Walter Mitty and Financial Data
Wriston, Walter B.
Every once in a while it is useful to pause and take a break from whatever daily routine we engage in and ask ourselves what it is we are trying to accomplish. All of us remember the old Charlie Chaplin motion picture depicting a man caught up in a huge machine. Despite his best efforts, he became a cog in the turning wheels of the machine he was supposed to be fixing. Those old machines are now gone, but they have been replaced by a kind of paper chase. The metal cogs are now word processors, and instead of running around with a wrench and an oil can, we are condemned to fill out endless forms replete with warnings of dire consequences concerning entering false data. While this is part of modern life, I would pose two questions--first, what is it we are really trying to do? And second, does what we are now doing help us achieve the desired result?
Sometimes we all play Walter Mitty and dream impossible dreams. One of my dreams has always been to be allowed to keep the books of Citicorp the same way for two years in a row so we, and our investors, would know how we are doing. This is not to be--each year brings mandated accounting "improvements" that may have a sound conceptual base, but nevertheless change the numbers in greater or lesser ways making it difficult to interpret results on a consistent basis. While consistency may be the hobgoblin of little minds, as Emerson said, it also has its uses.
In this forum we are talking about the SEC, which was originally formed to protect the unwary buyer of securities against being misled by fast talk and false data. Disclosure was to be the touchstone of investor protection, and over time, the form of disclosure became stylized like a Kabuki dance, while information presented in other formats was said by some to offer no real protection. This point of view reached its point of when a legislative committee in New York held hearings to imply that we bankers did not make full disclosure about what we knew about New York city's finances. At the hearing I held up the front page of the , a newspaper which at that time had the country's largest circulation. The headline covering the entire front page read "City Broke." I argued, not unreasonably I thought, that a paper read by millions of people constituted full disclosure. And yet, some people with straight faces advanced the notion that since it was not in fine print in a prospectus, this was not true disclosure. In the end common sense prevailed, but it was a near thing. If the purpose of disclosure is to warn and inform the investing public, certainly the is at least as effective as a 10k. On the other hand, if the goal is not really to inform, but rather to conform to a requirement of completing a form devised by lawyers, it was inadequate. So we arrive at the first question I posed: what are we trying to do? It seems to me what we should be trying to do is to produce reliable, timely informative data within an understandable accounting framework that allows people to make informed judgments.
Few organizations in the world need so much reliable, timely financial information as the corporation I serve. At Citicorp, we are investors of other people's money in the stock and bond markets of the world, so our investment analysis and portfolio managers require good financial information. We are also large lenders of other people's money to individuals and corporations, so our lending officers need accurate and timely data. As a corporation, our stockholders must be furnished a steady stream of financial information about Citicorp. We are also a large borrower in the markets of the world, and so we need to supply those investors with all manner of financial data. And finally, we have to run a fair-sized business, so we need good information to make rational business decisions. This short list does not include the approximately 7,000 reports we supply to our regulators each year.
For all of these reasons, our interest in good accounting and timely information is a great deal more than academic. Our business success depends upon it. One of the basic fundamentals we have come to believe in strongly is that accounting should reflect business decisions, and not drive them. We have all come close, a time or two, in succumbing to the temptation to make a dumb business decision that produces a good accounting result, or conversely, failing to do something that is economically sound that might be reflected poorly in financial accounting.
