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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 214198  
Subject: Please lie to me. Date: 2/21/2002 5:35 PM
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Please lie to me. After all, I am only a shareholder. And could you do it regularly, quarter after quarter, year after year? I sleep better at night. And my cat seems to enjoy it also.

In the current edition of Fortune, GE is selected as America's most admired company. And in the same issue, GE's management of earnings is discussed. Doesn't anyone see the irony?

From the article: In April 1994 the escapades of rogue Kidder Peabody trader Joseph Jett left GE with a $350 million hole in its earnings. "The response of our business leaders to the crisis was typical of the GE culture," Welch recalls in the book. "Even though the books had closed on the quarter, many immediately offered to pitch in to cover the Kidder gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise."

It's long-standing practice at GE, whenever the company makes a big gain from the sale of a subsidiary or another asset, to come up with some sort of big discretionary investment or a restructuring charge in the same quarter--which keeps net earnings rising smoothly instead of jumping around from quarter to quarter. In the fourth quarter of 2001, for example, GE made a $642 million gain on a satellite partnership and conveniently took a $656 million charge for exiting unprofitable businesses and marking down unsuccessful investments (including an $84 million loss on Enron bonds).

Immelt and CFO Keith Sherin don't deny this at all. They just find it incomprehensible that anyone would want them to report 30% earnings growth one quarter and 3% the next if they can avoid it. "It just doesn't make any sense to us in managing a business," Sherin says.


So lie to us then.

I am reminded of the perfect of police in Casablanca. Just before pocketing his winnings for the night, he announced that he was shocked to see gambling going on in Rick's, and closed the place down. We are collectively shocked at the fraud in the statements of Enron, all the while celebrating the earnings management that is standard practice at GE, our most admired company. And it is done for our sake. It is incomprehensible that we would want the facts, when warm and fuzzy lies keep us fat and happy.

Is "lie" to harsh a word? I don't believe so. What else would you call the reporting of financial results that companies know to be false, at least false in the sense that they are not management's best estimate of performance for the period under question? So we accept a practice from the management of American corporations that we would find deplorable in school children. Have we lost our sense of irony, or our sense of shame?

There is enormous pressure on companies to manage their earnings. But where is the pressure on shareholders to demand that they do so? There may also be enormous pressure on students to cheat in school. But does that mean that their parents should encourage such activity?

So please lie to me; don't include the cost of stock options on income statements. Please lie to me; take huge one time charges instead of reporting the cost of mistakes in the financial statements as they occur. Please lie to me; give me misleading pro forma earnings - everything but the bad stuff - instead of real results.

Just today, Conseco reported its fourth quarter results. Look at this howler. In their pro forma results, they classified $47.8 million of investment losses as a non-operating item. The following is their explanation: Net Realized Losses on Investments. In addition to realized gains and losses from the sale of investment assets, and other normal activities in this account, it includes impairments on fixed maturities connected to those widely reported business failures -- Enron, Kmart, Global Crossing, and investments in Argentina. Where is the sense of irony? They are claiming that investment losses are not operating in nature because they are the results of bankruptcies. And from Enron no less! Enron failed, in part, because they were trying to fool investors about the true nature of their earnings, pushing losses off the income statement. And Conseco is attempting to fool investors regarding the true nature of their investment income by removing investments losses from operating earnings just because they were from bankruptcies. If I could write stuff like this, I would go professional.

"Sure," people will protest, "there is a difference between managing earnings and fraud." But is it? To me, a little bit of earnings management is like being a little bit pregnant. The earnings are still wrong, and the lady is still pregnant. Maybe there is a difference, and it all depends on what the meaning of the word "is," is. But again, maybe not.

Is this what shareholders want? GE believes that it is. Conseco believe that it is. If so, we deserve the Enrons we get. We can't ask companies to lie just a little - good lies - but no so much that it creates problems - bad lies. When does a good lie go over the line to being a bad lie? Do you want management to make these kind of decisions, when they could just prepare the best financial statements possible and let the chips fall where they may. Can you ask the ladies to remain "just a little bit pregnant?"


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Author: timetogrow Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61097 of 214198
Subject: Re: Please lie to me. Date: 2/21/2002 6:06 PM
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If I could write stuff like this, I would go professional.

Ah, but professional "what"??



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Author: jmls Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61100 of 214198
Subject: Re: Please lie to me. Date: 2/21/2002 7:17 PM
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Dear EliasFardo,

Is this what shareholders want? GE believes that it is. Conseco believe that it is.

Frankly, I think GE and Conseco are correct, this is what most of us want.

