another.

While Wall Street may put the focus on investor confidence, Isaf insists that employees should be the number-one communications target, since they’ll actually be setting the ship aright. He warns executives against placing blame and making up excuses for the company’s woes, and tutors them to be frank about expectations and progress. When management leaves an information void, adds Isaf, the rumor mill will fill it.

The Great Profile?

Accounting scandals gnaw at the heart of a company because accounting is the basic fiber of a corporation, asserts branding expert James Bell, a senior partner with Lippincott Mercer. The situation tends to be worse for high-profile companies than for their wallflower counterparts, he adds; press coverage, especially since it often focuses on the bad news, tends to prolong the problem.

The best response to a scandal? “Be clear, concise, and quick,” coaches Roulac, the management consultant. He applauds the message sent by Edward Breen immediately after taking office, when the new Tyco CEO restocked the entire board and sacked 50 top executives. Roulac does worry, however, that the grand gesture left Tyco with little corporate memory. He suggests that the company might have done better to keep two or three hand-picked officials from the prior regime, perhaps granting them emeritus status.

Joe Phelps notes that product recalls are easier to recover from than accounting scandals. He maintains that it’s easier for a company to repair a product — or the perception of safety — than to regain trust after a greedy executive has fudged the numbers. That loss of trust is exacerbated, says Aviv, when stakeholders are insulted by an atmosphere of old-boy politicking and arrogance.

Unsurprisingly, a new corporate name may come across simply as a further insult, as if the company were trying to sell the public a bill of goods. And as for repeat offenders, “If the same problems comes around again, it’s much worse [for the company image] the second time around,” counsels Phelps.

And not to be totally cynical, but “The public tends to be very forgiving if a company turns a profit,” says Marc Holland, the CEO and a host of in-flight-programming company Sky Radio Network. “I wouldn’t be surprised if the public forgave Enron if the company became profitable.” Interfor’s Aviv adds that although time may not always heal, at least it puts the right amount of distance between a scandal and public acceptance.

Each of the companies we examine in our cleanup profiles has plenty of work ahead — though as for the cleanups themselves, a single “strategic misstep,” however major, must be approached far differently than “breakdowns in financial controls.” Perhaps the lesson here comes not from Le Carré, but from Tolstoy: “All happy families are alike; every unhappy family is unhappy in its own way.”