Who's Failing Us With Bad Information?

I am beyond sick of reading about the sub-prime mortgage mess, "hidden" losses emerging from Wall Street balance sheets and CEOs being ousted for poor risk management. We find ourselves with a market environment that is very uncertain, so much so that every day seems to bring a new revelation about losses to be realized or firms on the brink of a liquidity crisis. And we can talk for days about the factors that got us to this point. But the bottom line, IMHO: it's about bad governance.

All the problems that have been written about are tangential to this basic fact. And if there are two items related to governance that have most profoundly failed investors, I believe they are weak accounting practices and poor investor relations practices. And the problem is that these two items are actually quite closely related, and both relate to a simple and unimpeachable fact: investors often get bad information. And this has got to stop. Now. And corporate Boards of Directors and their senior management charges are the primary vehicles for change. If they can rise to the challenge.

Weak Accounting Practices or "How Real Are Those Earnings?" or "Can I Bank on That Shareholders' Equity?"

Let's face it - this is not a new issue. Accounting shenanigans have been around as long as dual-entry bookkeeping itself. Cookie-jar reserves. Earnings smoothing. Off-balance sheet transactions for financial statement presentation purposes. And every time the accounting rule-making bodies move to change a rule the lobbyists crank into gear, the comment periods stretch out interminably and the eventual change is either so watered down that is has little value (i.e., accounting for employee stock options) or so out-of-touch with actual business practices that the change does more harm then good (i.e., hedge accounting rules). Didn't we think that Enron-type off-balance sheet deals were done for (meaning deals that shifted assets from the balance sheet without true shifting of risks)? Think again. And while deals like these (off-balance sheet deals but with recourse if certain events come to pass, i.e., an inability to re-market auction-rate commercial paper) certainly impact the balance sheet, they also impact the income statement as well. Just look at Citigroup and Merrill. Running a massive carry trade until - whoops - liquidity goes away and that nice income stream you were booking as income turns into billions of mark-to-market losses overnight.

So who's to blame? Wimpy accounting rule-makers? Congress, who also can weigh in on such issues? Game-playing corporate managements who want to protect their own bonuses? Corporate Boards who should be watching this stuff but are likely long on other commitments and short on meaningful domain expertise? How about investors themselves for not being more critical and demanding answers to opaque financial disclosures before buying the shares? There is more than enough blame to go around. And there's nowhere to hide. The information investors are getting is often-times very poor, either because disclosures are intentionally vague or because active steps were taken to present the financial picture in a way other than the way it is from an operating perspective (i.e., certain sale-leaseback and asset defeasance transactions). And this sucks.

Poor Investor Relations Practices or "What is the MD&A Really Saying" or "Where is my Quarterly Earnings Guidance?"

The way I see it, most of the stuff coming out of corporate investor relations departments is pure drivel. Puffed-up press releases. Milquetoast, vacuous commentary by the CEO and/or CFO as it relates to the Company's prospects. Many companies' emphasis on earnings guidance, and the associated warnings and alerts that go with it. Quite frankly, it insults a thinking investor's intelligence and wastes a ton of corporate resources keeping up this charade. I've got a really new and innovative idea: how about being really, really clear about Management's strategy and plans, risks to these plans and mitigants that will be employed, and articulation of a medium and long-term strategy against which Management's efficacy can be measured? I'm not talking about giving away the formula to Coke; I'm talking about straight communication that is deserved by the owners of the company. All owners - and no favoritism (though I think Reg FD did a decent job of addressing that issue). And drop earnings guidance; it is completely worthless and foments the idiotic short-term thinking that both destroys shareholder value through perverse decision-making and enables Management to avoid a more substantive discussion of the issues.

And who is at fault? Everybody. Boards who favor "stealth" (yeah, like so much is really out of view today) over clarity. Managements who would rather sidestep the hard questions and tap dance when necessary. Investors who put money in companies that don't communicate well and serve to perpetuate the bad behaviors that have gone on for decades. No more! Get clear. Get substantial. Get real. Few words. Fewer releases. Greater substance. This isn't rocket science. It's just good leadership.

In Quest of Good Information

So where do we need to get good information from?

Company financial statements. Enough with all the off-balance sheet stuff. If it is a legitimate partnership that shouldn't be consolidated, ok. But all of the money that is spent pushing stuff off the books just to make things look better? Pure corporate waste and greed. And analysts shouldn't have to adjust for all of these hair-brained transactions, and it isn't like there is always enough information to properly adjust even if they wanted to. Management's need to stop doing this and Boards need to enforce a policy of simplicity and economic clarity. And investors need to use their brains and their wallets to reward companies that act in this manner.