I hope that I am wrong, but I don't think Joe Sixpack shareholder is the most analytical guy in the world. Part of it is an information barrier; how many shareholders do you believe actually know that there are three financial statements, or where to find a 10-K or a 10-Q on Corporation X? I hope it is the great majority, but I sort of doubt it. Joe Sixpack wants to save for retirement or send his kids to college, and he's heard on the news somewhere equities are the way to go. Joe knows GE is a solid company; it has had many consecutive years of double-digit earnings growth, and Joe buys GE lightbulbs and appliances. Company X, which returns 30% one year and 3% another, seems more risky than good old solid GE with its "automatic" double-digit returns. Somewhere some green eyeshades fellow talks about "poor earnings quality", "overfunded pension plan", "one-time gains", but these terms make Joe's head ache, and GE delivers the goods.

Incidentally, I don't think that Joe Sixpack is all that analytical in other areas either. How many Joes look up their elected official's voting record? Not so many. How many Joes listen to political debates? More than look up the voting record, but not so many. How many Joes, if they bother to vote at all, simply check the candidate next to their chosen political persuasion? My guess is that this number is larger than the number of folks who listen to political debates.

Best,

Lleweilun Smith

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Author: ROKO2 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61102 of 214198
Subject: Re: Please lie to me. Date: 2/21/2002 8:12 PM
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Dear Elias,
Your story reminds me of an incident long ago when I was in first grade, and walked home from school with the local attorney's daughter who was in my class. And since we passed a little neighborhood grocery store, we went in.
Usually we had a few pennies that would buy candy, but my friend looked longingly at some small cherry pie turnovers, wrapped in a sleeve of waxed paper, that cost a dime. Suddenly, she took one and put it in her coat and said "Let's go!"

I was horrified because I knew she was shoplifting and I knew that was terribly wrong. But as we got outside, she buried it in a snow drift, and took my arm to continue on home. After a couple steps she wheeled us around, and went back and dug it out, feigning great surprise at her find!! Then she led us back into the store, where she confronted the shopowner with her miraculous find in the snowdrift. He said, "Oh! Well, you can keep it."
At that, she thanked him, and went out triumphantly eating her pie with a very clear conscience in her mind!

I was amazed at her audacity and ingenuity!! And I never told my parents or siblings, as I was sure I was going to get a huge lecture on how I had aided and abetted a criminal - and I would probably have been sent to bed without supper.

And - by the way - she never even offered me a bite......

roko2, who learned a lot about how a lawyer's daughter knew her way around the world, even in first grade.

p.s. I never have shop-lifted in my life, either.

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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61104 of 214198
Subject: Re: Please lie to me. Date: 2/21/2002 9:35 PM
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Lleweilun

I believe that shareholders actually want the truth. Management manages earnings for its own benefit, not for the owners. They want to make their life easier by making your life harder.

It goes deep into the corporate structure. Division managers on a performance bonus plan will report enough earnings to maximize their annual bonus. Anything left over will be socked into reserves to be used to maximize their bonus in the following year. Reporting more or less income that actually earned just to gain monetary benefit for yourself is, of course, stealing. But it goes on. I have no reason to believe that senior management does not do the same thing.

Look at the respect that Buffett gets for attempting to put out honest numbers. Unfortunately, much of corporate America does not trust its shareholders or itself enough to come clean. I believe that you undersell the public. But, again, if this is what shareholders want, they can't complain about the Enrons. There is only a degree of difference between what Enron did, and GE does.



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Author: HamletsMill Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61106 of 214198
Subject: Re: Please lie to me. Date: 2/21/2002 11:27 PM
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I believe that shareholders actually want the truth

If it is given to them early on, afterwards, well...

It's long been noted in the field of social psychology that most people have the following decision making process:

1. A quick judgement call based on initial information.
2. Subsequent information received is heavily filtered through the earlier judgement made.

A basic example: You meet John Doe, a new co-worker. He makes a favorable first impression on you. Later you hear some negative things about him. You tend to interpret that information in the most positive way to support your first take about him.
Depending on how strongly you first felt, and/or how bad the following data is, it may take weeks to years, to never, to change your mind.


From an evolutionary point of view, this fast decision making can be seen as a positive. At the gathering & hunting band level of social organization that the human race lived in for 98% of its collective existence the adage about “he who hesitates is lost” was for the most part a superior survival strategy.
Going with that first impression – that lion looks like he can eat me with no trouble, from now on I'm going to stay away from the cat even if that weird guy claims that he has tamed him (whatever “tamed” means) – worked far better than slowly accumulating information and then making a flexible decision. (Are lions safe to approach after they have killed and eaten another prey… oops, guess not!)
It may not (almost certainly probably not) be in our genes, but that process seems to be deeply embedded in our behavioral patterns.

