The saga continues—and gets more bizarre daily. Politicians, reformers, and other warm bodies are weighing in. The revolution in corporate accounting sweeping the nation continues unchecked. Dirty little secrets are coming to light with amazing frequency. Companies are admitting to skeletons lest someone make them seem worse than reality. At times, the skeletons appear to be fashioned from whole cloth. Companies now believe that confession is good for their souls (and stock values), even if they have to make something up.
Call it Enronitis if you will; everybody else does; but it goes beyond that. The days of “skimming a financial statement substituting for a hard look at the guts of a company” are over. Everyone is newly aware these pieces of paper are just that—paper. They are prepared, reviewed, filed, and believed by people. The documents are only as good as that information chain. Despite their official appearance, balance sheets and income statements never have been and never will be any more than representations. Concepts of revenue, debt, and value are not as black and white as an accountant’s personality. Of course, there are cases where true intent to deceive is involved. We have jails for that.
Corporate accountants diligently doing their jobs, however, should not be subjected to a national witch hunt. We should get back to business, wiser but not overly fixated. As I’ve said before, the market will do far more than any regulatory agency could hope to in forcing firms with shaky practices to shape up. There are genuine issues which can be addressed, such as separating auditing from other functions. But the market may handle those as well.
Take the recent announcement of a plan to mandate “proper” accounting for dilution. In theory, dilution occurs when the number of outstanding shares of a company increases. The same underlying assets are spread over more shares; not surprisingly, dilution causes share prices to fall. One such scenario is when firms grant options.
But there’s a catch. Share prices will fall when shares outstanding rise only if the market didn’t know about it beforehand. The market must be surprised, meaning that none of the zillion people watching publicly-traded companies notice that shares or options were going to be issued. Shares of stock don’t just magically appear; there’s a process involved.
Many mechanisms, from footnotes in financial statements to press releases to eagle-eyed analysts, provide opportunities for word to get out. And it does. Everyone who needs to know is well aware that options have been issued. The market price fully incorporates this information, together with anything else deemed relevant. Very competent academicians have demonstrated this phenomenon for decades.
Some elected officials think they must rescue us from this phantom menace. They don’t! Stock options are not without costs, but they are fully recognized and reflected in the stock price.
This move is likely nothing more than a slap at corporate compensation. By making options more controversial, their use may decline, crimping executive pay. While it is certainly possible to limit options, no one is the better for it. Compensation should be left to those involved, not legislators with a camouflaged agenda. The proper solution is to structure options so that the CEO has an incentive to maximize the value of the company in the long term, rather than manipulate quarterly results. There is no one better able to accomplish this task than the shareholders themselves.
Stripping away the fluff, we’re left with an effort to impose complicated legal and accounting structures to deal with a problem that isn't a problem. There are substantive matters to consider, but this is not one of them. The needed changes will be handled by astute investors, who, after all, are the ones with money at stake. There are plenty of real issues for Congress to address. Education, perhaps?