Audit Integrity has updated its WatchList of the highest risk US companies, based on their corporate governance practices and financial transparency
Audit Integrity Chairman Jim Kaplan notes that ever since the market struck bottom on March 9, the “cruddiest” stocks have rebounded. However, on June 4 the SEC filed a civil securities fraud complaint against Angelo Mozilo, former CEO of Countrywide Financial Corp., alleging that he and his fellow executives misled investors by hiding the company’s deteriorating financial condition.
During the period in question (beginning in the third quarter of 2006), Audit Integrity ranked Countrywide as “Very Aggressive,” with AGR scores as low as 3 on our scale of 100.
In 2008, Audit Integrity WatchList companies returned -48.2% compared with -28.8% for all companies with market cap greater than $50 million.
Large Cap companies added to the Watchlist: BB&T Corporation, Boston Scientific Corp., Bristol Myers Squibb Co., Capital One Financial Corp., Chesapeake Energy Corp., Citigroup Inc., CVS Caremark Corp., Johnson Controls, Inc., Nexen, Inc. NVIDIA Corp., Republic Services, Inc., The Western Union Company, United Technologies.
The full report is available here.
Technorati Tags: Audit-Integrity, BB&T-Corporation, Boston Scientific Copr., Bristol Myers Squibb Co., Capital One Financial Corp., Chesapeake Energy Corp., Citigroup-Inc., corporate-governance, CVS Caremark Corp., Inc., Inc. NVIDIA Corp., Johnson Controls, Nexen, Republic Services, The Western Union Company, transparency, United Technologies
In light of a proposed NYSE rule change that will give activist shareholders increased voting influence, Audit Analytics has just released a new briefing on trends in shareholder activism. Using the Audit Analytics Active Shareholder Database, which tracks SC 13D filings, researchers identified a significant increase in shareholder activism focusing on control of companies and concern over share price.
Findings in the briefing include:
- In 2006, only .43% of accelerated filers had activist shareholders express concern about share prices. In 2007 it was 2.3%, an increase of more than 5 times.
- Accelerated Filers with activist shareholders expressing disagreement with management actions or strategy significantly increased from only 18 issuers in 2006 to 84 in 2008.
- In 2008, 3.45% of Accelerated Filers had activist shareholders seeking to change or nominate members of the Board of Directors, up from 1.1% in 2006.
The NYSE is considering a change to rule 452, which allows brokers to vote shares for which they have not received instructions on all “routine business.” Brokers usually support management recommendations. The proposed change would reclassify uncontested director elections to be considered “non-routine.”
With 70-80% of U.S. public company shares managed by brokers, and many shareholders not voting, the new rule has the potential to be a major shift of power toward activists.
The full report is available here.
Technorati Tags: activist shareholders, corporate-governance, social-security
Guest post by James A. Kaplan, Chairman and CEO, Audit Integrity
I sense a change in the direction of the tides that bodes well, even during these tough times.
During the late 1990’s, with prosperity rising year after year, it seemed the sky was the limit. The investment industry saw no reason not to remove the regulatory restrictions that had been put in place to safeguard investors after the Great Depression, which, surely, was not going to come again. As share prices went through the roof, shareholders saw no need to question the performance of Company managers, and did not examine the accounting practices that created an appearance of strength. Boards signed off on compensation structures that rewarded management for increasing share prices regardless of fraudulent, or at least, fraud-like behavior.
And from 2002 to 2007 (the Sarbanes-Oxley years), when the shaky underpinnings of these massive corporate megaliths began to give way, stakeholders learned a hard lesson – but the perfect storm of deregulation and deceptive accounting practice only grew in intensity.
In 2008 the real awakening began, and clearly, the emperor has no clothes.
The dramatic deterioration in economic conditions was the shot heard round the world. Economies are suffering in every nation. Foreclosures continue at an astronomical rate.Retirement funds have been decimated through no fault of the people who trusted professional money managers to invest wisely on their behalf.
The chasm between White Hats (companies with strong governance and transparency) and Black Hats (weak governance and transparency) has grown ever wider. Although stakeholders may have learned their lesson the hard way, I believe they have learned it well. When times were good, it may not have occurred to them to carefully examine the behavior of their executives.
Now that the market has deflated, we are discovering that integrity is not optional, but must be demanded regardless of rising or falling share prices. We have learned that fraudulent practices result in egregious short-term gain for the managers, who bear no risk and show no long-term commitment to the company’s health, while resulting in devastating losses to the investors. Of course, our government, hearing the painful screams of stakeholders, has begun beefing up the very same regulatory bodies they de-regulated over the last decade.
I believe this changing tide will reinforce and strengthen the use of Audit Integrity’s Accounting & Governance ratings, which quantify the distinctions between White Hats and Black Hats. Over the ten-year period ending December, 2008, annual stock return spreads averaged 15.29 percentage points difference between companies with the best and worst AGR Equity Factor. During that time the worst decile returned -4.84% annually, while the best decile returned +10.54% annually.
