The Dow Congress
An alternative theory of why the market collapsed.
But don't current rules make it easy for companies to deceive? Not unless they commit fraud--and we have plenty of criminal laws in that arena. In fact, U.S. markets are the cleanest in the world, as academic studies show consistently. For instance, research published last year by Christian Leuz of the Wharton School, Dhananjay Nanda of the University of Michigan, and Peter Wysocki of MIT found that U.S. firms "managed," or distorted, their earnings the least among companies in 31 countries studied. While financial markets, which rely on trust, cannot tolerate lying, the media have grossly exaggerated the extent and seriousness of accounting problems.
For example, a recent headline in the Wall Street Journal proclaimed, "Merck Recorded $12.4 Billion In Revenue It Never Collected." Well, yes and no. The truth is that Merck provided a rebate on drugs, and the company faced a choice: (1) record the entire value of the gross sale as revenue and list the rebate as a cost, or (2) record only the sale, net of the rebate, as revenue. Both methods produce the same profit. Merck decided to list the gross sale and the rebate separately, instead of just the net sale. That seems perfectly reasonable, and, indeed, more informative for investors. But, on the surface anyway, it's another accounting scandal.
In the face of the deluge of stories, some persist in arguing that the cause of the recent decline in the market is that investors believe politicians aren't doing enough. Alan Blinder, vice chairman of the Federal Reserve during the Clinton administration, wrote in the New York Times on July 21, "Can it be true that financial markets want the government to regulate them more? Paradoxically, the answer is yes."
Blinder's proof is that markets were disappointed that President Bush "spoke loudly but carried a small stick in his speech to Wall Street" on July 9. In fact, Blinder has it backwards. The Bush speech more likely frightened investors because he indicated he would back the most extreme legislation that was working its way through Congress.
In the current environment, perhaps it is too much to expect politicians to stick up for the thousands of publicly traded companies that play by the rules and that have provided the United States since 1982 with the most prosperous two decades the world has ever seen. Any top manager warning about the costs of the wild new laws coming out of Congress risks being portrayed as a corporate crook himself. But a little courage would be good to see.
After vigorous lobbying, corporate executives have now been rolling over--and may soon pay the price. The new accounting reform law creates byzantine regulations where even honest managers could face prison time. Requiring them to personally "ensure" the gathering of information for financial statements may seem innocuous enough, but consider that firms must frequently refile corrected statements not because of intentional deception but because new information has come to light. Prosecutors might need only to point out two conflicting certified statements to show perjury or fraud. Making a simple mistake or being fooled by subordinates may not be enough of a defense. At the very least, CEOs will be wasting time verifying accounting statements, time better spent running a business.
The only good news is that all this bad political news may now have been fully taken into account by investors. Unfortunately, the same cannot be said for misguided laws, whose effects can linger for decades--as, alas, can misguided politicians.
James K. Glassman and John R. Lott Jr. are scholars at the American Enterprise Institute. Glassman is also host of www.TechCentralStation.com.