Forum Archive Index - July 2002
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[sharechat] Fw: NYTimes.com Article: Who Really Cooks the Books?
Here is a view from the fountainhead !!
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Sent: Wednesday, July 24, 2002 9:35 PM
Subject: NYTimes.com Article: Who Really Cooks the Books?
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Who Really Cooks the Books?
July 24, 2002
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
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.
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