From the NY Times, nytimes.com
Who Really Cooks the Books?
By WARREN E. BUFFETT
OMAHA — There is a crisis of confidence today about corporate earnings
reports and the credibility of chief executives. And it's justified.
For many years, I've had little confidence in the earnings numbers
reported by most corporations. I'm not talking about Enron and WorldCom
— examples of outright crookedness. Rather, I am referring to the legal,
but improper, accounting methods used by chief executives to inflate
reported earnings.
The most flagrant deceptions have occurred in stock-option accounting
and in assumptions about pension-fund returns. The aggregate
misrepresentation in these two areas dwarfs the lies of Enron and WorldCom.
In calculating the pension costs that directly affect their earnings,
companies in the Standard & Poor's index of 500 stocks are today using
assumptions about investment return rates that go as high as 11 percent.
The rate chosen is important: in many cases, an upward change of a
single percentage point will increase the annual earnings a company
reports by more than $100 million. It's no surprise, therefore, that
many chief executives opt for assumptions that are wildly optimistic,
even as their pension assets perform miserably. These C.E.O.'s simply
ignore this unpleasant reality and their obliging actuaries and auditors
bless whatever rate the company selects. How convenient: Client A, using
a 6.5 percent rate, receives a clean audit opinion — and so does client
B, which opts for an 11 percent rate.
All that is bad, but the far greater sin has been option accounting.
Options are a huge cost for many corporations and a huge benefit to
executives. No wonder, then, that they have fought ferociously to avoid
making a charge against their earnings. Without blushing, almost all
C.E.O.'s have told their shareholders that options are cost-free.
For these C.E.O.'s I have a proposition: Berkshire Hathaway will sell
you insurance, carpeting or any of our other products in exchange for
options identical to those you grant yourselves. It'll all be cash-free.
But do you really think your corporation will not have incurred a cost
when you hand over the options in exchange for the carpeting? Or do you
really think that placing a value on the option is just too difficult to
do, one of your other excuses for not expensing them? If these are the
opinions you honestly hold, call me collect. We can do business.
Chief executives frequently claim that options have no cost because
their issuance is cashless. But when they do so, they ignore the fact
that many C.E.O.'s regularly include pension income in their earnings,
though this item doesn't deliver a dime to their companies. They also
ignore another reality: When corporations grant restricted stock to
their executives these grants are routinely, and properly, expensed,
even though no cash changes hands.
When a company gives something of value to its employees in return for
their services, it is clearly a compensation expense. And if expenses
don't belong in the earnings statement, where in the world do they belong?
To clean up their act on these fronts, C.E.O.'s don't need "independent"
directors, oversight committees or auditors absolutely free of conflicts
of interest. They simply need to do what's right. As Alan Greenspan
forcefully declared last week, the attitudes and actions of C.E.O.'s are
what determine corporate conduct.
Indeed, actions by Congress and the Securities and Exchange Commission
have the potential of creating a smoke screen that will prevent real
accounting reform. The Senate itself is the major reason corporations
have been able to duck option expensing. On May 3, 1994, the Senate, led
by Senator Joseph Lieberman, pushed the Financial Accounting Standards
Board and Arthur Levitt, then chairman of the S.E.C., into backing down
from mandating that options be expensed. Mr. Levitt has said that he
regrets this retreat more than any other move he made during his tenure
as chairman. Unfortunately, current S.E.C. leadership seems uninterested
in correcting this matter.
I don't believe in Congress setting accounting rules. But the Senate
opened the floodgates in 1994 to an anything-goes reporting system, and
it should close them now. Rather than holding hearings and fulminating,
why doesn't the Senate just free the standards board by rescinding its
1994 action?
C.E.O.'s want to be respected and believed. They will be — and should be
— only when they deserve to be. They should quit talking about some bad
apples and reflect instead on their own behavior.
Recently, a few C.E.O.'s have stepped forward to adopt honest
accounting. But most continue to spend their shareholders' money,
directly or through trade associations, to lobby against real reform.
They talk principle, but, for most, their motive is pocketbook.
For their shareholders' interest, and for the country's, C.E.O.'s should
tell their accounting departments today to quit recording illusory
pension-fund income and start recording all compensation costs. They
don't need studies or new rules to do that. They just need to act.
Warren E. Buffett is the chief executive officer of Berkshire Hathaway
Inc., a diversified holding company. |
