Atlas Shrugged
Richard Lehmann, Forbes/Lehmann Income Securities Investor, 08.08.02, 9:40 AM ET
NEW YORK - The current effort to force corporate chief executives to assume criminal liability for the financial statements of their companies is eerily reminiscent of Ayn Rand's book by the above title. In her novel, she portrays a government bent on writing laws so restrictive that everyone will be breaking some law all the time. Hence, government has absolute power. Corporate executives are ultimately responsible for whatever goes on in the company they oversee, but who wants government--in the form of some politically ambitious prosecutor--deciding when that executive should be punished and for what level of error or abuse. Isn't that why we have boards of directors? Not that their track records are all that splendid, but at least we know their goals are a little closer to home.
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The greater concern is if this will improve corporate governance and the financial markets. The answer is a resounding no. Thieves will be thieves. Honest men will be victims. To avoid the latter, CEOs will have to become much more familiar with accounting to even know what questions to ask. Bottom line, look for more and more chief financial officers to become CEOs rather than the more traditional heads of engineering, sales or marketing. CFOs are defensive thinkers for the most part, not the builders of companies. Look for firms to assume less and less risk--since it would not be uncommon to see an officer prosecuted for an infraction that would have been ignored had he not failed in a totally unrelated project. In fact, knowing the age of the CEOs will become more relevant, since their risk adversity is likely to grow as they get closer to retirement. Also, early retirements for reasons of health may take on a whole new meaning. As for companies in trouble, forget about finding a competent white knight.
The fact is that timely disclosure is not always the best disclosure. Business Week roundly criticized Boeing (nyse: BA - news - people ) executives for not disclosing production-line snafus until weeks after the completion of their merger with McDonnell Douglas. They told McDonnell, but both companies agreed that not jeopardizing the merger was in the best interest of all shareholders. I believe a CEO should have such discretion. As we prepare to invade Iraq, should President George W. Bush tell us, assuming it were so, that Saddam Hussein already has nuclear weapons? I think not. It's a tough call, but it's not one you leave to a public opinion poll or a stock market. Yes, Congress will rail that they should have been told, especially if things go wrong. But then, would we really want Congress to make such a call?
Assuming this rule change stands--and I don't believe that's a given--will financial markets benefit? Going forward, executives will no longer have the discretion of smoothing out quarterly bumps in earnings; stock prices will therefore become more volatile. As for earnings forecasts, expect less--not more--honesty. No one goes to jail for exceeding expectations. The problem of class-action suits for every earnings shortfall will become even greater, since CEOs will face discovery proceedings at which they could now be personally at risk.
Longer term, corporations will probably go back to high-dividend payouts as a way of reducing share volatility. Being an income-oriented investor, in my mind that will be a good effect. Worse, however, is that, like the Rand book, good managers may decide to just shrug and walk away.
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