FRONT PAGE article (LA Times)
Firms Reverting to by-the-Books
Balance Sheets
By THOMAS S. MULLIGAN, TIMES STAFF WRITER
NEW YORK -- As investors burned by
the Enron scandal punish companies with
even a whiff of accounting irregularity or
other questionable behavior, some firms
have found a new strategy: an
old-fashioned, forthright balance sheet and
income statement.
Espousing a cleaner-than-thou philosophy,
corporations are turning away from finance
practices that not only are legal but in other
times might have won them praise for
creativity.
Experts say the message these companies want to convey is
"We're not Enron." Some are swearing off complex ways of
reporting sales and profit that strike critics as misleading or simply
difficult to understand. Some are working to bolster the
independence of their boards, mindful of the tarring Enron
directors have taken for apparent conflicts of interest. The Enron
debacle has given the American public a quick lesson in complex
accounting, introducing such arcane terminology as synthetic
leases, special purpose entities, derivatives and pro forma.
Investors are taking a microscope to accounting methods that
seldom raised questions before the Enron scandal. IBM, Qwest
Communications and Marriott International last week joined a list
of companies whose shares have been rocked by accounting
concerns, among other factors.
If companies are being punished for tangled financials, perhaps
the flip side is that others will be rewarded for clarity. "Because of
Enron, a premium will be attached to companies with sterling
governance structures and financials that are very, very plain
vanilla," said Charles Elson, who heads the University of
Delaware's Center for Corporate Governance.
Much of the housecleaning is meant to reassure worried
stockholders and buff firms' public image, but there is a more
pressing concern: The Securities and Exchange Commission, itself
criticized for missing Enron's problems, has put corporate
America on notice that within the year, it will more closely
examine the books of the Fortune 500, the nation's largest
companies.
The SEC also has warned that adherence to the letter of
accounting rules may no longer be enough; companies that
produce misleading financial statements, even if they technically
comply with regulations, could be punished.
Some firms are making changes on their own initiative, others
only after the posse has arrived.
Krispy Kreme Doughnuts last week decided to scrap a synthetic
lease it was using to finance a new factory. It didn't act, however,
until it had been zinged by Forbes magazine for the arcane debt
instrument and then slammed by a headline in the tabloid New
York Post: "Krispy Kreme Bites."
"While this type of lease is both common and complies with the
most rigorous accounting standards, the company . . . will instead
use conventional, on-balance-sheet financing," Scott Livengood,
Krispy Kreme's chairman and chief executive, said. "There is no
reason for us to do anything that could be misinterpreted,
regardless of how legal and acceptable it may be."
Although firms are anxious to calm investor fears, you aren't
likely to see TV commercials touting clean balance sheets or
conservative revenue recognition, communications experts say.
"An ad campaign is far too blatant," said Jerry Swerling, who runs
the public relations program at USC's Annenberg School for
Communication. "Besides, it's not the kind of thing you'd
advertise."
Instead, companies are using their own investor relations staffs or
hiring outside public relations agencies for help in delivering the
we're-not-Enron message, he said.
One of the key questions raised by Enron's implosion has been,
where was the board of directors? Although board members
contend that key information was withheld from them, critics also
have noted that seven of Enron's 14 directors either did business
with the company, worked as paid consultants to it or were
affiliated with organizations that received large donations from
Enron or its top officers.
With board independence in the spotlight, Interpublic Group, the
world's largest advertising firm, this week announced that four of
its executives would step down from the board and an unaffiliated
member would be added. This leaves the board with two
Interpublic executives and seven outsiders, whereas the old split
had been six and six.
"The interests of Interpublic shareholders will be best served by a
board that is primarily made up of independent, outside
directors," Chairman John Dooner said in a statement that did not
mention Enron.
Procter & Gamble recently went out of its way to tell Wall Street
analysts that it has "no material off-balance-sheet financing." A
year ago, such a comment might have drawn blank stares, but
today anyone can see it's a direct reference to a finance and
accounting practice that was at the heart of the Enron collapse.
Enron used limited partnerships, some headed by former Chief
Financial Officer Andrew S. Fastow, to artificially boost profit
and keep large amounts of debt off its corporate balance sheet.
Enron's slide toward bankruptcy became steeper Nov. 8 when it
acknowledged that these arrangements were improper and
reduced its previously reported profit by $586 million.
Henry Silverman, chief executive of the hotel and real estate firm
Cendant, which has had serious accounting problems in the past,
complained in a recent television interview that the harsh new
scrutiny amounts to "the McCarthyism of guilt by association."
Nevertheless, Cendant bowed to the pressure and said that in the
future it would reduce the number of special "one-time" charges it
takes against earnings.
Financial watchdogs, including former SEC Chairman Arthur
Levitt, have criticized firms for excessive use of such
"extraordinary" charges. Many companies routinely offer separate
versions of their income statements each quarter and encourage
analysts to focus on the one with the better numbers.
The idea is to disclose charges as required by generally accepted
accounting principles, or GAAP, in one statement, but then to
whisk away the charges in a rosier pro forma statement, which is
a hypothetical description of a company's finances.
If firms can persuade Wall Street that the pro forma statement
gives a truer picture of their financial status, there is an incentive
for them to label all kinds of expenses extraordinary.
Post-Enron, however, that practice may be on the wane. Several
firms, including computer chip maker Xilinx and electronics
manufacturer Solectron, recently decided to stop issuing pro
formas entirely.
Kris Chellam, Xilinx chief financial officer, acknowledged in an
interview last week that because of the Enron blowup,
"everybody gets cast in a bad light" for practices that once were
widely accepted.
The only major effect the change will have on Xilinx relates to its
acquisition in 2000 of a company whose main asset was a group
of talented engineers. The engineers signed contracts agreeing not
to compete against Xilinx for a specified period of time should
they leave the company.
According to GAAP, Xilinx must take regular deductions from
income to reflect the declining value of those non-compete
agreements as time runs out on them. Now it will no longer
produce a separate pro forma statement excluding the deductions.
"The change in reporting will cost four or five pennies in [earnings
per share]," Chellam said, "but that's immaterial compared to the
benefit." He said he expects firms to be rewarded in the stock
market for greater simplicity in their financial reports.
"Ultimately, if the people don't understand your business and
don't like what's going on, you'll suffer," Chellam said.
Investors, however, shouldn't fool themselves into thinking that
more rigorous accounting methods will magically iron out the
rough spots in the stock market, said Robert Olstein, a Purchase,
N.Y., money manager who revels in accounting nuts and bolts.
"Every company in my portfolio does something that we have to
adjust for," Olstein said. "The notion that GAAP produces
economic reality is a fantasy."
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