July 4th,
2002 Issue - Op-Ed Section
NICOLAS VÉRON,
former CFO of Lycos France
Translation by the author from original text in French
Never, probably, had professionals of financial information had to put themselves into question like nowadays. The accountants, who see the word "creative" as an insult, are not known for being in love with change. But these last months' events put their profession at the center of the debate about how our economic system should be policed. The collapse of Enron, the disintegration of Andersen, the scandals at Worldcom, Xerox and the like are the first in a long line of disruptions which, to be sure, is only beginning.
Why is accounting necessary? Since more than five centuries, it provides Capitalism with a common language: namely, the possibility for assets-holders to compare different businesses with one another and to estimate their respective value and risk on an objective basis.
Does this language have an influence on the way companies are managed? No, in theory: accounting standards are meant to be neutral; they just serve to translate into financial figures a reality that they don't change. But in practice, these standards can have substantial effects. For example, if, as any other form of compensation, stock options were expensed when granted or exercized, then companies may grant less options to their employees while they strive to maximize their profits.
The growing importance of financial information is parallel to the growing power of institutional investors, helped by investment banks and rating agencies. They are the ones to whom, ever more exclusively, companies are "accountable", with ever higher requirements of accuracy and transparency. As a consequence, the accounting and financial information, while providing an ever more detailed picture of the company's activity, tends to replace most other management indicators.
But it's also becoming more difficult to find a "true and fair image" of a company's situation in its accounts. Corporations permanently change their perimeter of consolidation, as they go through accelerating cycles of mergers and acquisitions. "Intangibles" such as brands and technologies, which are difficult to value, represent a growing share of their total assets. Companies also use financial technologies which allow them to keep some assets or liabilities out of their balance sheets, such as Enron's "special-purpose entities". The perimeter of consolidation may also be adjusted in order to optimize financial ratios: Vivendi Universal consolidates 100% of its mobile-phone business SFR while it owns just 35% of its shares via Cegetel, its telecoms arm. "Our financial-reporting system is broken", as Joseph Berardino, then CEO of Andersen, prophetized six months ago while referring to those new challenges. A couple of weeks later, he had been swept away by the Enron debacle.
At the same time, globalization is rapidly blowing up national regulations. The European Union just handed its accounting standard-setting powers over to the International Accounting Standards Board (IASB), on the belief that only this private body could provide a way to unify the diverse accounting rules of its member states. In the United States, the Enron scandal has altered the reputation of excellence of GAAP accounting rules. Meanwhile, the IASB still has to prove the quality of its standards, the legitimacy of its decision processes, and its ability to manage a difficult transition towards the enforcement of its rules in all listed companies in the European Union in 2005.
Companies, certified accountants and investors all gradually wake up to the consequences of these sweeping changes. But they need to adapt quickly, if some trust is to be brought back into the financial markets; and this will not be painless.
First of all, companies must accept that they have to provide transparency. Many of them still prefer to hide the bad news, or play them down. Currently, in spite of corporate scandals, resistance to this change still dominates many boardrooms. The intense corporate lobbying against stock option expensing has won the battle over the US accounting standard-setter, and may still reach the same outcome with IASB. In France, the MEDEF business organisation engages in rearguard battles as it asks for the reversal of transparency-fostering clauses of the recent so-called NRE Act ("Les Echos", June 27th). The imperfections of "corporate governance" make it plainer: in not many corporations can the Board really form an independent opinion on corporate accounts, in spite of increasing pressure from the financial markets.
Second, auditing professionals are not convincing when they try to defend the status quo. Every practicioner knows how difficult it is for an auditor to resist its client's pressure, especially when the economic cycle is down--as recent scandals, alas, have just shown. At the same time, the auditing sector is now extremely concentrated among the "big four" major networks, thus multiplying conflicts of interest and ruining any presumption of objectivity. The "peer review" mechanisms, meant to guarantee a high level of auditing quality and independence, weigh little in face of the defense of common interests within the profession. "During forty years I've sat on many corporate boards and was frequently a member of audit committees; never have I heard an auditing firm express a negative opinion about any of its peers", Felix Rohatyn wrote recently.
Third and finally, investors are also far from keeping their obligations. The burst of the Internet bubble has destroyed the credibility of financial analysts who were paid less on their forecasts' accuracy than on the performance of sales teams from which they should have been isolated. The immense majority of individual investors, and a significant proportion of institutional ones, today lack the appropriate tools to analyse the information disclosed to them by companies.
Accounting has grown into too serious a business for accountants alone to be
entrusted with it--as Clémenceau once famously said that "war is too serious a
business for the military to be entrusted with it". In order to restore trust,
other players need to reinforce their role, such as individual shareholders' and
investors' organisations, equity markets regulators, the accounting regulation
committee of the European Union, or competition authorities facing the
concentration of the "Big Four". Considering the size of that task, the risk of
things going wrong will remain high during a long time. The Internet bubble, the
Enron collapse and the other recent corporate scandals have already made much
damage, but there is probably yet worse ahead of us.
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Translation by the Author
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