March 23, 2005
Surging commodity prices, led by oil, a plunging
dollar, and the woes of U.S. manufacturing that are reflected in General
Motor’s sharp downward revision of earnings all would make ample topics
for this column this week. But
you must excuse me for putting those issues on hold while I discuss
implications from the conviction of Bernie Ebbers.
Bernie Ebbers was the CEO of Worldcom, whose collapse,
along with Enron and a few other corporate scandals, led to the
Sarbanes-Oxley reforms in corporate governance.
No CEO ever again can use the excuse that massive losses were kept
from him or her by underlings. (Personal
fraud remains possible, but company management soon should observe that
something is not right when fraud happens).
Frankly, while the jury returned its verdict on Ebbers,
the proverbial jury remains out on whether the additional billions of
dollars spent to document controls and conform to the new corporate
governance environment is helping or hurting shareholders.
Corporate earnings certainly are more clear, but they also are
reduced by compliance costs.
My pet peeve is that Sarbanes-Oxley legislation is one
more example of righting the cruise liner but swamping the row boat.
Corporate processes are not that different whether the company is
doing a billion dollars in business or only a few million.
The accountants just add zeros to the invoices.
(There may also be a lot more invoices, but the process used to
determine invoice accuracy is not materially different between large and
For large corporations, the governance requirements are
costly but easily absorbed. For
small companies, the costs are overwhelming.
I know of small mutual funds whose compliance costs are too high to
justify their continued operations. I
know small public companies who are seeking to go private because they
cannot absorb the additional six figure audit fees required to meet
Nevertheless, the Sarbanes-Oxley blunderbust, along
with some corporate convictions and the demise of Arthur Anderson, should
dramatically change the corporate landscape.
How can a CEO assume ignorance, as several have, when
they now must attest that they, along with their chief financial officer,
approve the financial representations of their companies on a quarterly
basis? How can accountants
declaim that they could not identify the frauds at Enron or Worldcom when
they help guide the documentation of company controls.
And how can a board of directors turn a blind eye when
they know that insurance may not be enough to protect their wealth from
I would be surprised that any board of directors ever
again approves a loan to a CEO to protect him from margin calls, as they
allegedly did with Ebbers. I
doubt that any audit committee would miss dramatic changes in company
performance as subsidiaries are formed, as in Enron’s case.
Audit committees would certainly question the default
reserves provided for receivables or the surge in capitalization and slowing
in expenses related to services purchased from other communications
companies, as at Worldcom. And
Audit committees cannot plead ignorance either, because they have at least
one financial expert in their midst.
In short, what has happened to perpetrators of
corporate scandals and to some of their boards of directors will
significantly alter corporate behavior.
It also alters corporate costs.
Directors facing greater risks will want more compensation before
serving. CEOs may argue for
even more compensation than their already rich packages.
Unfortunately, Congress has not seen fit to make the
compliance burden depend upon market capitalization or revenues of a
company. Once again, in the
eyes of government regulations, a company is a company whether it has
billion dollar cash flows or is an infant that still gives stock instead of
cash to compensate valued employees.
Certainly, the pain suffered by investors and employees who were misguided by company fraud is very real. Let’s not compound that hurt by stopping the development of new companies because the costs of “going public” become too high.