In order to highlight these widening spreads, and to acknowledge those companies with strong governance and accounting, Audit Integrity will begin issuing regular reports on the “Most Trustworthy” companies which Forbes has published annually for the past three years. Our analysis indicates that these companies will continue to generate excess returns and avoid pitfalls over what I forecast to be economically turbulent years ahead.
Technorati Tags: Audit-Integrity, corporate-governance, financial-regulation, Sarbanes-Oxley
A new Working Paper from Harvard Business School has relevance for all of us, but should be required reading in the financial services industry. It sheds more light on when and why we engage in dishonest acts without feeling guilty, and concludes that codes of conduct do make a difference in curbing dishonest behavior, especially if they are signed and reinforced.
While the studies involved students, the experiments were relevant to the financial workplace in that they gave some students the opportunity to cheat by taking more money than they should and then to cover up their cheating by shredding documents.
A few excerpts:
Across four studies, we demonstrated that the decision to behave dishonestly changes levels of moral disengagement and that awareness of ethical standards affects the decision to engage in unethical behavior.
- …we find that once people behave dishonestly, they are able to morally disengage, setting off a downward spiral of future bad behavior and ever more lenient moral codes.
- …we also provide evidence that this slippery slope can be forestalled with simple measures, such as honor codes, that increase people’s awareness of ethical standards.
As a result, making morality salient not only reduces unethical behavior, but also makes individuals’ judgments more scrupulous.
- When bad behavior precedes moral questioning, people bend their moral beliefs to match the preceding action.
- When moral saliency precedes the temptation to act dishonestly, people adjust their actions to align with the established moral code.
*Dishonest Deed, Clear Conscience: Self-Preservation through Moral Disengagement and Motivated Forgetting
Lisa L. Shu, Francesca Gino, Max H. Bazerman
Technorati Tags: corporate-governance, financial-fraud
It was to be expected that AIG would suffer the biggest drop in the Reputation Institute’s 2009 index, falling to 152 out of 153 companies. What is surprising is that Bank of America was one of eleven companies that increased its reputation score by 7 points or more “due to major improvements in stakeholder trust, admiration and respect.” Well, in the words of St Evermond, “Reputation is rarely proportioned to virtue.”
Johnson & Johnson moved up one spot to take the lead as the most reputable U.S. company on 2009 U.S Reputation Pulse, based on interviews in February and March. Kraft Foods, UPS, General Mills, and FedEx rounded out the top five U.S. companies in 2009, all with excellent reputations. Last year’s winner, Google, fell to number eight and lost significant reputation capital. Dow Chemicals and Wal-Mart saw the largest gains in reputation, improving their Reputation Pulse scores by more than 12 points from 2008 to 2009.
As The Economist reports, Ferrero and Ikea edged out J&J for the top spot on a global basis. At least there were no banks in the top tier.
*Publilius Syrus - Maxims
Technorati Tags: (AIG), Bank-of-America, corporate-governance, Ferrero, Johnson & Johnson
Audit Integrity has issued rankings of US commercial real estate companies, based on how aggressive they are in their corporate governance practices.
Companies in Audit Integrity’s bottom-ranked Very Aggressive AGR category have had consistently opaque financial reporting, weak corporate governance, and as a group are expected to have returns inferior to their peers over the next three months on a total return basis. Conversely, companies in the top-ranked Conservative AGR category have had consistently transparent financial reporting, strong corporate governance, and as a group are expected to surpass their peers over the next three months on a total return basis.
Audit Integrity says Very Aggressive companies underperformed Conservative companies by 15.7 percentage points in trailing twelve month returns.
Worst performing among the Very Aggressive group is ProLogis (NYSE: PLD - down 86.3 percent) while the best performing among the Conservative group are Home Properties (NYSE: HME - down 21.7 percent) and EastGroup Properties (NYSE: EGP - down 21.8 percent.)
CreditSights noted April 30 that ProLogis “recorded FFO ahead of estimates as results for the quarter were adequate, but the more interesting story has been the improvement on the leverage and liquidity fronts.”
The full Audit Integrity report is available here.
Technorati Tags: (EGP), (HME), (PLD), commercial-real-estate, corporate-governance, EastGroup Properties, Home Properties, ProLogis
A proposed rule change by the Securities and Exchange Commission to give shareholders much greater power to influence corporate director elections should also benefit creditors, according to Moody’s. That is, unless activist hedge funds hijack the new rights in pursuit of short term gains.
“In play is the so-called “broker vote” rule that allows brokers to vote uninstructed client shares in uncontested (i.e. “routine”) director elections. The issue of broker votes is technical, but significant, since an estimated 70-80% of U.S. public company shares are held in “street name” and managed by brokers. Under current rules, if brokers do not receive voting instructions at least 10 days before the election, they may vote how they wish – usually “for” management’s slate of nominees.
Since many individual shareholders don’t vote, it dilutes the impact of those who do, namely institutional investors and “activist” investors such as hedge funds. Ending the rule (by stipulating that director elections are no longer routine items and brokers cannot vote without receiving client instructions) would therefore give shareholders much more leverage in director elections, including greater ability to remove or signal discontent with underperforming directors.”
