The term “management by mendacity” may be
new, but it is what the authors of a new book attribute the fall of Enron
to, denial by tobacco executives that the product they produce can cause
cancer, statements by airline executives that security has been adequately
increased in airports and so forth. The book “How Companies Lie:
Why Enron Is Just the Tip of the Iceberg—The Investor’s Guide
to Corporate Smoke & Mirrors” (Crown Business)—posits
that “managed mendacity” is being used by firms worldwide
to hide their executives’ incompetence. The authors, A. Larry Elliott,
president and CEO of EDA, Inc., and Dr. Richard J. Schroth, a consultant
and advisor on emerging technology, write, “Gamesmanship has replaced
business management competence as executives and boards have focused on
managing the stock first, the business second and strategic value last.”
The subtitle of Elliott and Schroth’s book suggests
it is written primarily for investors, but the book offers some of the
following accounting warning signs that all executives need to recognize
and acknowledge:
Use of the “gain on sale” method
of accounting. This allows companies to book profits based on the
estimated future profitability of a trade made today, which may be acceptable
if the estimates are reasonable ones. On the other hand, when those who
use this technique are overly unrealistic, they can promise profitability
or revenue growth that has no basis in fact.
Use of lower-than-average return on capital.
If accurately reported, it is normally a good sign of financial health.
To determine corporate health, the figure needs to be compared to industry
averages and cost of capital. For instance, at Enron, the number was 7%
and, as the authors report, this is “quite low compared with industry
averages.”
Trouble with customers, poor press relations
and bad press. Even when the message from the company is positive,
any of these in a significant degree can trigger Wall Street investigation.
High turnover. Abrupt resignations of
top executives may be a major signal that a company is in trouble.
Excessive insider trading. This is often
a signal of bad things to come, which is why the SEC wants insider-trading
reports to be produced much more quickly.
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