Is Congress qualified to fix accounting scandals?

Posted: Jul 10, 2002 12:00 AM
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 debate. 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 place. 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.