Company Managements. Investors need straight talk. Talk about strategies. Long-term goals. Steps that will be taken. Markets to be entered and relevant time frames. Stuff that investors can analyze in order to make their own determination of value. Enough with the emphasis on earnings guidance. Managements live in fear of these figures and are highly motivated to do things to hit these numbers. This does not make for value-creating decision-making. The calculus of Management incentives needs to change. A focus on long-term value creation, not short-term EPS attainment. And investors need to accept this new paradigm and to focus on doing good analyst work with better information, not merely trying to read Management's voice inflection and sweat glands on the earnings call.

The Internet. There is a wealth of valuable information out there that can be found in places other than SEC filings, earnings releases and mainstream media. Customers talk. Suppliers talk. Employees from other companies talk. Lots of good stuff that can be used to augment one's investment mosaic. The world has changed and information has changed along with it, and if an investor is closed off to all the new media that is available then they will be at a distinct disadvantage to those who take a more enlightened, technology-enabled perspective.

So that's it. With some eminently doable changes in corporate governance investors should be able to get much better information than they are getting today. And this would bode well for the markets. And we as investors can play our part to demand the kinds of changes I've proposed. Let's make it happen.

Comments

[goatfarmer:]

Those who enforce accounting standards are to blame.

2007 Nov 09 07:10 AM

[J.Stevens:]

I agree but would add. Any who fail to enforce legal statutes are to blame. Fraud and criminal behavior are like weeds, appearing and growing wherever possible. Governance should include governing. We no longer have governing in any great sense of the word. We have, "Oh! It makes me sad!" We no longer even are allowed to be "mad!", just "Sad!" . Our bravest and best are in harm's way, doing their best to protect us, facing injury and death, but our leaders appear primarilly to be trying to protect the wallets of a defacto aristocracy. No child left behind should be altered to little justice left behind, or a threatened future left behind.

2007 Nov 11 05:28 AM

[Bajatexas:]

It's actually not just a corporate governance or accounting problem. It is emblematic of problems in all areas of society. On the personal front, we have a citizenry that is not even slightly interested in assuming the responsibility that comes with the exercise of rights. We have a government that can't respond to disasters or provide the most basic needs of citizens in spite of taking in more money each year, etc. The real question is why would we think that our corporations would be insulated from these problems?

2007 Nov 09 08:19 AM

[Bajatexas:]

It's actually not just a corporate governance or accounting problem. It is emblematic of problems in all areas of society. On the personal front, we have a citizenry that is not even slightly interested in assuming the responsibility that comes with the exercise of rights. We have a government that can't respond to disasters or provide the most basic needs of citizens in spite of taking in more money each year, etc. The real question is why would we think that our corporations would be insulated from these problems?

2007 Nov 09 08:19 AM

[Sumit Batra:]

Fraud

I want to get attention of the fraud done by Bush administration and the federal reserve to the American people just to win election in 2004. In 2004 market Economy stated to cool off and by august 2004 had a good correction in the stock Market. See the chart below.

finance.yahoo.com/char...=^ixic;range=5y;indica...

The above chart clearly shows Since making bottom in August 2004 , the market rallied

Bush administration had inside information in Early 2003 that economy will slow down in 2004 and he will loose election . So, they came up with a plan. They Gave clear cut instructions to Banks to loan money to individual investor even if they are not qualified to get a loan. They started with 1% interest and zero payment. That practice started in Mid 2003. The result was the bubble in the housing prices and it is evident from the chart below.

finance.yahoo.com/char...=^hgx;range=5y;indicat...

The chart above clearly shows that home index tripled in two years


This was done during great depression, but with big difference. At that time the US industries benefited, but this time results were different. China , India, Canada, Brazil, and Oil producing countries benefited. Look at the chart below to see how commodities rose sharply after 2004.

finance.yahoo.com/char...;range=5y;indicator=em...

The chart clearly shows that oil service index went four times after 2004, so are the oil prices


finance.yahoo.com/char...;range=5y;indicator=em...

Look at Brazilian stock market, from $12 to $84

finance.yahoo.com/char...;range=5y;indicator=em...

Look at chart above Chinese market from 50 to 215

finance.yahoo.com/char...=^bsesn;range=2y;indic...

Look at Indian mkt above from 5000 to 2000

finance.yahoo.com/char...=^stq;range=2y;indicat...

Look above at steel stocks from 180 to 600

Why that happened. It is as simple, USA consumer refinanced their homes and took money out and bought Chinese goods and Indian services. The result was the strong boom in Indian and Chinese economy and massive USA trade deficit . China and India showed growth rate of 12% and 9% respectively after 2004. The USA government kept printing dollar to finance the deficit. . That created huge demand for the commodities and result is almost $100 barrel oil. That’s good for India and China. . It’s good for commodities producing countries like Canada, gulf, Australia and south Africa. Who Financed those economies, the answer is USA consumer and now USA banks.

