October 2002

How Companies Lie: Why Enron Is Just the Tip of the Iceberg

By A. Larry Elliott and Richard J. Schroth

New York: Crown Business, 2002, $18.95; ISBN: 0609610813

Reviewed by Rona L. Cherno

The financial press has been scrutinizing the way in which a number of corporations have been able to materially misrepresent their results. Too often, public companies have produced enormous after-the-fact restatements of their financial reports, and the securities markets have gone on a roller-coaster ride with more downs than ups. The regulators and legislators have been slow to recognize the dangers of these misstatements and the pressing need to protect investors; attention to business crime has not been a priority.

Those of us in the practice of public accounting have learned to expect numerous questions about the seemingly endless revelations of accounting and auditing irregularities and about how a major international corporation created such a grand picture of corporate profitability. Accountants are faced with making sense of huge benefits to greedy officers and enormous losses to individual employees and investors. We are asked to explain how Enron is not the only example of financial reporting as fiction. I, for one, am at a loss.

As someone who began her career on the audit staff of Arthur Andersen, I admit I am disappointed that the once-excellent firm has crumpled under the weight of lack of credible reporting practices. The firm spent huge sums of money educating staff on how to conduct proper audits and form appropriate opinions. Fortune once praised Andersen as a maverick in a staid profession, but over time these high standards seem to have eroded.

A. Larry Elliott (a CEO and former senior partner of a major executive search firm) and Richard J. Schroth (a consultant and adviser on emerging technology and business strategy) have written a short, concise book that presents strategies to plug the holes in the system. The causes of the problem are complexity, technology, the inability to grasp reality, and the need for precision. The answers begin with basic financial verification, corporate ethics, management candor, and a competent board of directors.

The authors place the blame with the preparers that engineer financial reports and the investors that do not demand more. The authors want us to be rude, skeptical, and assertive, not complacent and trusting. Although Elliott and Schroth do not lose sight of the fine efforts many businesses make to adhere to standards, they emphasize that even more is needed.

Elliott and Schroth introduce us to a fictitious CEO of Red Rocket International, who enumerates 28 tricks—all of them straight from current corporate behavior—that have been pulled. My personal favorite: “Stay in touch with lobbyists to make sure that all of the accounting boards and rule-makers keep the rules confusing and provide plenty of accounting hiding room. This will cost a few bucks, but it will be worth it because of the added benefit of providing political access on a number of fronts. You can appear with the powerful on TV.”

The book looks at the reasons for auditor misbehavior and gives guidance for changes to corporate behavior. Its best feature is a list of what investors must ask for from corporations and what strong, effective boards of directors and independent audit committees must demand from their corporations.

To fix what is wrong, Schroth and Elliott emphasize corporate responsibility and board of directors’ integrity. Time and pressure to meet or exceed growth targets have produced a reporting environment where pro forma public relations reports—which are unaudited and are seriously devoid of substance—have become the primary source of investor knowledge of corporate performance. Competitive pressure and greed have contributed to a large body of imprecise financial information. Some users of financial information receive better and timelier information, and some corporate officers receive compensation based solely on fabricated results. The authors go so far as to suggest executive escrow to recapture ill-gotten financial rewards.

Schroth and Elliott conclude that it is possible to fix what is wrong. Timely, realistic reporting is feasible, but investors have to keep after corporations to ensure that it happens. Elliott and Schroth join the call for limiting deceptive reporting, and they wisely remind readers how to promote corporate integrity and accountability: Disclosure is not a dirty word. Independent thinking needs to be restored to the boardroom. Auditors, along with corporate leaders, need to remember their commitment to ethical behavior.