And so it is in politics, and in investing. We, rightly or wrongly, give heavy weight to our first impressions.

Can we change that behavior? Of course, but it takes concentrated effort, hard work. And, largely, that pattern still works for us surprisingly well. (A number of studies have shown that most people are remarkably accurate in their first impressions about the quality of what they are judging – if they have some prior familiarity with general subject. We get the gestalt…).

But, and here is where I partially agree with you, those people who are responsible for managing other people's money – in effect being the surrogate decision makers – the ones who have the time and obligation to demand all the relevant information be honestly delivered should demand the unvarnished facts. However long it delays, or causes them to change a decision.
Given that pattern of reluctance to change a early opinion, and the unequal lack of leverage the average investor has, a shareholder revolt for truth and fiscal integrity, which I believe you are implying, can only be started by those who control the most shares, i.e. the institutional portfolio managers.
But if history is any guide, they won't, until the state of affairs becomes chaotically unprofitable.

[A sobering read is the history of the Stock Market in the 1920's up to the Crash. "Pools" a highly unethical, yet not really illegal, method of pumping and dumping stocks by cross-trading was widely known about and reported to the general and institutional investing public. However it was an era of strong belief in Lassiz-faire, not to mention Caveat Emptor, and shoe-shine boys becoming millionaires. Ignoring, ah, indiscretions was an acceptable part of the game.]

Back to the average investor, I think Lleweilun is right. They don't want to wade through difficult and possibly contradictory information about their investment decisions… and sad to say they also have a tendency to want to shoot the messenger who insists on providing them with such.
So, for good and bad reasons, I don't think we should expect too much from them.
Except, perhaps, a gradual withdrawal of active interest in the financial lives of equity corporations.
To mix a few adages: "They're all crooks... the hell with them... I going home to tend my garden."
So in politics, so in an earlier generation after the Crash, perhaps, so now...



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Author: solasis Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61107 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 12:39 AM
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Elias, unfortunately it isn't just a psychological issue because in the debt markets there is often a financial incentive for "smooth" and a premium to be paid for "lumpy". look at the current market. we haven't seen these kinds of yield spreads between treasuries and BBB or better corporates in 20 years.

that's one of the problems with GATX for example, and in my estimation a driving reason by the acquisition of XTRA. As a subsidiary of BRK, XTRA can get capital internally, and will no longer have to pay a penalty for "lumpy". GATX simply can not compete with GE on a cost of capital basis.

your point that little corruptions, if generally accepted, have a tendency to eventually become big ones, however, is right on the mark.

tr

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Author: Juggernaut8 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61109 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:14 AM
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<<<(A number of studies have shown that most people are remarkably accurate in their first impressions about the quality of what they are judging – if they have some prior familiarity with general subject. We get the gestalt…).>>>

The above point seems strange, and seems to contradict what you were saying in the rest of your post. Numerous studies in the social sciences have shown that people are:

Horrible eyewitnesses-
Terrible lie detectors-
Bad judges of candidates in job interviews-

So it seems that people are horrible judges of a lot of things. What were you referring to in the above quote?

-J8

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Author: jtayan Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61110 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:32 AM
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It has struck me as odd that GE, before this year began, declared what their earnings would be for 2002 and 2003. Now, do people realize that 2003 has not happened yet? So why do they feel better to know the future earnings? It is a statement from GE that they will either make those numbers or can manipulate enought to appear to make them.

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Author: HamletsMill Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61111 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 2:10 AM
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First, I think I have made a mistake in using the term “first impression” rather than first decision.

As for the examples of human error you noted:

Being an eyewitness is a matter of recall – and yes, our memories, especially under transient or stressful conditions can be terribly unreliable.
But what I was referring to was the decision-making process. You see a car hit a man and speed away. Later you can't quite remember the color of the car, or who actually was driving, and so on. But at that moment you make the quick decision to first call 911 on your cell phone before rushing to the aid of the injured man.
Bad eyewitness, good fast decision-maker.

People are often bad lie detectors because either lack context for determining the veracity of the statement (a lack of background, gestalt) and automatically default in assuming truth (it is both our naivete and our saving grace that most of us tend to assume the best in others until proved otherwise) Or, they lack the skills to detect non-verbal cues, speech pattern, etc. that give away most non-pathological liars. That lack of skill again relates to background – the more trained and experienced we are, the more likely our first decisions are going to be correct.

As for being bad interviewers, I haven't seen the data that argues that those managers that hire quickly are any worse than those who take their time.
I can only say anecdotally that experienced managers who go with their gut feelings seem have a better track record than those newer at hiring and/or are rigidly by the book employers.

