Infectious Greed: Restoring Confidence in Americas Companies - page 53


The incentive system of the accounting and auditing function has two problems that have the potential to decrease the effectiveness of auditors as monitors . The first problem is that auditing firms want to keep the public company as a client over the long term . This makes it less aggressive in rooting out problems because management can easily threaten the firing of the auditing firm. Indeed, accounting firms have become more like the hired guns of management instead of the sheriffs they are supposed to be. The second problem is that auditors are frequently asked to sign off on the dubious gimmicks that their own accounting firm recommended through its consulting group . The government seems to be attempting to rectify this second problem by not allowing accounting firms to provide both consulting and auditing services for the same public company. As explained in Chapter 12, we do not believe that this solution is the best remedy. We offer an alternative in Chapter 13.


  1. There are limitations on how different the public reporting and IRS reporting can be.

  1. Al Bows' tale is detailed in the article by Lanthe Jeanne Dugan, "Auditing Old-Timers Recall When Prestige Was the Bottom Line," Wall Street Journal , July 15, 2002, pp. A1, A7.

  1. Jon Birger, "Glowing Numbers," Money , November 2000, pp. 112 “122.

  1. Spencer Ante and David Henry, "Can IBM Keep Earnings Hot?" BusinessWeek , April 15, 2002, pp. 58 “60.

  1. Allan Sloan and Johnnie Roberts, "Sticky Business," Newsweek , July 22, 2002, pp. 26 “30.

  1. Paul Krugman, "Flavors of Fraud," New York Times , June 28, 2002, p. A27; Paul Krugman, "Everyone Is Outraged," New York Times , July 2, 2002, p. A21.

  1. "SEC Charges Ex “Rite Aid Execs with Fraud," Reuters Business Report , June 21, 2002, 11:05 a.m. EST.

  1. Rite Aid Corporation, Accounting and Auditing Enforcement Release No. 1579, Securities and Exchange Commission, June 21, 2002,

  1. Howard Gold, "The Graft Next Door," Barron's , July 1, 2002, p. T8.

  1. Jesse Drucker and Henny Sender, "Sorry, Wrong Number: Strategy Behind Accounting Scheme," Wall Street Journal , June 27, 2002, p. A9.

  1. WorldCom had not released details of its accounting problem at the time of publication, so we don't know the number of years the expenses were capitalized over. Other information that has leaked out of WorldCom hints that accounting problems might go further back than originally feared.

  1. John Byrne, "Inside McKinsey," BusinessWeek , July 8, 2002, pp. 66 “76.

  1. William Symonds, "The Tax Games Tyco Played," BusinessWeek , July 1, 2002, pp. 40 “41.

  1. Jonathan Glater, "Recomputing Earnings with Lawbook and Eraser," New York Times , July 2, 2002, p. C8.

  1. Christian Leuz, Dhananjay Nanda, and Peter Wysocki, "Investor Protection and Earnings Management: An International Comparison," Wharton School working paper, May 2002.

Chapter 6. The Board of Directors

"Where Was the Board?" "Pointing Fingers at the Board." "Enron Board Asleep at the Wheel." "What's Wrong with our Boards?" These are the types of headlines that appeared regularly in the nation's newspapers and business magazines following the business scandals. At first, it was the company officials allegedly guilty of various fraudulent acts who were being lambasted in our nation's headlines. Then, people naturally started wondering how these perpetrators were even able to get away with their acts in the first place. Why weren't the perpetrators, and their questionable acts and shifty maneuverings, better monitored ? Of course, some of the monitoring responsibility belongs to a firm's auditors, which we discussed in the last chapter. However, even good, objective, independent auditors are limited in their ability to monitor company officials because their main job is to evaluate the accounting numbers . So, whose job is it to monitor the executives? This responsibility belongs to the company's board of directors. The question is, why didn't the boards do a better job to prevent these scandals from taking place in the first place? So, indeed, "Where was the board?"

Many investors do not really know how a typical firm's board of directors is structured, who makes up the group , or even what it does. When you think of a boardroom meeting, you might imagine a large penthouse conference room and a large oval table in the center ”the board chairman at the head of the table rubbing shoulders with other distinguished-looking, gray-haired corporate giants, politicians , and even university presidents . While they sit in their large plush black leather chairs and enjoy a professionally catered spread and perhaps a cigar, are they going over the numbers, heatedly debating strategy, and making important decisions? Or are they just looking upon the meeting as a social gathering and cozying up to one another while catching up with their friend, the firm's CEO? The former is the effective, engaged board we want. The latter may be the actual board of many firms. It is hard to know which kind of board a firm has because the vast majority of us have never stepped inside the boardroom.

In 1934, William O. Douglas, a law professor who would later serve as the SEC chairman for 36 years , claimed that directors do not direct. [1] For the most part, it remained this way for quite some time. One director boasted, in 1962, "If you have five directorships, it is total heaven, like having a permanent hot bath . No effort of any kind is called for. You go to a meeting once a month in a car supplied by the company, you look grave and sage, and on two occasions say, 'I agree.'" [2] By all reports , however, things have changed dramatically for the better, but this is primarily a recent trend. For the past 15 years or so, shareholders have become ever more demanding of directors, and as a result, directors have been working longer hours, taking more stock ownership in the firm to ensure a vested interest, challenging the CEO more often, and taking their duties more seriously. But now board members are asking themselves , is this worth it? After all, think about the humiliation suffered (albeit perhaps deserved) by the Enron directors. Who would want to put himself or herself in a position to be embarrassed like that? According to recruiters Christian & Timbers, 60 percent of nominated directors are turning down the appointments. [3] Nonetheless, with director compensation that averages more than $40,000 per year, along with perks, travel, stocks, and stock options, all for working about 150 hours and attending eight meetings a year, a directorship is still a nice gig. [4] But now, given the recent avalanche of one scandal after another, are board members going to respond to the cry from angry shareholders for even better and stronger boards? Also, how much of our current crisis can we really pin on them?

The main purpose of this chapter is to give some basic background and information regarding boards so that we can better understand them and learn more about their effectiveness (or ineffectiveness).