Archive for August, 2010

Closer Look Series: Topics, Issues and Controversies in Corporate Governance, No. CGRP-09, by David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program, And Brian Tayan, MBA ’03, Stanford GSB;

• Pro Forma Earnings: What’s Wrong with GAAP? (PDF)
  

Reliable financial reporting is essential to the proper functioning of capital markets. Investors rely on reported financials to make investment decisions and to evaluate the performance of management and the company over time.

Recent years, however, have seen a proliferation of non-GAAP metrics to supplement official financial statements. Non-GAAP metrics exclude income and balance sheet items that are required under U.S. generally accepted accounting principles. Over half of all companies in the Dow Jones Index make such adjustments when reporting quarterly net income.

What does it say about the quality of the system that so many companies report non-GAAP earnings?

Are these adjustments being made for the benefit of shareholders, or to distort reported results?

Is That CEO Telling the Truth?
Stanford GSB News, August 13, 2010
How do you tell if CEOs are not being truthful during quarterly earnings conference calls? Stanford Graduate School of Business researchers have developed a model to analyze the words and phrases used during these calls and found some specific speech patterns that give clues.

Referenced working paper:
Detecting Deceptive Discussions in Conference Calls (PDF)
Working paper dated: July 29, 2010
Authors: Professor David F. Larcker, Stanford University – Graduate School of Business; PhD student Anastasia A Zakolyukina, Stanford Graduate School of Business

Paper Abstract:
We estimate classification models of deceptive discussions during quarterly earnings conference calls. Using data on subsequent financial restatements (and a set of criteria to identify especially serious accounting problems), we label the Question and Answer section of each call as “truthful” or “deceptive”. Our models are developed with the word categories that have been shown by previous psychological and linguistic research to be related to deception. Using conservative statistical tests, we find that the out-of-sample performance of the models that are based on CEO or CFO narratives is significantly better than random by 4%- 6% (with 50% – 65% accuracy) and provides a significant improvement to a model based on discretionary accruals and traditional controls. We find that answers of deceptive executives have more references to general knowledge, fewer non-extreme positive emotions, and fewer references to shareholders value and value creation. In addition, deceptive CEOs use significantly fewer self-references, more third person plural and impersonal pronouns, more extreme positive emotions, fewer extreme negative emotions, and fewer certainty and hesitation words.

Related Media Coverage: Wall Street Journal Blogs: Deal Journal, “How Can You Tell If A CEO Is Lying?, August 11, 2010

Power: Why Some People Have It And Others Don’t” (Video)
Interview with Professor Jeffrey Pfeffer on his new book

Stanford Graduate School of Business Professor Jeffrey Pfeffer discusses his new book “Power: Why Some People Have It And Others Don’t”. Pfeffer, an internationally recognized authority on power in organizations, talks about his motivation in writing the book, interesting anecdotes, and what he hopes the book will accomplish.
More info on his book found here.

(Commentary by David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program, And Brian Tayan, MBA ’03, Stanford GSB;  Date: 8-9-2010)

Last week, Forbes published a list of the “20 Most Responsible Companies” based on ratings provided by GovernanceMetrics International (GMI). While the list contains many well-regarded companies—such as Colgate-Palmolive, Dover, and PepsiCo—it also has some questionable picks.

The most notable is Occidental Petroleum. Oxy is notorious among shareholder activists for the generous compensation awarded to CEO Ray Irani. Irani was ranked third on a list compiled by the Wall Street Journal of the highest paid CEOs over the last 10 years, bringing in a cumulative $857 million. While Irani has overseen tremendous shareholder value creation during his tenure, many have questioned whether this level of pay is excessive.

For example, the Teacher’s Retirement System of Louisiana has long lobbied to reduce his compensation. Proxy advisory firms RiskMetrics Group and Glass Lewis routinely recommend a vote against the company’s equity plans. Prominent journalist Geoff Colvin of Fortune has called Irani an “excessive-pay hall of famer.” In May, shareholders handed the company defeat in its first advisory vote on compensation (“say on pay”). And just last week, shareholder activist Ralph Whitworth of Relational Investors and the California State Teachers Retirement System launched a proxy fight to gain access to the company’s board. Whitworth described Occidental’s board as “ossified and entrenched” and was critical of the company’s compensation and succession planning.

All of this makes you scratch your head over why GMI would place them on their top 20 list. The only explanation that GMI provides is that Oxy is “responsive to shareholder initiatives, such as special meetings.” We doubt Mr. Whitworth would agree.

Even The Corporate Library (TCL) has been pulled into the fray. TCL merged with GMI last month. In a recent blog posting, TCL wrote: “Several observers have noted the fact that TCL has criticized some firms GMI rates highly, and have asked us how we plan to reconcile the differences. Our answer could apply to any good marriage: we’re going to discuss, explore, and learn more about each other’s points of view, and then decide what to do.”

Sounds like code for: “We have no idea where they came up with this one.”

For our purposes, it gets to the fundamental question: if the so-called experts can’t agree on what constitutes good governance, how can shareholders be expected to rely on their judgment?

Sources:

• GMI, “Beyond the Balance Sheet: The 20 Most Responsible Companies,” Forbes, August 3, 2010.
• Geoff Colvin, “As Executive Compensation Becomes Topic A (Again), the Real Outrage is How CEOs Are Paid, Not How Much,” Fortune, May 3, 2010.
• The Corporate Library (TCL) Blog, “A Marriage of True Minds,” August 5, 2010.

Closer Look Series: Topics, Issues and Controversies in Corporate Governance, No. CGRP-08, Stanford Graduate School of Business, By
David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program And Brian Tayan, MBA ’03;  Date: 8-5-2010

• Director Networks: Good for the Director, Good for Shareholders (PDF)

A director’s social and professional network contributes to his or her qualifications as a board member. In recent years, much attention has been paid to the negative aspects of inter-board connections, such as the spread of bad practices and a reduction in independence.

At the same time, not enough attention has been paid to the positive effects, including the access they provide to important market data and the referrals they bring for new business relationships.

We consider these effects in more detail and ask why it is so difficult for commercial governance ratings firms to incorporate this information into their analyses of governance quality.

Related Research:

Boardroom Centrality and Stock Returns(PDF )

Working paper dated: July 24, 2010

Authors: David F. Larcker , Stanford University – Graduate School of Businesss; Eric C. So, Stanford Graduate School of Business,

Charles C. Y. Wang, Stanford University