The contradiction lies in the two parts; while we are generally good at making quick decisions – and yes I'll grant that there sometimes clear exceptions to that – once we have made an early decision we want to stick to it regardless of contrary evidence later on.

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Author: drosophilosopher Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61112 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 8:15 AM
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The book "Influence" by Robert Cialdini has a wonderful explanation of the mental shortcuts we use, which lead us into bad judgments. Everyone who wants to think clearly and understand unclear thinking should read this book, along with "Beyond Greed and Fear" and "Innumeracy." I read this book because Charlie Munger recommended it at the annual meeting, and it is remarkable. Charlie knows good books.

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Author: TMFOtter Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61113 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 11:27 AM
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A basic example: You meet John Doe, a new co-worker. He makes a favorable first impression on you. Later you hear some negative things about him. You tend to interpret that information in the most positive way to support your first take about him.
Depending on how strongly you first felt, and/or how bad the following data is, it may take weeks to years, to never, to change your mind.


First of all, Elias, amazing, amazing post. I do think that Lleweilun is right, sadly many people want the information that reinforces their earlier decisions. One need only look at the reaction on many discussion boards when an analyst downgrades. Heaven forfend one of CFRA's opinions attacks the accounting of a beloved company!!

HamletsMill's response resonated deeply with me, because I see it every day. Mostly with the real momentum stocks, but even with companies that one would think a more sober type of investor would own.

A few weeks ago I wrote an article blistering AIG for its bizarre and opaque executive compensation structure.

http://www.fool.com/news/foth/2002/foth020212.htm

I got the usual raft of "you're just trying to talk down the stock" messages, and a few comments from people who appreciated (or took issue with) the work. As usual, not one single person said "Wow, this information is going to make me revisit my ownership of AIG." Certainly I don't need that kind of reinforcement to do my job, but nonetheless, the pattern is amazing.

I think Elias has mentioned this book in the past (and I know our resident poster laureate DeliLama has), but I highly recommend Robert Cialdini's book "Persuasion". kro56 told me about it when we met at the Berkshire AGM last year, and I have since completely dogeared and marked a copy of the book.

Bill Mann

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Author: TMFOtter Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61114 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 11:31 AM
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but I highly recommend Robert Cialdini's book "Persuasion". kro56 told me about it when we met at the Berkshire AGM last year, and I have since completely dogeared and marked a copy of the book.

...and yet I cannot remember the title of the book. Ahem. It is "Influence: The Psychology of Persuasion".

Drosophilosopher beats me to the punch, then I get the name of the book wrong. Not my day.

Bill Mann


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Author: number9er1 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61115 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:18 PM
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"First, I think I have made a mistake in using the term “first impression” rather than first decision."

If I may come to your defense with a new concept to me called Heuristics. For some it is about shortcuts that help, but in this dialogue it emphasizes , not a disdain for "joe sixpack", rather, a healthy respect for the constraints real people have to live within, making decisions of all kinds, even investing.

This adds another book recommendation," Heuristics That Make Us Smart "( If I knew how to "link" I would) try Amazon

It also counters the"hunter-gatherer" gibberish that is really a big bag of , "Why did they make that choice? It's because of what our ancient ancestors did, I think and this idea makes me feel good, sounds plausible, and who's going to argue -no one knows any way ,and I'm back to where I started from with none the wiser", non-Scottish CRAP!
oops, did I just get cancelled??

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Author: TMFSelena Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61116 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:18 PM
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<<...and yet I cannot remember the title of the book. Ahem. It is "Influence: The Psychology of Persuasion".>>

Well, "Persuasion" by Jane Austen is also a pretty good book, so no harm done!

Selena

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Author: greenmartian1 Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61117 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:28 PM
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Do you want management to make these kind of decisions, when they could just prepare the best financial statements possible and let the chips fall where they may.

Great points all but to expect GE to let 'chips fall where they may' seems pretty simplistic, right? After all, with all those different businesses a little fluctuation here and there in the timing of an event isn't the evil thing you imply. And since when did GE dictate accounting standards in regards to options?

Besides, I follow an industry that consistently reports results 'where they may'. That's retail. You know how investors react to month to month changes? They brutalize or rhapsodize the stock depending on how the wind is blowing. As a fundamental investor this is an ideal situation but if you were a long term holder of the stock and periodically planned to make withdrawals for whatever reason would you like stock performance to diverge so significantly from business performance? No.



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Author: brk40 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61118 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:43 PM
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I don't know about the others on this board, but I just got my $29.95 worth by reading Elias' post. Great work. Spending $30 to have access to this board and his writings was a very easy decision. And it just paid off. I wish all my investment decisions were that easy.