The USA dollar is depreciated 40% against other world currencies. Banks are suffering because people can’t pay their mortgages. Fed can’t cut rates because of inflation, but doing it because elections are coming. Cost of living has gone up considerably, and Market is on the verge of collapsing.
Bush administration also showing inflation data by removing energy and food prices.



This is just done by Bush to remain in power. They are selling USA to china, all the USA dollar is owned by emerging countries and oil producing countries. We are heading towards stagflation. Pl see the link below

www.thestreet.com/s/do...


Mr. Bush is good for above mentioned countries except for USA. Bin laden must be smiling, he got his wish fulfilled , oil at $100 a barrel.


People will argue with Clinton bubble, but in that bubble Americans were gainer and were losers too. In bush bubble, Americans are loser while other countries are gainers. Look at the US dollar after stock market crash in 2001, it never dropped. Why dropped now is a question to ask. The answer is simple we transferred our money to emerging markets. All the bank losses are gone to emerging markets

2007 Nov 09 09:13 PM

[Gerald:]

The way forward is to resolve the valuation issues surrounding all the CDOs and other ultra complex fixed income derivatives. It is now apparent that these investments are more equity in nature rather than fixed income. If the credit ratings for these instruments were nullified, then equity valuation techniques could quickly be applied to value these instruments and their values determined accordingly. This will naturely involve some discomfort but then chapter on these difficult products could be closed sooner rather than later.

2007 Nov 09 09:20 PM

[brij srivas...:]

Lift the corporate veil............check all the accounts of employess past and present.I hear that Mr.Prince gets a $40 million parting gift from the Citibank...thats what u call an icing on the cake.

2007 Nov 10 04:18 AM

[ghamilton:]

The author (Ehrenberg) makes a language mistake in the sentence quoted below that is becoming fairly common of late, namely using the Latin abbreviation "i.e." as if it meant "for example", when it fact it means "that is" (i.e. = id est). The abbreviation he should use is "e.g." - exempli gratia (for the sake of an example).

"The information investors are getting is often-times very poor, either because disclosures are intentionally vague or because active steps were taken to present the financial picture in a way other than the way it is from an operating perspective (i.e., certain sale-leaseback and asset defeasance transactions)."

2007 Nov 10 11:02 AM

[gordon:]

Gov't DEREGULATION is the mantra of "trickle-down" Republicans, both are corrupt, and in many case criminal. All this starts at the top, the gov't's own CRIMINAL STATISTICAL LIES. How about the recent "3.9% GDP"? How about all those FINANCIAL AND CONSTRUCTION JOBS the Bureau of Bullcrap added as birth-death employment? Americans are saps, fools, controlled by a media -monopoly growing bigger everyday, feeding us a steady diet of lies..
This is from Peter Schiff's latest newsletter>
"The recent rosy GDP data was made possible only by reporting annualized inflation for the quarter at the absurdly low .8%. This historically low inflation rate makes nominal GDP gains appear to be substantive. Similarly, the October payroll report relied on significant job growth that the government claims took place in construction and financial services! Given all the job cuts in these two sectors, such assumptions are clearly absurd, and paint an unrealistically sunny picture of the U.S. employment landscape."

2007 Nov 10 11:30 AM

[J.Stevens:]

Most of the problems we have can be directly traced to the failure to hold scoundrels and crooks accountable fo their wrong-doings. Years ago, I had good friend from the Dominican Republic who once said, "You know, "Jeem", if a man is rich, he will not be sent bills very quickly. If he is rich enough, he will never be sent a bill. ". Today, we can see that if a man or group of men are rich enough, and placed well enough, they will never have to be subjected to justice or even be questioned by the law. Until recently, I thought it was only the poor who were regularly at the lowest levels of justice protection. Now, I, and millions of others can see that the middle classs doesn't count either. For example, is Mr. Paulson still working for GS or is he working for us? Are we to be forced to make sure he and his rich friends have their flawed "due diligence" behavior covered by our taxes and our childrens, now and forever into the future? Have we now traded in out democracy for an autocracy of economic scoundrels? We are no longer merely threatened by monetary meltdown. We are threatened by a loss of any faith that we even have a democratic enforement system of law. Everyone is not responsible. The guilty only are responsible. We must find them, convict them, and punish them, not forgive them and reward them. They are SOB's and potential killers of all our futures.

2007 Nov 11 05:09 AM