General Electric, IBM and Boeing: American capitalism has known no greater gods. Yet all three idols are now displaying feet of sticky mud. It's the same clay that's weighing down the whole trio - cooked, if not crooked figures that are symbolic of deeper sins.
The Gang of Three are by no means unique in their distress. As faith in figures has fallen, the top 600 companies in the US have suffered a year of whopping declines (17%) in market value. You can't blame investors for turning off the giants. After all, if you can't trust their accounts, you don't know what you're buying - and pigs in pokes are singularly unattractive.
This is more than a stock market crunch. What's revealed is a San Andreas fault in the Western capitalist system, nothing less. Ironically, in the aftermath of defeating communism, the capitalist order has been busily undermining itself. As the name says, capitalism is based on the allocation of capital. That distribution is supposed to finance those who use capital most efficiently. Today, it doesn't.
The consequent coverage is downright alarming. To quote Business Week, 'GE - Is Something Fundamentally Wrong?': 'IBM - Crafty Financial Moves Are Losing Their Clout': and 'How Boeing Played the Numbers Game'. That game goes to the heart of the capitalist fault. Boeing's favourite sport, 'programme accounting', is played eagerly by other aerospace companies. Instead of taking the massive costs of new planes, etc. where they matter (i.e, when incurred), the happy players average the bills over the project's life.
The praiseworthy idea is to protect the companies (or rather their published results) from the severe ups and downs inherent in the business. The far less laudable outcome is that by fiddling their forecasts - mainly of profit margins and future airplane orders - the managements can create whatever numbers they fancy. According to Lynn E.Turner, quoted in BW, 'The problem with programme accounting is that it is virtually impossible to audit'.
Turner is director of the Center for Quality Financial Reporting at Colorado State University. 'Quality Financial Reporting', to put it gently, cannot exist with processes that are 'virtually impossible to audit'. If the auditors, highly trained and experienced professionals with full access to the books, can't decipher the figures, outsiders (investors, analysts and other commentators) are in the darkest of darks. Naturally enough, preferring the light, they are starting to question whether cash profits actually exist under the murk.
In the case of GE, a significant proportion certainly didn't. That sounds unbelievable. This is the company, after all, which Jack Welch over 20 years elevated (along with himself) to superstar status. Now doubters are gathering around - pointing out, for example, that an overfunded pension fund generated $1.4 billion in 1999, equal to 16% of GE's operating income. That bookkeeping adjustment doesn't reflect any efficiency or even effort by GE's managers. The 'profit' is not crooked, it's not illegal, but neither is it hard cash.
The armies of accountants employed by companies and their auditors are trained to ensure that laws are not broken, tax is minimized (legally), and reality is represented. Their past devotion to these tasks won the figure men the sneering name of 'bean-counters'. In Britain, they were even blamed for the lack of dynamism in the local economy. Managers, claimed the blamers (talking rot), were raring to go, but the accountants (including some boardroom chieftains) held back enterprise by nit-picking obsession with counting the beans.
That can't be said of IBM's little helpers. Here irrelevant pension fund 'gains' represented 8.3% of pre-tax earnings in 2001. One-off sales of intellectual property controversially added a similar amount. Then, only 2.75% of loans and debtors was provided against bad debts, when 4% may have been more realistic. Like Welch at GE, IBM's CEO, Lou Gerstner, has quit the helm, laden with vast personal lucre, but with a gathering cloud over how it was accumulated.
When the business genuinely starts to suffer, then the patient really gets massaged. Boeing's 777 programme was crippled by real-world disasters: the development budget was overshot by 100%, deliveries fell behind schedule, production costs soared thanks to monumental mismanagement, and 'a forward loss position' loomed. It was averted only by financial juggling that in February cost Boeing $92.5 million - the price of settling a fraud suit brought by aggrieved investors.
The juggling was all to no avail, anyway. Boeing was eventually forced to take a $2.6 billion write-off on the chin. That raises a paramount question. Would managers in such situations manage better if their problems and pains are revealed immediately, inside and outside? The question answers itself. Financial accounting is the lingua franca of management. It enables apples and pears (not to mention beans) to be counted together, so that clear visibility and effective action and reaction are obtainable across the board.
Modern financial managers go far beyond bean-counting to create business models that describe the firm's strategic posture and enable other managers to achieve superior returns on resources. But this advanced work can only be safely executed on a bedrock of solid, honest counting that everybody understands and respects. Creation of profits out of thinnest air is purely cosmetic. As in the case of the Gang of Three, removing the make-up may reveal an unpretty sight.
Big-time auditors (witness Arthur Andersen) set a timebomb for themselves by adding and abetting bogus creativity. Their real role is to ensure that bedrock and creativity alike are fair, honest and true. Under pressure, auditors have failed in that duty even after querying, say, phoney 777 cost-reduction figures for Boeing as a 'plug'. That, says BW, is 'a number artificially generated to produce a desired result'.
The cumulative result of the mega-plugs is deeply undesirable: undermined faith in corporate capitalism has cost investors hundreds of billions amid suspicions that the super-scam is motivated by top management desire to maximize personal super-profits. The full American disease hasn't yet reached Europe. But rocketing executive rewards are a worrying symptom. Preventive medicine is required.
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