US business not dishonest, expert says

By NZPA

Tuesday 9th July 2002

More corporate accounting scandals are likely to come out of the woodwork in the United States, but business there is not "dishonest," according to international corporate governance expert Mervyn King.

In Wellington today at the launch of a new "corporate governance" academy, Mr King traced the accounting scandals back to quarterly financial reporting in the United States and the wide use of executive share options.

"I wouldn't call stock options the root of all evil -- but it is a motivating factor," he said.

Mr King said he predicted more "smoke and mirrors" accounting problems after the Enron collapse, and since then there have been accounting shocks at Worldcom, Xerox, and this week at drug company Merck.

"Who else (will follow)?" Mr King said.

A former top judge of the Supreme Court in South Africa, a lawyer, and a director on many boards, Mr King has been an adviser on corporate governance issues. He was chairman of the King Committee on Corporate Governance and wrote the King Report.

After a recommendation from Mr King, there is a new government body to review accounts of listed South African companies.

If a shareholder thinks the accounts are not a fair representation, they can go to the body and ask for an investigation. Directors can be called to give an explanation, and the issue can be taken to the Supreme Court.

If the court finds for the accounts review body, the company must then put out new accounts and the directors personally have to pay for the investigation and court proceedings.

"Even if it never functions -- it is there," Mr King said.

He traced the US problems back to quarterly reporting for listed firms which he said was "problematic".

"It seems impossible to report, year after year, and come out at analysts predictions within cents (a share), without having to make some adjustments," he said.

If companies made "adjustments" to meet profit expectations in the market, they would build up over time and the results of that were now coming out.

"I don't believe that suddenly the American corporate mind has become dishonest," he said.

Business people generally acted honestly, but were caught by "short-term greed".

US executives were paid with huge share options, so there was a strong incentive to report the accounts which meant an apparent short-term gain, rather than another way of reporting which might be fairer, but would mean a longer-term gain.

"If greed takes over, you get the short-term decisions for senior executives holding share options," he said.

Enron chairman Kenneth Lay sold about $US4 million ($NZ8.31 million) of shares three months before the company collapsed.

Some executive packages in the US were now "huge and out of proportion", such as General Electric chief Jack Welch who earned $US170 million in one year -- an "obscene" level Mr King said.

"How do you justify that?" he said.

Worldcom's chief financial officer had just paid $US20 million cash for a holiday home in Florida before the company collapsed.

This was all evidence of a "greed mentality".

But the accounting scandals also raised the issue of whether non-executive directors were doing their job correctly, or whether there was something wrong with management, Mr King said.

Management and boards had to go through an exercise of "intellectual honesty", looking for potential conflicts of interest, making sure they had all the facts and adjourning board meetings if all the facts were not in.

"Am I (as a director) making a rational business decision in the circumstances as they exist?" Mr King said.

A board could make a bad business decision, but if directors "applied their minds properly" legal action against the board for a lack of skill and care should then favour the board.

Directors also had to ask if the decision was in the best interests of the company, especially long-term interests, Mr King said.

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