Week 12

“Dealing with Shareholders

Honesty in dealing with shareholders has become a major issue in recent years.
Clearly, shareholders have a right to expect accurate, complete and understandable
financial reports from the company in which they invest. Yet many observers
believe that the revelations about suspect financial reporting by Enron,
WorldCom’s investors saw the share price from a 1999 high of $64.50 to 9 cents at
the time of its bankruptcy filing in mid-2002, after the company admitted
improperly accounting for billions of dollars in expenses in an attempt to report
higher profits. Investors are unlikely to wring any value out of their shares if and
when the company is able to reorganize and emerge from bankruptcy.

Moreover, revelations about securities analysts being pressured by their employers

to continue recommending certain stocks have also hurt investor confidence. New
York’s Attorney General has pushed Wall Street firms to adopt new rules
preventing their investment bankers (who usher new stock offerings to market)
from improperly pressuring their analysts (who research company finances and
issue reports about the stock’s prospects). Regulators are also investigating
institutions like Citigroup and J. P. Morgan Chase for their role in questionable
transactions that helped Enron and other investment banking clients hide debt and
shape their financial results in other ways. Some of the public pension funds that
invested in WorldCom’s $11.8 billion bond issue in 2001—and suffered huge
losses in 2002—sued the banks that handled the bond offering (as well as the
company and its former top executives). They alleged that the defendants should
have known about WorldCom’s true financial situation, a charge the banks deny.

A growing number of shareholders are paying closer attention to the social

responsibility actions of the companies in which they invest. In response,
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McDonald’s and other companies are releasing sustainability reports, showing how
their business operations affect the environment, human rights and other social
issues. Royal Dutch/Shell now includes its sustainability report with its annual
report so shareholders can read about the company’s financial and social
responsibility performance at the same time. Some companies even have their
social responsibility reports audited, to increase confidence among shareholders.”
(Wood, 2004: 15-16).

Discussion:

“Honesty in dealing with shareholders has become a major issue in recent years.
Clearly, shareholders have a right to expect accurate, complete and understandable
financial reports from the company in which they invest.”

Suggest measures that would contribute to encouraging honest reporting.

“Another concern revolves around how public companies report information about
the cost of the stock options they grant to some or all employees. These options
given as a reward for performance, allow (but do not require) the employees to buy
the company’s stock at a certain price during a certain period. Over time if the
stock price goes up, the employees can exercise their options to buy at the older,
lower price. Then as the stock price appreciates, the employees remain motivated
to continue their outstanding performance. Different companies use stock options
in different ways. Ford for example awards stock options only to top-performing
managers, less than 10 percent of its 350, 000 workforce. In contrast Amazon.com
has granted some options to nearly every one of its 7, 700 employees.

The way companies account for these options—not the options themselves—are

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the issue. In the past most companies mentioned options in footnotes to their
financial reports, with little explanation. Now in the spirit of more transparency,
General Electric, Coca-Cola and other companies are treating stock options as
another expense to be more fully disclosed in financial reports, along with rent and
other expenses. Many companies that announced this more straightforward method
of disclosing the cost of options have been rewarded by higher share prices,
indicating that shareholders applaud their honesty.

The balancing act with stock options comes in when employers wind up being hurt
due to the trend toward more complete disclosure to shareholders. This is because
reporting options as an expense makes the corporate bottom line look a little
thinner. As a result some companies may curtail their use of stock options and seek
other methods to motivate and reward the workforce—methods that less directly
affect the earnings figures they report quarterly and annually. Amazon.com for
example, is changing its reward program to move away from options while
continuing to stress share ownership as a motivating factor for employees. Is it
ethical for companies to change or eliminate a valuable employee benefit because
of a move toward more transparent accounting?” (Wood, 2004: 16-17).

Discussion:

1. “Another concern revolves around how public companies report information

about the cost of the stock options they grant to some or all employees.”
Suggest ways of reinforcing accountability for greater transparency and
better control.
2. Is it ethical for companies to change or eliminate a valuable employee
benefit because of a move toward more transparent accounting?”
What are your views on this statement?
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