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Author: horacekgl Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61119 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:47 PM
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...would you like stock performance to diverge so significantly from business performance? No.


Thanks for your comments.

Not to put words in your mouth, but I thought I was the only one who EXPECTS his companies to operate with an eye to the longer term. Part of that long-term view is to try to match increases in one area of the company with decreases in another area. I EXPECT my management to operate in a manner to, over the long term, smooth results to better reflect the long-term fundamental growth/decline of the company. This is what you pay management to do; to manage the day-to-day operations in a manner to smooth out the hills and valleys to achieve a result, hopefully positive. Planning a big acquisition? Then I expect management to anticipate where/when the gains from other parts of the business will be available to smooth out the acquisition.

This is not Carte Blanc for unethical behavior, but it is a far cry from being the bane of an investor's life. One should certainly by aware of smoothing attempts, but they should also be expected. Beyond that, it is up to the individual investor to ascertain whether the smoothing was done out of fear or as a continuous process to reflect the true long-term operating results. I.e., is the smoothing a short-term deceptive device or a planned long-term practice? One reason is worrisome; the other is welcome.

glh


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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61120 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 1:59 PM
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Great points all but to expect GE to let 'chips fall where they may' seems pretty simplistic, right? After all, with all those different businesses a little fluctuation here and there in the timing of an event isn't the evil thing you imply.

If an event should be recognized in Year 2, then recognizing it in Year 1 is an evil thing. Accountants face difficulty in determining when to recognize certain transaction. For instance, when does goodwill become impaired? That is not an easy question. I don't expect management to be perfect, but I want their intentions to be honest. I don't know why it is simplistic to ask companies to just present that period's activity without managing the results. It may seem simplistic today, but that is in part a function of the culture. And cultures can change.

Besides, I follow an industry that consistently reports results 'where they may'. That's retail. You know how investors react to month to month changes? They brutalize or rhapsodize the stock depending on how the wind is blowing. As a fundamental investor this is an ideal situation but if you were a long term holder of the stock and periodically planned to make withdrawals for whatever reason would you like stock performance to diverge so significantly from business performance? No.

But the fact that you get good information in retailing and asset management is one of the very things that attracted you to those industries. Would you be following the retail industry without its same store sales information? Can you imagine what aggressive management of earnings in retailing would look like? They could paper over problems until it is too late. Things would be wonderful: sales would be growing, profits would bee growing, when suddenly the floor falls out. There would be huge inventory write-downs, store closings and operating losses. You would be blindsided. Your SSS figures, which are not easily manipulated, help warn of trouble.

But is a divulgence of stock performance from business performance a bad thing? What if you were presented with a choice between better financial information to use in the valuation of a business or a less volatile stock price. Which would help you to be successful? I believe that the better financial information would be better, hands down.

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Author: WuLong Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61121 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 2:12 PM
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if you were a long term holder of the stock and periodically planned to make withdrawals for whatever reason would you like stock performance to diverge so significantly from business performance?

If I'm dollar-cost-averaging out of a stock over a significant period of time, I would expect my return to match the market's. An up month here will be countered by a down month there but I'm still meeting my expectations.

The problem I have with "smoothing the earnings stream" is that it makes it that much more difficult to tell how good a job management is really doing. It shortens the warning period and requires bigger mistakes to occur, one's that would overwhelm the shock absorbers the CFO has built into the reserves. How much sooner would the problems at LU have come to light if the accounting were reported properly? It should have been obvious that the hardware vendors were acting as banks, supporting the dot-coms in an effort to maintain/grow marketshare. Remember the CSCO writeoffs? These should have been predictable. Suddenly in early 2001 everyone said "Oops. We've got all this capacity and inventory but no customers and the customers we did have are gone now and by the way they never paid us for what they bought and now its obsolete so we're just going to trash a couple billion dollars worth of stuff. Who'd have thunk it?"
At least in retail they have to stand up every quarter and say "We've still got shelves full of stuff. Here's the write down and here's how we intend to keep it from happening again".

Finally, the "lie to me" philosophy says people want to feel safe even though they know they live in an unsafe world. They'd really like the Strong Form of EMT to be true, so they manipulate the system to try to make it true - if the stock price is at odds with the performance of the company, let's make the performance of the company appear to conform to the stock price. The funny thing is, people know this is happening. If GE ever misses its earnings target, the stock will crater because everyone will know the CFO sucked down every dollar he could find to avoid making that statement. The attempt to dampen volatilty will result in increased volatility, much like diking a flood plain creates worse floods downstream.

