Author Archives: george

Yesterday, I argued that raw cash flow numbers alone are not enough information for an investor to understand a company. The accounting industry always understood this. In fact, cash flow statements were not required until 1987!

What about giving an investor complete access to all (non-confidential) financial information, which the investor then can massage as she sees fit? While this would have seemed impossible in 1933, presumably it could be done today. The SEC is trying to get companies to do financial filings in a format called XBRL, which permits the reader to analyze underlying data. More sub fold.

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Back to the discussion of understandable accounting.

So, it is 1933. You are Congress. You want to give investors all of the information that they need to make informed decisions on buying and selling securities. What material would you require companies to make public? Obviously their locations, goods and services sold, brands, management, history, and the like. But, in the end, everything comes down to numbers. The investor has to decide what is a fair price in dollars for a stock or bond. So, investors must have financial information in dollars.

Which raises the question of what financial information is relevant to investors’ — and therefore to the markets’ — pricing decisions. This is the fundamental question of corporate finance: what is value? More below.

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Sorry, but I am going on another tangent because I actually was a bit player in a drama that made the headlines today: Engle, the $145 billion judgment against the big 5 cigarette companies, which was overturned today by the Florida Supreme Court — essentially on procedural grounds, as discussed below. But, by the way, the Court upheld the jury’s findings that the tobacco companies behaved wrongfully and are liable to Florida smokers!!!!!

I was one of two finance experts for the plaintiff class (Florida smokers). My involvement began very late in the trial in 2000. I testified before the jury that the companies’ ability to pay punitive damages should be measured by the companies’ ability to generate cash. The $145 billion was near the upper bound on the present values of the companies’ discounted cash flow generating potential.

Rather than respond to this analysis, the tobacco companies called their CEOS, mostly marketing guys, to testify. The CEOs said that they can only pay their accounting balance sheet value. This “book” value shows no value for the companies’ brands (except for RJR) and is a tiny fraction of the market value of the companies. (The key economic resource of a tobacco company is its brands.) Not surprisingly, the jury rejected this self-interested testimony.

In this posture, the $145 billion judgment was completely reasonable. The tobacco companies gambled and lost. While this aspect of the our trial system is disconcerting, it is the law. If the tobacco companies had won, they would have laughed all the way to the bank.

Which gets us to today’s decision by the Florida Supreme Court. Down under….

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Glad that I am pretty much done with dissing Enron — out of respect for the late Mr. Lay.

Monday, I suggested that it is troubling that the average investor could not understand Enron’s accounting. Later, I will talk at whether it is possible to have accountings for new economy businesses that the average individual investor can understand. (Enron pretended that it was all new economy. It really was just another energy trader.) But, a little background seems helpful.

After the amazing business scandals, even by Enron standards, of the late 1920s and early 1930s, Congress had to do something about the public securities markets. Public faith was nigh zero. The question on the table was what to do. One answer would have been to have a government agency that really regulated public capital. For example, a government agency could look over the shoulder of corporate managements and second-guess the stock and bond markets. Congress instead decided to put their faith in, among others, the accounting industry. Really! Laff, laff! More below the fold….

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With all of the media attention given this week to Joe Lieberman’s waivering loyalty to the Democratic Party, I decided to go on a slight tangent and discuss how, more than anybody else in America, Joe Lieberman is responsible for some of the worst corporate abuses during the recent tech bubble and for the current growing options backdating scandal. The Connecticut media has noted this, but not the national media, and it is real important. In short, in 1993, Lieberman saved amazingly bad accounting for when a company pays an executive with stock options instead of cash. This caused options to flourish. Options make an executive more concerned with short-term fluctuations in her company’s stock price than in running the company well. Disaster resulted. Details below the fold. Back on track tomorrow.

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Thanks to Michael for giving me the chance to guest blog. It was fun 2 years ago. Hope you out there find my stuff somewhat interesting.

I am a tax guy. Unfortunately, from my blogging point of view, in the US, the only interesting discussion going on about taxes these days is about the estate and gift tax, and I have little to add to that debate. (Yes, we should not be Mexico…)

But, in the other area in which I know something, law and accounting, lots is happening. The ongoing option backdating scandals make it clear that much still is wrong with the accountability of corporate managements. So, for now, accounting seems more worth writing about.

Which gets me to Enron. Many have noted the importance of the recent convictions of Lay and Skilling: The convictions restored some faith in justice. More importantly, for my purposes, they saved public capitalism. If Lay and Skilling had been able to get away with what they did, it would have seriously undermined the public’s faith in the capital markets.

But another aspect of the convictions has not received public scrutiny and merits discussion: how the convictions were achieved.

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