Corporate America Gets Slammed
Corporate America is finally getting the message: Financial reporting that is technically correct but does not clearly reflect a company's operating health is no longer acceptable. In the wake of criticism about how it booked the gain on the sale of one of its businesses, IBM (IBM ) announced on Feb. 19 that it would expand the information it provides investors on such things as its intellectual-property income and the impact on earnings of the company's overfunded pension plan. And a day later, General Electric Co. (GE ) Chairman and Chief Executive Jeffrey R. Immelt also heeded investors' calls for better disclosure by promising to provide more detail on how the company's individual units--including its finance arm, GE Capital--churn out their earnings.
Expect this lifting of the veil to spread rapidly throughout Corporate America. In the wake of Enron's collapse and questionable accounting at telecommunications companies such as Global Crossing Ltd., investors are demanding better, more frequent, and more expansive information about companies' financial health. This rising pressure will force executives in boardrooms across the country to wrestle with exactly how much new information to reveal, much less the question of how to flag changes for investors without causing their stocks to tank. "GE and IBM are bellwethers," says Patrick S. McGurn, vice-president at proxy advisory service Institutional Shareholder Services Inc. "You will see a huge wave of imitation."
Of course, that's good for shareholders--and for the long-term health of the market. But the tsunami of new disclosures, unfortunately, isn't necessarily what the recovering economy needs right now. The trick will be to strike the right balance. Companies that reveal too little, too late will get punished in the market. But dumping too much on shareholders may only muddy the picture further. "If you give too much information, people can get overwhelmed by the minutia, and the important stuff gets buried," says Charles M. Elson, director of the Center for Corporate Governance at the University of Delaware.
In fact, IBM and GE join a growing list of companies that have already been compelled to improve their disclosure. At Tyco International Ltd. (TYC ), which has been buffeted by concerns about its complex accounting and financial health, senior execs have begun holding weekly phone conferences with analysts and investors to address questions about its accounting and operations. Franchising giant Cendant Corp. (CD ) has put detailed information on its Web site about its off-balance-sheet entities, while hotel operator Marriott International Inc. (MAR )recently provided details on write-offs it has taken for loan guarantees as well as some hotel-development projects.
The Securities & Exchange Commission has also joined the fray. On Feb. 13, the agency said it would push for beefed-up or accelerated disclosure on issues such as off-balance-sheet entities, corporate write-offs, and how the use of accounting methods affects results. These steps, SEC Chairman Harvey L. Pitt figures, "will minimize the chances of another Enron occurring."
There's no doubt the market is already penalizing those who ignore this demand for openness. On Feb. 15, when The New York Times reported that Big Blue had used the gain on the sale of one of its businesses to lower reported expenses, its shares got slammed, dropping 5%, to $103. On Feb. 19 and 20, they dropped 3% more, to $99, falling below $100 for the first time since last October.
Some accounting pros say the move was within the bounds of financial-reporting rules. And IBM says the transaction was properly disclosed and approved by its auditors. Big Blue notes that it has offset such sales against expenses on its income statement since the mid-1990s. But investors weren't buying it. Many argued that the accounting makes IBM's operations look more robust than they actually are--not a good thing at a time when quality of earnings is all the rage. "Most investors are going to feel that gains on the sale of property are not core operations, no matter how frequent it is," says Robert Willens, a tax-and-accounting analyst at Lehman Brothers Inc.
The timing of disclosures also matters. Take Tyco. The conglomerate's shares are down 50% so far this year, largely on concerns about Tyco's unexpected break-up plan and deterioration in its business fundamentals. But the company also undermined its credibility by providing some crucial financial information belatedly. It waited until issuing its annual proxy on Jan. 28, for example, to reveal that it had paid a director $10 million, and gave another $10 million to a favored charity, for his services in arranging last June's $9.5 billion acquisition of CIT Group Inc. Equally important, management only recently disclosed that it made hundreds of acquisitions in recent years that were never even announced. The company argued those deals were too small individually to be "material," but investors clearly thought the totality was.
Investors are now putting heat on other companies to reveal more about their operations. Cisco Systems Inc. (CSCO ) is under pressure to disclose more about adjustments to its sales numbers because of customer discounts. Investors in telecom player Nortel Networks Corp. (NT ) want it to release its cash-flow statement with quarterly earnings. And Amazon.com Inc. (AMZN ) shareholders are pressing management to disclose things like monthly figures for the change in sales in each of its major categories, such as books or electronics. "I'm struggling these days to think what we would consider an `off-limits' question from analysts," says Michael L. Smith, a global risk-control officer at wholesale energy company Mirant in Atlanta. "Everything is fair game."
Will this new candor reassure shaken investors? In the long term, most investment pros agree that better transparency on the part of corporations will result in less uncertainty, a positive for the market. But in the near term, the result is likely to be more jitters and turmoil. Gene Pisasale, senior investment officer at Wilmington Trust Corp., says investors are bracing for a rocky period over the next few weeks as many companies file 10Ks. He figures many will use this period to explain issues more fully that investors have been questioning--and shareholders are fretting that most of the news won't be good. After all, says Pisasale: "If a company of IBM's stature makes an announcement that raises eyebrows, what are some of the lesser-known companies out there hiding?"
That's likely to have important consequences for the recovering economy. David Hawkins, a Harvard business school professor and Merrill Lynch & Co. accounting consultant, warns that if investors remain uneasy about the new, most likely unfavorable, flood of information soon to be released by some companies, it could undermine consumer confidence. In the worst case, that could slow or delay any economic recovery. "It's a negative, no question," says Hawkins of the uncertainty.
But over the long haul, the new ethic of disclosure is likely to be good for the stock market even if much of the news that comes out is negative. More information can help investors and the markets operate more efficiently. "The more efficient the financial markets are, the better off the economy will be," says Mark Vitner, a senior economist at Wachovia Corp., the Charlotte (N.C.) banking company. It's a painful lesson--and one that is likely being learned in executive suites around the country.
By Amy Barrett in Philadelphia, with Spencer E. Ante in New York, William C. Symonds in Boston, Mike McNamee in Washington and bureau reports