NCPA - National Center for Policy Analysis

Better Corporate Reporting: Through Market Mechanisms or More Regulation?

March 14, 2002

Treasury Secretary Paul O'Neill called the Enron aftermath the "genius of capitalism." Although he was criticized for the remark, he made an important point, observers note. The ongoing Enron debate has strengthened the economy.

  • Enron's humiliation has been a cautionary lesson to corporate executives throughout the land.
  • The stock prices of companies with obscure and incomplete financial reports have suffered since Enron's collapse -- now they're scrambling to supplement official reports with additional details to reassure market analysts.
  • Many CEOs have concluded it is wise to highlight the bad along with the good -- as part of an effort to build a reputation for honesty and above-board dealing.

Still, some critics contend that the market needs government regulation to guarantee good behavior.

  • They would like to see stricter rules governing the reporting of options compensation packages for top executives -- conceding that options are a strong incentive to superior performance.
  • According to Harvard Business School professor Mihir Desai, companies are now keeping two sets of books -- one for the Securities and Exchange Commission and one for the Internal Revenue Service.
  • He says that in 1998 income reported to shareholders was 63 percent higher than taxable income -- and that roughly 26 percent of the difference was attributable to exercising options.
  • This ambiguity arises because for accounting purposes, options can be valued at the time they are issued, which the SEC does, or when they are exercised, as the IRS does.

A possible compromise for such cases might be to make sure the details of the options package are clearly, prominently and fully disclosed and let investors apply their own valuation rules.

Source: Hal R. Varian (University of California at Berkeley), "Economic Scene: The Real Value of Enron May Be as a Worst-Case Example of the Need for Clearer Accounting Rules," New York Times, March 14, 2002.

 

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