Each of us sees the world from our own perspective, like the blind men and the elephant--and like the blind men, each of us can reflect absolutely accurately what we discern while, at the same time, missing the whole picture. In the world of finance, the market is the greatest data processor in the world. It adjusts for things seen and unseen in a way no single person can perceive. This is one reason that companies that grow and prosper present an honest face to the market. Adam Smith explained it all more than 200 years ago:
That is why markets discard companies that are not forthright, no matter how pure their accounting conventions. Indeed the most important element in looking at the strength of a company is not reflected in accounting conventions. Peter Drucker, in his usual blunt way, put it like this: "What the accountant calls productive labor is manual workers tending machines, or actually the least productive labor. What he calls non-productive labor--all the people who contribute to production without tending machines--is a hodgepodge...finally what the accountant lumps together as overhead--the very term reeks with moral disapproval--contains what should be the most productive resource: the managers, researchers, planners, designers, innovators." The ability of a market to look through the mass of data and arrive at a conclusion on everything from the dollar/yen cross rate to the price of a given security is frustrating to people who believe a particular professional discipline should have more influence on prices than it apparently has. George J. Benston of the University of Rochester's Graduate School of Management has done research that "shows that, on average, earning changes produced by accounting are not associated with changes in stock prices except when new methods result in lower taxes. In short, the market appears to be able to see through accounting gimmickry." He goes on to say: "There is also some evidence to suggest that the market is not fooled by all the distortions of financial data resulting from inflation." The fact that the market makes judgments at variance with what you and I might regard as the "correct" judgment based on the "facts," does not alter the printout that records what people will pay at a given time for a security or currency or commodity. The reality of an efficient market is not at variance, in any way, with the conviction that our accounting standards be well thought out and followed. I would therefore suggest that the answer to the first question i posed: "What is it we are trying to achieve," is that we want and need accounting and reporting standards set in a forum of due process in a manner that reflects the results of management decisions, and does not dictate them. This does not necessarily mean that more is better. We may have too much "data" and not enough "information," indeed we have a data overload.
Clearly we must have a set of standards if we are not to have chaos. At the same time, the accounting profession and the regulators who have the power to mandate financial reporting rules must come to grips with the question of what information is relevant for financial decision making. I would suggest that they use the old adage, "less is more," as their guide. Our ability to discern what is important and what is not may be impaired if one is inundated by a sea of numbers. Too many numbers may make the decision-making process harder, not easier, for the average investor. All of life is the management of risk, not its elimination. We can have too much exercise, or too little; too much food, or too little; too much medical attention, or too little; take too much risk with our investments, or too little. Increased disclosure may help reduce ignorance-induced risk, but can never protect investors from the natural risks inherent in investing. When I started out as a credit officer, I used to go down the street to a lending officer at another bank and ask him, "Is company X's credit any good?" He would say, "Yes" or he would say "No." And that was a credit check. The assumption today is that more and more statistics make life less dangerous for the investor, but the number of loan write-offs and bankrupt companies fail to prove the case. Today's record is not all that different from yesterday's, before the data explosion presumably gave us all better information.
Investors may be reaching the saturation point. Maybe we should consider a sunset rule for reporting disclosures. The hot topic on today's front page produces a demand for a huge stream of data that seems to go on forever, or at least long after the topic it was meant to illuminate has faded from view. The time has come to streamline and, more important, prioritize financial disclosures. It is heartening to see that the SEC has started to move in this direction with its integrated disclosure program and its concept of a continuous offering under a shelf registration. Citicorp and many other corporations have used the shelf registration format a number of times and found it well accepted by the market. Today's fast moving global financial markets require investors' access to financial information but they also require flexibility and speed.
While some progress has been made in reducing "data overload," the tendency to over-disclose and over-regulate still remains. A current example is the controversy over pension accounting rules. Many have serious reservations as to whether the proposed disclosures will be more useful than the currently required footnote. The proposed recognition of a net pension liability and related intangible asset might needlessly inflate the balance sheet without adding anything useful to the investor's knowledge. On the negative side, it is possible that it would cause many companies to be in technical violation of debt covenants spelled out in indentures and loan agreements. Of course, lenders may be expected to waive these violations if they don't reflect a real worsening of the company's economic position. But if that is true, all we have accomplished by the exercise is to waste time and make more work for companies, their bankers, accountants, and lawyers. But the key question is, as always: what are we trying to accomplish? Would the investor, lender or manager be served by this additional information? Would this change help us make better lending judgments; would investors be more successful in making money; or would managements form better business decisions? Any incremental benefit, which may be seen by accounting theorists, might be far outweighed by the negative effects, which may translate, in some cases, into a real impact on companies' attitudes towards granting retirement benefits to their employees.
