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The tone of “NASA, We Have a Problem” (May) may have misled your readers about the state of financial management at the National Aeronautics and Space Administration.
We have encountered serious challenges with our conversion to an integrated full-cost accounting system, and, yes, they resulted in a disclaimed audit opinion. However, NASA’s administrator, Sean O’Keefe, has stressed management reform as a necessary condition for accomplishing the vision for space exploration. Accordingly, NASA is implementing leading-edge management-information technology to support the agency’s strategic vision and to ensure the taxpayer receives the best value from America’s space agency.
NASA’s financial community is at the forefront of these changes. Six months ago, I became CFO as the agency labored to convert 10 major and more than 100 related accounting systems and processes into a centralized, rigorous system. Now in use, that system is providing NASA with the under-pinning to clearly identify, analyze, and report the full cost of our exploration activities.
Your attention to and interest in NASA’s financial health is both warranted and appreciated. We want to be able to provide Congress and the American public with a fair, timely, transparent, and complete accounting of the resources that support the significant results the entire NASA team is achieving. I know any CFO who has attempted to manage the magnitude of changes we are making to NASA’s financial infrastructure and processes will be aware our path forward is long and arduous, but ultimately well worth the effort.
Manipulating the Numbers
I really enjoyed your article on compensation in the June issue (“New Carrots, Old Yardsticks?“).
At one point, you referred to a potential encouragement to cut costs at the expense of revenue and cash flow. To expand on that a bit, costs can be manipulated as well as cut. It is possible to park costs in inventory, for example, or to allocate them out of current expenses, as WorldCom did. Manipulation of revenue recognition is the most publicized way to manipulate earnings, but manipulation of costs works just as well.
A Three-legged Stool
Your article regarding 401(k) provider fees was outstanding (“Raiding the Returns,” May). While this is a big problem for plan fiduciaries, they most often do not have the tools or knowledge to deal with it.
I see a lack of qualified advisers in this area, in part because broker/advisers who market the plans disappear when the residual revenue is so low that it doesn’t pay them to stay involved and to guide the employer. The turnover compounds the problem, and obvious expenses get lost, not to mention the hidden expense of revenue sharing. Taking over are the vendor reps, whose paychecks depend on maintaining their companies’ profits. Thus, the customer is in the hands of the “fox,” and doesn’t really know it.
Good business operates as a three-legged stool: it has to be good for the customer, the vendor, and the broker/adviser. Very seldom do I find harmony in this equation for a customer’s 401(k).
Independent pension consultant
Matstock and Associates
From the Horse’s Mouth
Your article “Forget Black-Scholes?” (May) highlights the shortcomings of the Black-Scholes option-pricing model with respect to valuing employee stock options, citing the model’s failure to consider factors such as lack of transferability and risk of forfeiture.
Should anyone in the finance community feel that moving away from the Black-Scholes model somehow violates the sanctity of what may be viewed by some as an established standard for valuing options, consider this: the model was never intended to be used for valuing employee stock options. I know this because, prior to his untimely death in 1995, I had occasion to discuss this matter directly with Fisher Black.
In 1992, I was representing a U.S.-based multinational in a dispute with Dutch tax authorities over the value of employee stock options, and I contacted Black for assistance. He told me, directly and emphatically, that he would never use the Black-Scholes model for valuing employee stock options — for the very reasons cited in your article!
With his help, we won our argument. Need I say more?
Donald M. Ferencz, Esq.
Chief Tax Officer
“Forget Black-Scholes?” highlighted the valuation conundrum posed by the mandatory expensing of employee stock options. As evidenced by the highlighted quote from FASB member G. Michael Crooch, it is quickly becoming conventional wisdom that the binomial method provides a “better measure” of employee option value. Whether this assertion is even true is one question; whether use of the binomial method enhances the transparency and reliability of reported earnings is yet another. The current footnote disclosure required under SFAS 123 is sufficiently uniform that analysts can easily determine the sensitivity of reported earnings to different (potentially more realistic, in their opinion) valuation assumptions. This transparency will be sacrificed if companies use the more sophisticated custom-tailored valuation models that FASB is presumably anticipating. (Recall that under the basic assumptions, the Black-Scholes and binomial models yield identical results.)
Analysts will not be able to assess the sensitivity of reported earnings, or the reasonableness of the underlying assumptions to custom-tailored binomial models, as they are accustomed to Black-Scholes disclosures. Does this really represent a step forward in the transparency and reliability of reported earnings?
There has been much speculation regarding whether the proposed rule change will modify the compensation practices of employers. One alternative for incentive compensation is the issuance of restricted stock. It has long been observed that restricted (that is, nontransferable) stock is sold at a discount to its freely traded counterpart. The central issue of the employee option valuation controversy is likewise the effect of nontransferability on fair value. Why not look to existing data on the pricing of restricted stock for evidence as to the appropriate discount to apply to the freely transferable option price? Further, why not simply add such a discount for nontransferability to the list of disclosed assumptions? Surely that would be more transparent and reliable than the use of arcane valuation models that cannot be easily replicated by the market.
Travis W. Harms
Tomatoes and Bananas
The sidebar “Paying the Piper,” in “Looking under the Hood” (May), which dealt with the increased costs of audits due to Sarbanes-Oxley’s Section 404 requirement, reminds me of an old grocery-store owner’s saying: “What you lose on the tomatoes you make up on the bananas.”
At the beginning of the technology era, the firm with which I was associated for 50 years encountered a prospective client. The client was designing software that everyone would want. One of my partners was discussing our possible role with their effort. But the client wanted an audit first. Their response to our proposal: “You lose. Firm X [not the real name of the then Big Eight firm] agreed to do the audit free for five years, if they get to help us sell the software to the government.”
If you looked at the proxy statement disclosures so far this year compared to last, for those that disclosed the fees breakdown, “other” accounted for half of the total fees paid to the auditors. Sarbox made the “other” go down, so the price of audits was bound to go up.
Due to an editing error in the June story “The Backlash,” Equitant was incorrectly described as being located in Dublin, Ireland, and Sacramento, California. The company is based in Dublin and Stamford, