Is Congress qualified to fix accounting scandals?
7/10/2002 12:00:00 AM - Linda Chavez
Given the accounting scandals at WorldCom and Enron, it's hard
not to call for new laws and regulations to reign in corporate America --
but the remedies could end up hurting more than they help. Congress is in
the mood to try to "fix" the problem -- but Congress is almost guaranteed to
botch the job.
Few members of Congress have any real business experience. Many
couldn't interpret a balance sheet if their lives depended on it and
wouldn't know EBITDA (earning before interest, taxes, depreciation and
amortization) from an ewok. Yet, they're ready to micro-manage corporate
compensation and audit committees with misguided legislative proposals in
the hopes they can prevent the next corporate collapse.
Sen. John McCain is a good case in point. The maverick
Republican is a smart man and a capable senator. But he appears to know next
to nothing about how corporations operate, judging from a New York Times
op-ed he authored this week laying out a new scheme for corporate accounting
and executive compensation. Among his suggestions: force companies to
account for stock options granted to senior executives as an operating
expense on the company's financial reports, and require executives to retain
the net gain from any options they exercise in company stock that could not
be sold until 90 days after the executive left the company.
Stock options are a standard way of giving executives a
financial stake in the decisions they make by rewarding them for helping the
company grow. If the company's stock goes up in price, the executive
benefits; if it falls, so does his or her advantage.
Of course, stock price alone is not the only gauge of a
company's financial health, and it may be that some CEOs emphasize stock
price to the exclusion of other important measures, such as revenues,
profits, earnings or debt ratio. But McCain's proposal is irrelevant to that
What's more, the McCain proposal is problematic on its face. It
makes no sense to charge options as operating expenses for a number of
reasons. An "option" is just that -- it gives the recipient the option of
buying stock at some point in the future at a pre-set price (usually, the
market price at the time the option is granted).
If I'm given 5,000 options at $10 a share and the stock price
increases to $20 a share and I exercise my options, I make $50,000. If the
stock price goes below $10, the options are worth nothing to me. And since
no one can predict whether the stock price will go up -- or by how much --
there's no easy way to assign a "cost" to the transaction until it takes
McCain's proposal for forcing top executives to reinvest their
net gains from exercising options makes even less sense. When I described
McCain's proposal to a friend of mine who's a CEO, he said it sounded like a
nice way for the government to get their piece of the action while tying up
the executive's money. "Why would the exec exercise those options and fork
out the cash to buy the stock, only to have it tied up until retirement?" he
asked. "If the only way to get at your stock is to retire, it might serve to
drive the best and brightest -- who presumably would have the most
options -- out of the company at an early age."
There's no question that some corporate boards and executives
have abused their fiduciary responsibilities and enriched themselves at
shareholders' expense. They deserve to be punished to the fullest extent of
the law. President Bush is on target proposing increased criminal
penalties -- including jail time -- for those who intentionally distort
information on their required financial reports and better oversight from
the Securities and Exchange Commission.
However, Congress should be careful not to become overzealous
while trying to legislate corporate governance and compensation. "As is
often the case," Washington Post economics reporter Steven Pearlstein
writes, "economic markets tend to work faster than political ones." And
better, I might add. In the wake of so many recent reporting scandals, most
corporations are quickly adopting new safeguards. By the time Congress gets
around to approving legislation, most of the necessary reforms will already
be in place in most big companies. Self-interest -- the need to restore
investor trust in order to keep the economic engine running -- is still the
best motivator in cleaning up the mess.