Bush also created a new corporate fraud task force to target major accounting fraud and other corporate crimes, and he urged Congress to immediately approve $20 million for the SEC to hire 100 new enforcement officers. The President revealed a new 10-point accountability plan that would create a more independent auditing system and would require companies to provide more information to shareholders and CEOs to personally vouch for their financial statements. And he appealed directly to Wall Street, where he gave the lunch-time speech, asking analysts to give “honest advice” to investors and urging investment firms to keep their analysts and their banking operations strictly separated. Will Bush’s proposed measures be enough to restore investor confidence? NEWSWEEK’s Jennifer Barrett spoke with B. Espen Eckbo, a professor of finance at Dartmouth College and founding director of The Center for Corporate Governance.
Excerpts:
B. Espen Eckbo: The speech was necessary to help repair confidence. A lot more has to be done, but I think he set a useful tone in terms of focusing on integrity and ethics. It’s not the end of the story, but it certainly sets the tone. Executive-compensation issues are more prone to ethical misconduct than other things we’ve seen in these crises. Financing and accounting issues are more technical, and more complex, in terms of how things can go wrong. But when we talk about compensation, ethics and integrity must play a role. President Bush seems to think about the compensation issues a lot when he talks about ethics.
Frankly, I don’t think it should harm his reputation or his ability to make these kinds of statements today. In fact, it illustrates nicely the complexity of the issues. There are things that can go wrong by anybody in this game. Even people with content and character can occasionally end up confusing the reporting numbers or making the wrong financial decision, which seems to be what happened to Bush in the 1990s. It doesn’t seem like he was involved in self-serving, potentially fraudulent acts. But, at the same time, he should recognize how easy it is for various parties at the top of the firm to get into trouble in a world where accounting numbers are hard to pin down sometimes.
I don’t have much to say about Cheney. The nitty-gritty, everyday changes will come from the SEC when it comes down to it. Bush and his administration play a tone-setting role to get people’s attention and to create the political climate to get these regulatory changes going. Both political parties really want to be out there to beat the other one in terms of being aggressive on this issue. I don’t think any personal issues regarding Bush or Cheney will stop that momentum.
The CEO is very close to paying himself or herself-with the approval of the board, but still the CEO plays a big part in setting compensation for the top management. So you need to create a little bit of distance and reiterate the issue of fairness to stockholders, to be open and to disclose exactly what you are getting in the compensation package. I think it is probably good to have strong regulatory-maybe even legal-recourse if compensation packages are misused.
I think this whole debacle will have a big effect on compensation practices. Will we be better off in the end because of it? That’s a much harder question. I can’t answer that. Bush said that he wants management to protect shareholders. What’s the best way to do that? It’s for the manager to think like a shareholder. That’s the principle of compensation-compensate in terms of stocks so they become shareholders and do what is in best interest of shareholders. We will continue to see stock-based compensation. It’s more a question of the level of compensation in order to get that effect of aligning interests.
That’s easy to do so I think that might be a result of this. And that is a good thing. It has been hard in the past to get companies to clearly display compensation packages. And if they don’t do it voluntarily, then the SEC rules should force them to do it.
It’s not so easy to prove fraud. It’s not even clear what will happen with Enron and WorldCom. They need to show direct violations of the rules at that time. The charge at Enron is that they knew things were going down and sold out, but it’s not that straightforward. maybe It’s going to be hard. That’s probably why the SEC wants to go about this a little differently in the future and be able to demand that the money be returned. In the future, maybe there is will be more discretion on the part of the SEC to force back profits. There is a rule now that if an officer of a company buys the stock prior to a takeover, for example, and then sells it right after, he must return the profit within a six-month period. The SEC could direct this toward compensation in association with certain acts.
His speech will have a short term effect so it’s important to use this momentum to go forward with new proposals and SEC rules and regulations. A year from now I don’t think you’ll have the same momentum unless we get more scandals. There is a window of opportunity here for the SEC to propose rules that are sufficiently pragmatic to work. There is a push to clarify the accounting issues-clearing up some of the gray areas too. That may be a good change. In the end, all of these proposals will come to debate. Some of the intent behind them will be preserved, but not everything Bush says will go through.
I hope the purpose of the additional manpower is not to go around hunting for scandals. But then, what is the purpose for hiring them? Perhaps, they will serve more of an advisory role. If I could call them up and say, I have these choices and this situation and do you have advice on what to do, that would be helpful. If you have more people looking into these things, you will see more-whether it’s more crime or fraud activity, I’m not sure. We’re still struggling with how much of these recent events were fraudulent and how much was just stupidity and bad luck. I am going after what we can learn and how we can make sure decisions are better made in the future without necessarily attacking executives’ character and ethics.
There is a second distinct issue. Why did firms like Enron, WorldCom, and maybe Tyco, go wrong? This a much broader issue that concerns more companies around the world. The kinds of things they are pushing for in the SEC don’t address that that much. There are issues in correctly accounting for off-balance sheet transactions, for example. We need to look at firms’ debt structure and understand how financing can unintentionally put a firm into bankruptcy-not because of a bad product or a bad market but because the debt contract was written in such a way that you can give away the company because you had to restate the accounting number. That’s what likely happened with WorldCom. I hope we don’t go overboard on all off-balance sheet transactions because they have done a lot of good for companies. You don’t want to say that you cannot be allowed to do all these activities or discourage them but instead encourage a system so the firms can be more open. These are technical issues. I don’t think Bush should get into those details. I don’t think the SEC should get into them either. But the accounting industry should clear these gray areas up.
They will know more. They should also better understand what a financial analyst’s role really is. They should take the analysts’ recommendations with a grain of salt. And they should take responsibility for their own investments. Hopefully, we’ll have more intelligent investors.
