Manage Your Earnings and Go To Jail!

There is a lot of glamour and prestige that goes with being a CEO at a public company. Do you ever wonder if it’s worth it?

If your company has sales of under $ 1 Billion, it maybe time to consider going private. The cost of being public has increased 200% to 300% due to the Sarbanes-Oxley Act and the new SEC and exchange requirements. For a small company (say under $100 million) these cost can run over $300 to $400K per year. Most estimates of the yearly cost of being public for companies of $1 billion or more are over $1 million per year. This does not address the time and management attention that needs to be directed away from running the business and toward compliance issues.

We are just now beginning to see the full impact of SOX, 404 compliance etc. A year ago I talked to CEOs who were hopeful that some of these requirements might be “good things to do anyway”. Now the only people with anything good or hopeful to say about these new requirements are auditors and attorneys, certainly not CEO’s.

The largest cost could well be the increase in shareholder litigation. I have no idea how to estimate this cost, and I suspect it will be greater than the direct cost of compliance.

I used to think I could spot most of these by a careful review of the cash flows and a very careful reading of the footnotes in the annual report and 10K. WorldCom showed us it is not always that easy; people can lie about the cash flows. In addition estimating restructuring reserves is a black art.

Unfortunately you can get into trouble these days trying to do the right thing. For example, restating a reserve for warranties, or estimating a restructuring charge in an M&A transaction etc. (someone will question whatever you do).

How do you stay out of trouble? Do not depend on your audit firm alone for advice, make sure you have informed you Board of Directors (and the audit committee) of any questionable issues. Most of all make sure your audit committee is really qualified and independent.

If you are not a CEO, CFO or a board member why would you be interested in this subject? Well if you own any stock or work for a public company you are involved.

This issue would be less of a problem if we asked our auditors the questions Warren Buffet recommends.

1. If the auditor were solely responsible for financial statements what would be changed and why? 2. If the auditor were an investor does she believe she has all the information essential to understand the company’s financial performance?

3. Is the company following the same internal audit procedure the auditor would if he were CEO?
Buffet’s philosophy is don’t worry about the performance of the stock but of the company. He believes investors who are unduly worried about the stock’s price are not in for the long haul so why worry about them?
Many of the “so called” fixes the government requires punish honest business people and do nothing to deter the dishonest few.

What is the answer? Let me know if you have suggestions.

Ralph Muse
Muse Consulting