We see these moves as largely positive from a creditor perspective, potentially enhancing board accountability and investor awareness. However, short-term investors, namely “activist” hedge funds, could hijack these and other proposed new rights, using them to press companies harder for short-term gains at the cost of long-term credit quality.
“Generally speaking, these new rights, if promulgated, could help improve director and management accountability and awareness if they are used prudently and thoughtfully by long-term shareholders, whose interests are generally aligned with bondholders in terms of long-term value creation. Short-term investors, however, could exercise their new rights to press companies harder for short-term gains, including the adoption of more aggressive financial policy, at the cost of long-term credit quality.”
Moody’s comments are included in its latest Weekly Credit Outlook.
Technorati Tags: activist shareholders, corporate-governance, financial-regulation, Hedge-Funds, SEC
A new Working Paper from Harvard Business School finds little difference in the quality of financial reporting between public and private-equity backed companies.
“Public ownership of the firm’s equity exposes management to investors’ demand for reporting quality. This demand, which is expressed by investors in the form of the regulatory and legal environment in which the public equity firm operates, should lead to higher reporting quality,” the paper says. “At the same time, the findings support the notion that management of firms whose equity is publicly traded has stronger incentives to manage earnings, thus reducing the reliability and usefulness of financial reports.”We further find that public equity firms report more conservatively than privately held firms although…this result does not necessarily imply a higher quality of reporting for the former group of firms.”
Overall, while public equity and private equity firms differ along various quality and financial attributes dimensions, neither type of firm “dominates” the other as having the highest quality of financial reports.
“Unless weights are assigned to different dimensions of earnings quality and attributes, one cannot conclude that the public listing of a firm’s equity necessarily improves the quality of its financial reporting.”
Does Public Ownership of Equity Improve Earnings Quality?
Dan Givoly
Carla Hayn
Sharon P. Katz
Technorati Tags: corporate-governance, financial reporting, private-equity, public companies
Guest Post by Jim Kaplan, Chairman, Audit Integrity
The Wall Street Journal article published March 10, entitled “Moody’s Aims to be Ahead of Defaults,” was a real eye-opener, as was the response to the article. Moody’s Corporation has taken a bold and positive step in publishing a list of Companies with the highest probability of default. The Moody’s Bottom Rung consists of the riskiest 15%, approximately, of all Companies they track.
It is interesting to note that Moody’s has been widely criticized for publishing the Bottom Rung, with many Wall Street champions declaring it a “publicity stunt.” I struggle with this response from the marketplace. Moody’s should be encouraged to provide more transparency and information to stakeholders, particularly in view of the legitimate criticism that accepting compensation from the Companies they rate creates a conflict of interest.
Of course, the Companies on the Bottom Rung are unhappy that their solvency has been called into question, but they have no one but themselves to blame for their position. Although not always perfect, Moody’s corporate listing model is objective and has been proven to be statistically significant.The Companies on the list have made poor corporate decisions, have taken on excessive risk, or are simply suffering from an extreme economic downturn.Moody’s should not be pilloried for pointing out the potential consequences of their excesses.
It appears that Wall Street wants to hear only cheerleaders, not Cassandras, regardless of the merit of the message. At the risk of being another Cassandra, I took Moody’s analysis a step farther.This additional step goes beyond Moody’s more traditional analysis.However, I believe, and the evidence supports, the view that poor accounting and governance positions are a strong indicator of future under-performance – including insolvency.
Eliminating 13 non-publicly traded Companies in the top 30 on the list, I took a look at the Accounting and Governance Risk (AGR®) scores of the remaining 17 Companies.
Not surprisingly, 11 of the 17 Companies, or 65% of the sample, had an AGR® rating of Aggressive or Very Aggressive. This distribution is almost double the expected distribution of 35%.
Accounting and Governance risk measures are independent measures not incorporated in Moody’s ratings. I am not surprised, however, that a high correlation exists. Low management integrity, coupled with accounting manipulation, often leads to serious problems including potential default.
Technorati Tags: (AMR), (EK), (F), (GM), (IAR), (LCC), (LEA), (LVLT), (RAD), (SORC), (TEN), (VC), (WNR), AMR Corporation, Citadel Broadcasting, corporate-governance, Dana Holding Company (DAN), Eastman Kodak, Ford Motor, General-Motors, Georgia Gulf Corpration, GGC, Idearc, Lear, Level 3, Moodys, R. H. Donnelley Corporation, RHD, Rite Aid, Source-Interlink, Tenneco, US Airways Group, Visteon, Western Refining
Anyone interested in a vision of what the finance function of major companies might look like in 2020 might want to check out KPMG’s free “Finance of the Future” paper.
Once you get past the inevitable consulting buzzwords the paper does provide a helpful recap of how finance has changed over the last several years and how it might change in the next several. Not surprisingly it argues for a more central and integral role for the finance function in corporate strategy and management.
What has not changed,however, is the fundamental role of finance. Finance still needs to provide insight to the rest of the organization,ensure effective control and risk management and drive its own and the organization’s efficiency.
Technorati Tags: compliance, corporate-governance, finance, strategy