Pension accounting is not the only issue I could cite. The FASB will soon have to evaluate the usefulness of the inflation data it has made companies report since 1979. Was it worth the effort and additional cost needed to prepare it? Does it help the investor in his, or her, pursuit of profit to look at three or four earnings-per-share figures for the same company in the same year? There is no clear consensus, but there is much evidence that the market understands with or without the data how to adjust for inflation or deflation.
If we are to have reasonable and useful accounting standards, which we all desire and need, it seems logical that standard-setting should remain the sole responsibility of a single body, lest confusion abound. A good argument can be made that a cohesive body of accounting and reporting standards requires the centralization of responsibility in one organization. Since the FASB was the body set up to handle this function, it needs everyone's support.
Some would like to dilute the authority of the FASB by having certain of its functions "farmed out" to the AICPA. In the view of many, the AICPA's accounting standards executive committee in particular is not suited for any authoritative role in the rule-making process. The financial community accepts the FASB as rule-maker because the board is representative of, and accountable to, the entire community, its process is open and accessible, and its composition ensures an adequate level of quality in its work.
The FASB is also best able to handle the wide range of standard-setting problems because it is immune to undue influence from any one constituency. Its system of due process requires it to gather input from all constituencies using financial information. The FASB can also better balance the needs of the users of financial data with the needs of those who prepare that data since its mandate is not geared towards the protection of one group over another.
The second question I posed is this: after we agree on what it is we are trying to achieve, are we really taking actions which move us toward our goal? I would suggest the answer is not totally clear. On the one hand, the setting of standards by FASB is clearly moving us toward a worthy goal. But the tendency of the accounting profession to avoid exercising judgment and to clamor for a "cookbook" with a recipe for every conceivable accounting problem does not inevitably move the world forward. This attitude can result in the kind of proliferation of accounting standards exemplified by the lease accounting rules found in FAS 13, and FAS 17, and FAS 22, and FAS 23, and so on, . Lawyers have never succeeded in producing a rule of law that exactly fits every conceivable legal dispute. A good lawyer will produce an opinion, based on the facts and the existing precedents, that permits business to proceed with reasonable confidence. If accounting is to remain a profession, its practitioners must be willing to exercise similar judgments as professionals. And those practitioners should include in-house accountants, not just public accountants. Members of the profession on corporate payrolls should be held to the same code of ethics as external auditors, and should have the same responsibility to exercise professional judgment as independent CPA's.
This means that if we are to achieve the goal of producing useful financial information in a timely manner, we must all pitch in to make it happen. If, as Clemenceau said, "War is much too serious a matter to be left to the military," accounting standards are too important to be left to accountants. We, in industry and finance, must help the investing public and the standard setters distinguish between information that is really necessary to make an informed investment decision and that which is marginal-to-useless data. We must work for the reduction or elimination of unnecessary and burdensome data. We must present the important information in a more usable form, and also make the information simpler to prepare on a timely basis.
While the ancient rule that to simplify is to falsify has some grain of truth, it does not follow that to complicate moves one closer to the truth. It is also possible to fill up the background with so many facts that the foreground sinks out of sight. The touchstone should be usefulness rather than form, timeliness rather than all-encompassing data produced too late. We all have to believe that what we do is important in the scale of things or it would be hard to come to work. Without plumbers, modern life could not function, without farmers we would starve. Each occupation plays a part in a complex society. But in all this complexity, we must keep a sense of the important. Daniel Boorstin in writing about us, the Americans, put it this way:
The modern miracle of high speed printers driven by micro processors now records 2,000 lines of data a minute in dozens of remote locations simultaneously. Perhaps as Boorstin suggests, this miracle could warp our sense of perspective about what is really needed to make informed judgments.
If we return once again to the dreams of Walter Mitty, I suggest the not-impossible dream that common sense and the rule of thumb may help us arrive at the best answer to the questions I have posed.