Corporate governance in crisis

Scan the business section and one will see the following headlines:

"US stocks tumble to new lows unseen since October 1998.

"Some $1.5 trillion (P75 trillion) in investor wealth evaporated from stock market since July 4."

Why are the stocks in the US market being battered? Why is the market being described as "selling on fear"? Simple, the investors are worried over corporate scandals. There is crisis of confidence on how corporations are being managed and governed. There is widespread uncertainty of the true financial condition of these entities. When will the next reported earning adjustment occur due to improper accounting treatment?

All of the above surfaced after the Enron scandal in the US exploded. They are the aftermath of creative accounting techniques that dress up "the corporate books" and related financial reports. Worldwide, accounting principles, standards and procedures continue to be putty in the hands of creative bookkeepers and accountants in cahoots with greedy owners.

Today, in this era of transparency, the Boardroom has found itself under intense scrutiny. A growing number of stockholders, formerly silent and acquiescent, now want to know whether board members are performing their role. They are likewise asking for more information that can help them understand how their money is being used.

A US-based magazine’s recent survey done right after the Enron scandal showed a growing concern of the potential widespread of accounting fraud in the United States. More so when several other financial fraud stories came out of Wall Street.

Consider. Xerox Corp. admitted having overstated its income by 36 percent of $1.4 billion over a five-year period. Then there was Supervalu, then Adelphia Communications, Global Crossing, Tyco International and Qwest Communication: all of them either admitting or being questioned for declaring highly profitable reports when they actually had not earned much.

And very recently, there was telecom giant WorldCom, Inc., revealing that while it had actually incurred a net loss, it had nonetheless declared earnings. By booking $3.8 billion in expenses as capital expenditures, WorldCom was able to show earnings of $1.4 billion for 2001, and $130 million for the first quarter of the year.

US President George Bush could not have found a better word to describe WorldCom’s accounting impropriety: it was simply "outrageous." Unfortunately, this corporate disease we now call as accounting fraud is not merely confined in the United States.

Yes, financial report juggling also happens here

The Philippines too has had its share of corporate misfortunes that had for a time remained hidden under firm’s rosy financial statements. Long before Enron’s collapse, there were the local tragic stories of stockholders and creditors who fell victim to creative accounting used by companies that were in reality under deep financial trouble.

In the local corporate arena, the temptation to juggle financial figures is greater because of the weaknesses inherent in the local Philippine Stock Exchange (PSE) and Securities and Exchange Commission (SEC).

The PSE, as gleaned from the BW story and other stories of "burned" investors, is prone to manipulation. The modus operandi usually starts with a "praise release" about a company’s sharp rise in profit, followed by a flurry of corridor talk to drumbeat excitement; a buying and selling frenzy is then initiated by the manipulators and soon other small public investors are sucked in; and when the stock value zooms rocket-high, comes the painful finale of a share price bursting and dropping as fast as deflated balloon.

The SEC, on the other hand, is another over-staffed bureaucracy that is just too swamped with bureaucratic work. How can investors look up to SEC for assistance in getting a clearer picture of the status of companies when SEC can’t even take action on conflicts involving pre-need companies that are supposed to be directly regulated by them?

With ineffective regulators or government overseers, there is also an absence of heavily penalized violators. In fact, I have yet to recall of any crime of financial fraud or stock manipulation in the Philippines that has brought any individual or group of individuals to prison.

Would you believe that insider trading is not an offense in the Philippines? There are persons connected with publicly listed companies who have access to confidential vital information, and who use them with undue advantage to acquire or dispose stocks for their personal benefit. At whose expense? The small unknowing investors, of course.

Board members and management are main culprits

Back to unreliable and outright false financial statements and reports. Some sectors place the blame squarely on the accounting and auditing firms for these anomalies. The fact that most auditing firms also act as consultants for their clients’ other activities does not help, and only highlights the issue of conflict of interest.

I believe, however, that the burden of responsibility lies more in the business firm’s management and board of directors. We now live in a world that demands transparent corporate governance, where financial statements are not figments of imagination but of clear, accurate and trust-worthy disclosure. And is the primary responsibility of the board and management that financial statements are just that.

As with the Enron case, a big part of the guilt falls on the first line of defense, or the management team. It was, after all, this same group that cultivated a culture of "aggressive accounting" and "illegal cover-ups".

Directors and officials most especially cannot claim innocence of corporate misdeeds. As owners (or representatives of owners), how such crimes can "escape" them is beyond imagination.

Code of Corporate Governance

At the end of the day, it all boils down to good corporate governance and a re-examination of corporate moral values.

I couldn’t agree more with what the SEC Chairperson Lilia R. Bautista is doing to bring back morality in business as well as institutionalize good and transparent governance in Philippine firms. The chairman is pushing hard for the immediate adoption by all companies of the Code of Corporate Governance.

There are a slew of other recommendations, not only from the government but also from the private sector, for meaningful reforms. These include the creation and strengthening of an audit and compliance committee at board level headed by an independent board member, stricter disclosure rules, more independence and accountability of external auditors and improved monitoring of compliance with laws.

All of the above, however, have to be complemented by a well-funded streamlined but more productive, professionally staffed, less-bureaucratic and more pro-active business-oriented SEC.

As it is, our capital market is weak and under-developed. We just can’t take a local Enron-like corporate blow up.

Should you wish to share any insights, write me at Link Edge, 4th Floor, 156 Valero Street, Salcedo Village, 1227 Makati City. Or e-mail me at [email protected]. If you wish to view the previous columns, you may also visit my website at http://bizlinks.linkedge.biz.