Michael is back and will be resuming his normal level of blogging. So, my time blogging is at an end for now. Thanks to Michael for giving me this opportunity again. It was fun. I cannot imagine how Michael summons the time and intellectual resources to run this blog solo on an ongoing basis. And, of course, much thanks to all of you who read my posts. I wish that something was going on in taxland, but it isn’t. Accounting is deadly dull, but, as demonstrated by the consequences of all of the recent accounting problems, real important to our economy. Let me plug the AAOWeblog again as a great place to keep up on what’s happening from a reasonable perspective.
Finally, a correction: Karen commented on my July 22 post pointing out that, therein, I misconstrued an earlier comment that she made. Please consider reading her comment.
Thanks again. I hope that you all have some fun in what is left of Summer. Barley hasn’t indicated whether I will be allowed to….
So, here is my fix. It is exactly what one would expect from a former US Treasury tax lawyer: have the SEC affirmatively protect the small investor with regard to financial information of public companies by nationalizing the audit function.
Companies would be required to prepare financial statements that, in management’s judgment, best present the company, not that are merely “generally acceptable.” (See my post of July 8.) The accounting rules would be set by a government agency (the SEC), not a private group, as today (the Financial Accounting Standards Board). These rules would be codified. The SEC, not private firms hired by the audited company, would do all audits. In appropriate cases, the SEC might even comment publicly on a stock price range that is appropriate in light of what is learned during the audit.
Whoa, socialized capitalism!?!? There’s more has a defense.
Michael should be back in a couple of days, so it is time to start winding up. Which gets back to the my July 9 post. There, I identified my two key questions: “Is it possible to come up with accountings that investors can understand? If not, what to do?” Since then, we have been exploring the first question. Draw your own conclusion. We now turn to the second question: what to do if we cannot fix the current regime.
Karen’s comment on my post yesterday suggested that we should get rid of the public corporation, as it no longer serves a public purpose worthy of holding funds from the public: “I really wonder if it’s time to *rethink* this legal fiction and concept of these entities that are now no longer “Citizens” of any particular country…but Global Actors with allegiance to only their Corporate Profit maximization and those of their CEO and management at the expense of even their sponsors (shareholders).” To this point is the movie The Corporation, which certainly is worth viewing. I am not an expert on corporations. But, in the abstract, Karen’s comment has a lot to recommend it. Unfortunately, the public corporation plays a central role in postmodern capitalism. Removing that role would make a radical change in the play. So, less radical solutions are worth thinking about.
More after clicking.
Yesterday, the SEC bought the first criminal charges against a Gregory Reyes, the CEO of Brocade Communications, the company’s CFO, and Brocade’s VP for human resources for options backdating. This is the first criminal action brought with regard to the growing option backdating scandal. The SEC also indicated that at least 80 companies are under investigation. On Wednesday, the Wall Street Journal had an article on how the big law firms are generating huge fees as companies prepare for investigations into their options practices. So, this seems like a good time to review what the problems are here.
There are two problems: lying and theft, as to be discussed after the break.
I am in the process of relocating my home office from the dining room to a bedroom, so today’s post will be sorta short. Fortunately, there is a development in the papers worth a brief note. Today, the Wall Street Journal reported that it is likely that the SEC will withdrew a proposed rule that would have required companies to disclose the compensation of up to three non-management employees, if they are paid more than management. This proposal became called the “Katie Couric clause” for obvious reasons.
This seems like a bad thing. Admittedly, the principal reason for disclosing employee comp is to make sure that management is not ripping off the shareholders. But, there is another reason. As I have been arguing, investors in the new economy need a variety of non-traditional information to evaluate a company. Mega-star employees like Katie Couric and Howard Stern are key resources. The value of these resources depend upon what they cost. Hence, this comp info would be very useful to investors.
Shawn, in a comment, said that Generally Accepted Accounting Principles (GAAP) are satisfactory to compare apples to apples. That is not the case in the new economy. For example, during the tech bubble, GAAP was unable to distinguish a winner high-tech start-up from a loser. Here is another.
For more, let me give you a link to my favorite accounting blog AAO Weblog
I want to go down a tangent a bit and talk about accounting for taxes. This topic is in the media this week because on July 13 the Financial Accounting Standards Board changed the rules, effective next year. (It is funny that the interpretation released on July 13 says right on the the front that it was issued in June. Backdating may be in the air these days.)
Accounting for taxes is tricky for two reasons: First, the accountants want tax expense shown on the financial statements at the same time that the associated pre-tax profit is reflected. For a number of reasons, tax payment timing varies considerably from the timing of accounting profits. Second, the concern here, a company’s ultimate tax liability is uncertain. Firms take favorable positions on returns and then end up paying more after audit, and perhaps after having to go to court against the IRS.
Whether companies show low tax expense on their financial statements based on aggressive positions and force investors to gamble with the tax man is discussed below.
I have been arguing that investors need more than just raw financial data. (Of course, CEOs like rah, rah data…) Investors also need financial statements that analyze, organize, and compress all of this information. But, I am not arguing that we should let accountants do all of the valuation work. That is “mark-to-market” accounting, which was the most important factor in Enron’s problems. [Haters of early 1990s pop music insert Funky Bunch jokes here.]
Under mark-to-market accounting, all of a business’ assets (and liabilities) are revalued (“marked”) to fair market value. Any increase (decrease) in the net value is added to (subtracted from) any profit distributions to shareholders (like dividends and share buybacks) in determining the business’ profit or loss. (Adjustments also are made for share issuances and the like.)
In theory, mark-to-market gives investors the most useful information, since it presents management’s stewardship of all of the busines’ resources, not just of financial transactions. In reality, however, matters are much different.
Reality is in the footnote.