Analysis: New woes may need new fixes

Los Angeles Times

When President Bush dresses down the nation's business leaders today, he is likely to rely heavily on tried and true techniques for coping with corporate corruption.

What he is unlikely to do, however, is offer anything approaching a comprehensive answer to how so much could have gone so wrong so quickly for corporate America.

Most of Bush's reforms, like those of his Democratic critics, will represent old-time fixes for what at least until recently was considered a New Economy.

That worries a wide array of analysts, who say the president's proposals may not be up to the task of catching corporate crooks and restoring public faith in the nation's financial markets. They say that the country needs a new system for keeping tabs on its corporations.

Among the key elements: new accounting to unmask the new ways companies take risks; replacement of the "carrot capitalism" of lavish executive pay packages with a "watchdog capitalism" that gives the public a greater say in corporate affairs; and a Federal Reserve willing to apply to stock prices the same tools it uses to prevent consumer prices from getting out of hand.

"The economy has changed and we need to change with it," said New York's Democratic comptroller, H. Carl McCall, who, as the sole trustee for the state's $112-billion public pension fund, is one of the nation's biggest investors.

"The level of fraud has reached the wallets and pocketbooks of all Americans and created a crisis of confidence," said McCall, who recently co-chaired a New York Stock Exchange panel that called for major changes in the way publicly traded companies are managed. "We need a system that holds [companies] more accountable to shareholders and to the public."

To be sure, not everyone is convinced the nation's economic landscape has changed so drastically it needs a new regulatory scheme for business. Even McCall cautions: "I guess we're starting down a path here and, if it appears that this is not enough, I think we are all prepared to do more."

By now, most Americans are especially skeptical about talk of a New Economy, viewing it as little more than a figment of some tech whizzes' overwrought imaginations.

But against this popular view, a wide array of analysts from Fed Chairman Alan Greenspan on down continue to believe that the economy has indeed undergone a fundamental shift that promises greater growth, but at a cost of new vulnerabilities.

One indicator that analysts cite as evidence of the shift—and of the need for substantial change in regulations—is the growth of corporate "intangibles."

Consider: As recently as 20 years ago, the value investors placed on the nation's major corporations was roughly equal to the worth of all their factories, machines, vehicles and so forth.

Today, about 70% of the value of the Standard & Poor's 500 companies consists of intangible assets that are hard to quantify.

"They are all the research and development, the brands, the technology and the employee know-how that are at the core of a company's value, and never show up on its balance sheet," said New York University accounting theorist Baruch Lev.

Lev and others argue that the growth of intangibles is one measure of the nation's transformation from an old-line, industrial economy to a new, knowledge-based one. It is also an indication of the trouble confronting the president and the Congress in coping with the current crisis.

Because if intangibles give U.S. companies a leg up in the global race for valuable new ideas, they also present a problem. By being so hard to count, track and audit, they have made it harder to follow how a firm operates and much easier for its executives to commit fraud.

"An economy in which the most valuable assets are intangible is a very different and more difficult one than the old physical economy," Lev said. "Our ancient accounting system is completely broken when it comes to handling them."

Here are three proposals that analysts say would start to address the real problems in corporate America:

  • Count more than dollars: Virtually the entire debate over the accounting breakdowns behind Enron's collapse and the string of corporate calamities since has centered on how to ensure that accountants properly count a company's valuables. There has been almost no discussion about what they should be counting. Virtually all the reform proposals—including a bill written by Sen. Paul S. Sarbanes (D-Md.), which has emerged as the gold standard for toughness on this issue—assume that the nation's "generally accepted accounting principles" properly capture firms' value and portray their most important activities. Critics assert they do no such thing. Economists Robert E. Litan of the liberal Brookings Institution and Peter J. Wallison of the conservative American Enterprise Institute argue that changes in the economy—especially the rise of intangibles—require "a fundamental rethinking of the kinds of information that corporations should be disclosing" and accountants should be checking. As examples of key measures, they cite the pattern of patent applications and approvals for drug companies, subscription trends for Internet service providers and customer complaint statistics for consumer product firms. "People think accounting is an exact science; you add up numbers and you get the right answer," Wallison said in an interview. "But especially with intangibles, companies have to guess at what the value is." Only by receiving nonfinancial information about companies can investors and others judge whether the guesses are correct, he said.
  • Call in the watchdogs: Greenspan warned this year that knowledge-based companies appear particularly prone to trouble if investors and the public come to doubt their disclosures, which are the only way to judge their performance. Commentators argue that much of the run-up in executive pay during the last decade can be seen as an attempt to cope with this problem—as it turns out, a failed attempt. The lavish pay packages gave top managers huge stakes in the companies they ran—chiefly through stock options—in hopes that by enlarging their own wealth they would improve that of the shareholders. But this "carrot capitalism" failed because some executives found it was easier to increase their wealth by cooking the corporate books, and thus raising the stock price to unwarranted levels, than by improving their companies' performance, said Litan, the Brookings economist. The failure is likely to usher in a new era. "If you had to think of where we're headed, it's toward 'watchdog capitalism,' where we have independent boards of directors and independent audit committees and a lot more SEC audits," Litan said.
  • A Fed that fights bubbles: Under the law, the Fed's job is to protect the economy from inflation by maintaining price stability. Greenspan and other Fed officials insist that they are not responsible for managing stock prices. But recently released transcripts show the central bank was worried about a stock bubble as early as 1996, and Greenspan engaged in an attempt to talk the market down that December by labeling its activities "irrational exuberance." The most vocal advocate for the Fed taking on the stock market was then-Fed governor Lawrence B. Lindsey, now President Bush's top economic advisor, who called for knocking down stock prices by raising interest rates. He argued that the case for doing so was as strong as it had been in the U.S. in the late 1920s and in Japan in the late 1980s. "It is far better we do so while the bubble still resembles surface froth and before the bubble carries the economy to stratospheric heights," he pleaded with his Fed colleagues. "Whenever we do it, it is going to be painful." In the end, the central bank held interest rates steady for almost two years, then cut them dramatically in the face of the Asian financial crisis and the collapse of Long-Term Capital Management. The result was the most spectacular stock boom in U.S. history—setting the stage for the market collapse and today's emerging scandals.
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