Friday, July 3, 2015

Bubble, Bubble on the Wall, When Will You Burst, When Will They Fall

Accounting. It’s complicated. For those of us living normal lives, we have “cash basis” accounting. We spend and allocate money based on what we actually have. Perhaps credit on mortgages and credit cards is sort of individual “accrual basis” accounting, but for every corporation other than the smallest of the small, “accrual basis” accounting is the rule.
It’s easy to explain what this rule does, although it is truly complexity in action. Take a company that makes basketballs in 2014 but winds up selling them in 2015. What that company does is to carry is normal projected income for 2015 into their tax return for 2014 so that the costs for what it manufactures can be deducted against the revenues from those goods. Otherwise the costs and income don’t line up on the books. Makes sense, sort of. For the government, it is a wonderful thing. They make companies move expected future earnings into the current tax year, and then they make the company pay the tax as if they had received the income. The accounting industry has created Generally Accepted Accounting Practices (GAAP) to deal with it all. Projecting future income required by law? An invitation to lie?
As companies have grown in complexity, with various operating divisions and subsidiaries, the attempt to match future revenues with current costs now defy logical sense. These are rules on rules, complex rights to deduct and depreciate, etc. And when logic is supposed to be introduced into our tax code, the thought of making companies deal with cash realities like the rest of us, the government is in a huge conflict of interest. It wants the current tax on those “earnings,” knowing that “earnings” are often the basis for stock valuations. That the economics are woefully distorted, well, that’s life.
But these artificial accounting schemes have also become a bad habit in the tech-valuation world, where even GAAP rules seem too restrictive. Even a worse habit has developed. Some having no income against which to pay taxes with others just to puff up the values, tech companies are often have to find ways to attract or maintain investors with their complex aspirations. They need to show investors that they are or will be wildly profitable to justify high stock price, even if their numbers resemble fairy tales more than facts.
“Corporations still must report their financial results under generally accepted accounting principles, or GAAP. But they often play down those figures, advising investors to focus instead on the numbers favored by those in the executive suite — who, it just so happens, stand to gain personally from the finagling.
“Among the biggest costs these companies ask investors to ignore are those associated with stock-based compensation, acquisitions and restructuring. But these are genuine expenses, so excluding them from financial reporting makes these companies’ performance look better than it actually is… This, in turn, makes it harder for investors to understand how their businesses are really doing and whether their shares are overvalued or fairly priced.
“Not all technology companies encourage the use of funny figures. Apple and Netflix report only GAAP results. But they are in the minority… Cooking up funny figures to accentuate the positive at a company is not a new problem. Justifying rocketing stock prices with kooky financial metrics was central to the 1999 Internet mania. We all remember how that ended.” New York Times, June 20th.
So this clearly seems to be moving us in that horrific bubble-bursting moment that crashed the tech market in 2000. We’re supporting lying with numbers, but the U.S. economy will pay the price. Meanwhile, if you can exclude all those stock-based executive deals in reporting financial results, senior managers will obviously press for getting paid “large” in ways that will not “harm the company”… at least on paper.
But perhaps the most disturbing aspect of the funny numbers used by companies is the way they serve to raise executive pay levels. That’s because these companies often exclude the cost of stock grants awarded to executives and employees, significantly improving reported performance.
“Consider, a supplier of customer management software and services. In spite of recording a loss from operations of $146 million in fiscal 2015, the company’s stock is a highflier; its market capitalization is almost $50 billion.
“Investors may be focusing on the revenue growth at — up 32 percent last year and up 34 percent on average in each of the last four years. Or that the company’s most recent loss was half that generated in 2014.
“But when computes its executives’ cash incentive pay, its $146 million operating loss turns into a $574 million operating profit. This transformation occurs because the company excluded $565 million worth of stock grants awarded to employees last year.” NY Times. There are moves afoot to clamp down on such financial manipulation, but a purposely- underfunded SEC (the impact of an anti-regulatory-minded GIOP Congress) has been struggling to implement the few restrictions they are able to implement:
“Senior executives of companies that publish faulty financial statements would have to give back some of their compensation as punishment for the accounting missteps under a rule proposed on [July 1st] by the Securities and Exchange Commission.
“The rule, required by the Dodd-Frank financial overhaul law, which Congress passed in 2010, is aimed at increasing accountability within corporate America. It focuses on executive bonuses, also known as ‘incentive-based compensation,’ which have grown consistently larger in recent years. Critics of this pay boom say that it creates incentives for executives to cash out quickly, regardless of whether their companies falter in the ensuing years.
“The size and payment of bonuses typically depend on whether a company meets or exceeds certain financial metrics, like stock price performance or earnings. As it stands, an executive may get to keep a bonus even if the company artificially inflated those metrics and then corrected the missteps by issuing new financial statements. The S.E.C.’s new rule would enable a company to ‘claw back’ bonuses when the financial statements have been restated. The proposed rule will apply to companies listed on United States stock exchanges.” New York Times, July 1st. We’ll if this ever happens and whether Congress or the SEC remotely begin to shut down the other manipulative irregularities designed to keep those at the top of the economic ladder… er … at the top of the economic ladder no matter what.
These accounting distortions are actually one great big benefit that allows the one percenters to maintain their income inequality above the rest. What’s worse, we just let them!!! And we have a Congress that has absolutely no reason to make their contributors account to the rest of the world fairly.
I’m Peter Dekom, and if this practice does not bring down the whole system, at the very least it is a bubble eventually has to burst.

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