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Author: greenmartian1 Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61122 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 2:20 PM
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If an event should be recognized in Year 2, then recognizing it in Year 1 is an evil thing. Accountants face difficulty in determining when to recognize certain transaction. For instance, when does goodwill become impaired? That is not an easy question. I don't expect management to be perfect, but I want their intentions to be honest. I don't know why it is simplistic to ask companies to just present that period's activity without managing the results. It may seem simplistic today, but that is in part a function of the culture. And cultures can change.

Let make this clear: I agree completely with the intent of your message.

But look at it this way. In my own personal situation, I try to structure purchases and sales of items in my business depending on my tax situation. I may move an item up to Dec 31st instead of Jan 1st. This makes perfect sense - no one would disagree with it. Maybe GE does things the same way. They more expenses or income up or down depending on their view of how it reflects on the earnings presentation. That isn't all bad - if the result is 'stability of sorts' in the stock price. Think of all the moving parts in a business as complex as GE's. A lever here, a lever there - what's so wrong with that. Of course these sorts of things could get out of hand. No one disagrees with that. But letting things fall where they may seems irresposible to me if things could be 'managed' in a different fashion.

What if you were presented with a choice between better financial information to use in the valuation of a business or a less volatile stock price. Which would help you to be successful? I believe that the better financial information would be better, hands down.

No one in their right mind would disagree. I'm just not as certain as you that smoothing earnings is the same thing as non-disclosure (that's how I read these things). But then again, I'd never invest in GE with any thought that I could really and truly understand everything that was going on. Nobody could (IMO). In businesses that complex, if you are going to invest it is basically a 'trust me Bubba' situation to a large degree.



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Author: JimB100 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61123 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 3:13 PM
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" A lever here, a lever there - what's so wrong with that. Of course these sorts of things could get out of hand."

I think you just answered your own question. I am not interested in 'adjusting earnings' to the point of stability. If I am looking at a business that has its ups and downs, I want to know that. I just don't see what is wrong with managment presenting and CPA's certifying the truth. Complex businesses call for difficult judgments and I accept that, but what is wrong with management explaining the reasons for these judgments? All this time we counted on the CPA's to certify as accurate a firm's financial statements. Now the perception is that this is not the case. What a great feeling!

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Author: gdefelice Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61125 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 5:20 PM
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but I highly recommend Robert Cialdini's book "Persuasion". kro56 told me about it when we met at the Berkshire AGM last year, and I have since completely dogeared and marked a copy of the book.

but you better buy it quick, they're in their final printing...

:)

those that have read it will get it.


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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61126 of 214198
Subject: Re: Please lie to me. Date: 2/22/2002 7:34 PM
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I have no objection with companies deciding when to sell an asset in order to reflect the gain in a specific period. That is completely acceptable. I do however take exception with companies taking impairments in periods that match gains on asset sales. This was one of the things that GE did in the fourth quarter of 2001. In the fourth quarter of 2001, for example, GE made a $642 million gain on a satellite partnership and conveniently took a $656 million charge for exiting unprofitable businesses and marking down unsuccessful investments (including an $84 million loss on Enron bonds).

We are asked to believe that decision to exit the unprofitable businesses was made in the same quarter as the gain was realized. Maybe it was. But timing and amounts sure look suspicious. I wish I had kept the annual reports, but for a period of time about 15 years ago, Dun & Bradstreet had a habit of recognizing large gains on sales of assets, and charges of a like amount for restructuring or impairments, both in the same quarter. This happened about 3 or 4 times over a like number of years. It was clear that the charges were being made coincidentally with the gains. The questions were always there to be begged: "Would you have taken the charge without the gain? Should the charge have been taken in a earlier period, but delayed for the occurrence of an offsetting gain?" My belief is that companies often delay taking charges until that have an offsetting gain

In my own personal situation, I try to structure purchases and sales of items in my business depending on my tax situation. I may move an item up to Dec 31st instead of Jan 1st. This makes perfect sense - no one would disagree with it.

I have no problem with this kind of activity either. This is not managing earnings. If the transaction is pushed into the following year, it should be accounted for in the following year. But that is not what companies do.

I believe that most of the manipulation of earnings comes from reserves and deferred charges. Back to GE again, Even though the books had closed on the quarter, many immediately offered to pitch in to cover the Kidder gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise.' They could not move transactions from one quarter to another, the time for that was well past. They were going to find these extra millions by adjusting their reserves downwards, or their deferred charges upwards.

