Category Archives: Law

The question today is what to do in light of the fact that the accountings currently provided to individual investors are impenetrable. Most obviously, one would like penetrable accountings. Unfortunately, that is easier said than done. The question is how hard we should try to come up with penetrable accountings. Today, I argue that we should try real hard, as the alternatives are not happy.

We could no nothing and let things go on. After all, if it made economic sense to have better accounting, market forces would make companies have better accountings. Well, no. Market forces likely encourage a company competing with others for capital to provide comparable accountings. Market forces do not necessarily protect entire markets or investors as a class. The US saving rate is frighteningly low. Bad accountings, and the resulting distrust of the markets, particularly the stock markets, may be part of the problem.

One still might not care. Let people do stupid things. I’ll put my money in the bank or a mutual fund. But, if a rising tide raises all ships, even a smart loner could benefit from better markets.

Old Europe down under.

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Betty the Crow News called my attention to a great little piece about Enron in the the San Francisco Chronicle that expresses my views about Enron and my point the numbers matter far better than I could On Facing Facts

Yesterday, I wrote about the process by which corporate financial information is processed and presented to investors. It was my plan to write about how that process effects the quality of the product. But, it seems more fun to cut to the chase and think about, in light of this process, what financial information should be given investors. (Perhaps later we can chat about the audit process.) The goal here is to evaluate whether it is troubling that most investors could not understand Enron’s financial statements, which is where this discussion began.

Should investors understand the basic financial attributes of a company they invest in? Few car buyers understand modern automotive engineering; yet nobody thinks that this means that there is something wrong with the automotive markets. (Hey, I’m from Detroit: Cars are an analogy to everything.) Individuals can get expert analysis from places like Consumer Reports and JD Power. Reputation and brands provide useful non-technical information about a car. Experience over time drives (pun intended) bad cars out of the market. And so on.

But, cars are not corporate stock. Click for the analysis underlying this surprising conclusion.

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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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