Barry Shanoff

January 1, 2000

4 Min Read
MANAGEMENT: The Numbers Game

"Unfortunately, at this time we aren't able to provide guidance on future quarters with the level of confidence the investment community would expect and deserves." - Waste Management Inc., Chairman Ralph Whitworth, commenting last November on the company's third-quarter performance.

The Houston-based waste company continues to struggle with accounting problems. Last year, a round of larger-than-expected charges, reflecting asset markdowns and write-offs, could have jeopardized the company's bank credit if its lenders had not generously granted waivers.

As if its huge net losses - nearly a billion dollars in the third quarter of last year - were not enough, Waste Management officials could not say for sure if the company had overcome its bookkeeping irregularities. The company's seeming inability to get itself unstuck has astonished and disappointed waste industry observers, has angered stockholders, and has troubled regulators and others who demand and count on the financial assurance that Waste Management provides in connection with its nationwide operations.

Investors and industry analysts knew that the former Waste Management - that is, before its mid-1998 merger with USA Waste Services - had problems with the reliability of its financial statements. By all accounts (no pun intended), the purchase was supposed to resolve and eliminate these concerns. Instead, teams of accountants and auditors continue to probe and recalculate the financial reports and records from divisions and operating units throughout the company.

Waste Management is not unique among large national firms in its struggle to present a "true picture" of its financial status. Companies such as Rite Aid Corp., Cedant Corp. and Sunbeam Corp. have had to explain why previous financial statements were misleading.

In 1998, Securities and Exchange Commission (SEC) Chairman Arthur Leavitt Jr., decried the "numbers game" played by companies that manipulated accounting data to produce desired results. (No inference should be made that any of the companies named above or their respective auditors have done anything illegal.)

Some company managers feel tremendous pressure to "make one's numbers" - to match or, better still, outperform Wall Street expectations, or to create steadily improving results. Indeed, some top officials seem as though they were managing their stock more than managing the company.

"This process has evolved over the years into what can best be characterized as a game among market participants," Leavitt said in a speech.

How can a company tinker with its books if its outside auditors are doing their jobs, that is, assuring that the numbers presented to the public accurately represent the performance of the company?

Maybe the auditors simply are not doing a proper job. When a fraud is uncovered or when a company revises its statement of earnings, it as much reflects an audit failure as a management shortcoming, according to Howard Schilit, who heads the Center for Financial Research and Analysis Inc., a Maryland firm that dissects corporate financial statements.

"The starting point always is the same - a business that is starting to struggle," he said. "At that point, management has two choices - come clean and get hammered" in the market, or "don't play fair."

Outright fraud can be hard to detect if management is clever and can count on help from vendors and customers. Take the case of receivables. An auditor must verify that they exist and are likely to be paid. Sometimes, however, company records contain letters from customers acknowledging the receivables and promising to pay - even when the sales were fictitious. SEC officials say that approximately 20 percent of the enforcement cases it brings involve financial or reporting fraud.

More pervasive is the practice of aggressive accounting, according to experts. Besides coping with numbers, the process of auditing involves many judgment calls, which, critics say, provide an opportunity for pressure from management.

One explanation stems from accounting trends. These days, accounting firms make a lot of money from consulting. Meantime, auditing services are very competitive, and hourly rates are relatively low. If the auditing department wants to sustain or boost its revenues, it can't afford to antagonize management.

Currently, the law does not require auditors "to discuss with the [company] board of directors the 'quality' of financial accounting being reported by the enterprise," said Walter P. Schuetze, chief accountant of the SEC enforcement division.

However, the SEC has proposed a new rule that is intended to eliminate overly aggressive accounting by forcing board members, particularly members of an audit committee, to confront directly the underpinning of financial reporting.

If adopted, the rule would require that "the auditor discuss with the board the accounting policies, the estimates and judgments being made by the enterprise, [and] how these fall on the spectrum between aggressive and conservative," Schuetze said. "Once boards ... and audit committees become more involved in understanding ... financial affairs, corporate governance will improve ...," he added. "It is after all the directors whom everybody looks to."

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