If you looked at the accounts of manufacturing companies, you would see a whole list of reserves. They would vary by company, but they would include reserves for things like doubtful accounts, unissued credit memos, returned merchandise, co-op advertising, workman's compensation ( if they were self insured ), environmental remediation, employee health insurance claims ( if they were self insured ), excess inventory, obsolete inventory, deferred executive compensation, performance bonuses, etc. There could be dozens of them, all of which require estimates. They are not accruals for items which were purchased in the previous period and just remain unpaid at period's end. They are estimates of amounts that the company will either be required to pay, or be unable to collect in the following years. And there are no correct answers because they are unknown. They are kind of like the liabilities set up by insurance companies to pay future claims. This is probably where those GE managers were going to find the money to cover the Kidder loss. Much of the smoothing of earnings comes from moving these reserves up and down as is needed. When this is done, it means that management is not giving its best estimate of what earnings actually were, but what they want to show.

These various reserves can, in aggregate, be a very large number,. At the end of 2000, GE had $12 billion of accrued expenses. Much of those accruals were subject to estimation. There is a lot of wiggle room in $12 billion. At that is just the reserves on the liability side. That $12 billion does not include any reserves against inventory or receivables, which would also be in the billions of dollars. And that does not include over $100 billion of insurance liabilities and reserves which are also subject to estimation. GE could sandbag billions of dollars of income to be applied against bad results in future periods.

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Author: hartmanbirge Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61130 of 214198
Subject: Re: Please lie to me. Date: 2/23/2002 1:27 AM
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Jmls..."I hope that I am wrong, but I don't think Joe Sixpack shareholder is the most analytical guy in the world. Part of it is an information barrier; how many shareholders do you believe actually know that there are three financial statements, or where to find a 10-K or a 10-Q on Corporation X?"

I agree with this in part but it raises another issue which I find infuriating... Most Joe Sixpacks are so analytically tuned out that they simply throw their money at mutual funds...the ultimate mindless investment strategy. When they do this they are empowering the "experts." And heck, it's more than just the Joe Sixpack, it's also our societal professionals who as my colleague put it yesterday, "don't have the slightest interest in that stuff." The majority of Americans invest through mutual funds....not individual stocks. So then we've got our little MBA toting mutual fund manager out of Liberty Baptist University making the decisions for us.... WoW!!! It is this mindless herd...the fund managers who SHOULD be insisting on transparent accounting...they're the ones who own the bulk of the shares. In my mind this makes them more reprehensible than the companies themselves. Joe Sixpack may own some shares but he won't yield the influence of say a Janus. Consider the enormous assets in 401Ks - most of which are in funds. It is a crime....A CRIME!!

I do believe that most people want honesty....but now we've got two or three layers of lies. The company, the funds, and the investment advisor.... three layers of lies and deceit. Three years ago I came to realize that I was empowering this field of lies and deceit by giving them my money and turning off my mind and I sought out the most honest impeccable investment vehicle I could find - Berkshire. Certainly not all will take the time to read and evaluate business character...there are huge systemic flaws in the money management industry. It is so pervasive and "the norm" that it is not readily apparent. The fund industry IMHO will have to lead the way out of this....and they're the worst - where does that leave us?

HB

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Author: Goofyhoofy Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61134 of 214198
Subject: Re: Please lie to me. Date: 2/23/2002 11:59 AM
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If I could write stuff like this, I would go professional.

Clearly, you should.

I can't imagine any editor of any business publication reading this and not saying, "Yeah, we should print this."

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Author: greenmartian1 Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61139 of 214198
Subject: Re: Please lie to me. Date: 2/23/2002 3:28 PM
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Rather than me try to defend something I don't really understand and could never grasp for more reasons than I can count, there is another thread that addresses the topic:

http://boards.fool.com/Message.asp?mid=16777014

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Author: TMFOtter Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61166 of 214198
Subject: Re: Please lie to me. Date: 2/24/2002 9:14 PM
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In my own personal situation, I try to structure purchases and sales of items in my business depending on my tax situation. I may move an item up to Dec 31st instead of Jan 1st. This makes perfect sense - no one would disagree with it. Maybe GE does things the same way.

I realize that at this point your statement is nearly two days past, but I did not see this mentioned anywhere else. The only problem with this theory is that SEC statements for companies are not the same as tax statements. Their earnings as submitted to the IRS can be entirely different to those submitted to the SEC, so the tax angle for why companies match revenues and writedowns is not relevant.

One proposal that I have seen being knocked around is to force companies to streamline their SEC reports with their tax reports. The thought is that if companies were forced to pay tax on their reported earnings, then perhaps they wouldn't be so keen to pump the number ever higher.

I haven't really thought about it enough to decide whether I like the idea, but on the face of it I do see a certain merit. Hell, if earnings are good enough to report to investors, they ought to be good enough to report to the IRS.

By the way, TMFScott, a GE management alumnus, wrote a really good post on this subject on the GE board.

http://boards.fool.com/Message.asp?mid=16777014

For your interest.

