Monday, January 24, 2005

Slip Sliding Away 

How does a respectable corporate executive slip into fraud and ruin his reputation and the reputation of his company? Oddly enough, a book on Accounting Irregularities and Financial Fraud, (Aspen Law & Business, 2002) paints a convincing picture of what happens.

It's important to understand how irregularities occur because every one of us can be tarred by major failure. The editor of the book, an attorney by the name of Michael R. Young, draws a picture that limns the Internet Bubble.

It starts with a company that is a hot stock and a CEO who is overly concerned with Wall Street's opinion. The CEO sees business starting to slow before Wall Street senses it. Usually a slowdown is cyclical because no business grows at a fast pace forever. The CEO refuses to accept that the company must cut earnings, and he damn well doesn't want to see his stock price fall. To prevent that, the CEO holds his executives to high earnings targets and will not bend. His subordinates MUST find a way to meet sales and earnings goals -- often called "stretch goals."

A division president knows there is no way he is going to make the target based on the business, so he looks at gray areas of accounting and starts to cut corners legally. He'll ship as much inventory at the end of a quarter as he can. He'll cut reserves for bad debt. None of these things are wrong, but they are not recommended. The problem is the next quarter the business still has not picked up, and the president has to make the bogey again. He becomes even more aggressive with accounting. It happens the next quarter too and the quarter after that. Pretty soon, he has uncollectible receivables and erroneous inventory levels. There is nothing he can do except to continue the fraud until someone discovers it, and the reputation of the executive and the company are damaged.

The president didn't start out to be dishonest. The CEO pressured him and created a "no-excuses" environment that was more than the president could bear. The president didn't engage in massive irregularities at first. He did little things that took control of him rather than he controlling them. The fraud grows and grows, and there is no way out. Eventually, it bursts.

Every one of us has seen companies run like this, and most of us have probably gone along with the pressure because "that's the way business is." The point this attorney is making is that isn't the way business should be. Honesty is the first and best policy. The first person who was dishonest wasn't the president but the CEO who would not accept the cyclical nature of the business. Unfortunately, the CEO is likely to get away unscathed and the division president take the fall.

There is not much PR practitioners can say when CEOs become arrogant, but it should be a warning to get out of the company before the house of cards collapses.

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