Bill Mann



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Author: greenmartian1 Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61168 of 214198
Subject: Re: Please lie to me. Date: 2/24/2002 10:10 PM
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The only problem with this theory is that SEC statements for companies are not the same as tax statements.

Fwiw, I never meant my comment about taxes to be taken literally. Specifically, I said this: Maybe GE does things the same way. They more expenses or income up or down depending on their view of how it reflects on the earnings presentation.

I only mentioned taxes because as a private entity tax considerations would be the only thing that would induce me to delay a purchase that I would otherwise want to make.

In theory from what I've read (very little - the book Quality of Earnings by Thorton O'Glove had a specific chapter devoted to tax vs reported books), you are supposed to be able to tell differences between the two from current statements. I have no idea if this is true.

By the way, TMFScott, a GE management alumnus, wrote a really good post on this subject on the GE board.

I know. I referenced that note here:

http://boards.fool.com/Message.asp?mid=16786643

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Author: jeepthedog Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61228 of 214198
Subject: Re: Please lie to me. Date: 2/26/2002 8:15 PM
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The quartly reporting system and the fact that Americans are addicted to immediate gratification is the root cause of the corporte lying game. If we were to take a true long view of life, investing, relationships (more like the Japaneese)the country would be better off. Example. 11 years ago, Toyota lost considerable money on every new Lexus sold in this country. It was viewed as an investment to gain a foothold into the American Luxury Vehicle market, Now they are the biggest player whiile Caddy and Linclon are not even serious players. General Motors would never fade the heat from investors or wall street in general for such a move. Profit now. I sold my business to a public company and signed a employment to stay and run the operations. After closing, all long term training expense, educational bennies for employees and the like were killed. I was told very directly:"If it won't benefit this quarters earning, don't do it." Not, in my opinion the way to run a railroad but one fostered by the short term outlook we Americans view life. Of course we ask companies to lie to us. Most people are only interested in a pop in the stock based on last quarters earnings

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Author: WCMinor Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61231 of 214198
Subject: Re: Please lie to me. Date: 2/26/2002 9:36 PM
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The quartly reporting system and the fact that Americans are addicted to immediate gratification is the root cause of the corporte lying game. If we were to take a true long view of life, investing, relationships (more like the Japaneese)the country would be better off. Example. 11 years ago, Toyota lost considerable money on every new Lexus sold in this country. It was viewed as an investment to gain a foothold into the American Luxury Vehicle market, Now they are the biggest player whiile Caddy and Linclon are not even serious players.

And yet long-term thinking has not helped Japan avoid the most remarkable stretch of economic under-performance of an industrialized economy since WWII. Where do you think there are more healthy companies, Japan or the US? Where would you rather invest?

WCMinor

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Author: jamesoid Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61288 of 214198
Subject: Re: Please lie to me. Date: 2/27/2002 5:52 PM
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I would rather know the truth. What effect such disclosure has on the price of the stock is a magnitude lower than the value of knowing the quality the business. Management is paid to direct efforts that are relevant to the success of the business not manage numbers that are relevant to Wall Street expectations.

Investing seems to have become a Confidence Game. Are CEOs, COOs, CFOs Chairmen and Directors of the Board the new Grifters. Is investing a Shell Game where investors are betting against slight of hand that they can find the pea? Three Card Monte! Is this Capitalism or a Carnival Show?

If an company is managed on the basis of meeting Wall Street expectations then management does not have the right target in its sights.

The price of a stock has become oveweighted in considering value of an enterprise. The quality of product or service. The value of the enormous variety of efforts in creating the product or service. The value of ownership of the product or benefit of receiving the service. There a more factors to this value than am able to enumerate here now.

Massaging the numbers to look good is a disservice to investors, employees, customers and our society (it may even harm the trees).

Everyone that invests should know when it's good, why it's good and if it's bad why it's bad. This is what the 10-Qs and the 10-Ks should show via the Numbers and Explanatory Notes.

When that happens then my confidence will return.
It would help too if some paid restitution and went to jail for breaking the intention if not the letter of the law.

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Author: lesdupuy Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61364 of 214198
Subject: Re: Please lie to me. Date: 3/1/2002 6:43 PM
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To post on the B-H board is presumptuous on my part, not to denigrate my contribution. What has bothered me about the Enron deal is not so much the grievious errors. but that they were not able to complete a great business plan. What I an postulating withou any deep investigation is that maybe this "business plan" could have resulted in a really corporate success. The cover was blown prematurely. Agreed the profit-taking of the corporate leaders does not indicate any altruistic motives, but is it possible that the corporation could have survived, provided good returns for the leaders, employees, and stockholders? What we are talking about is risk, could it have worked?

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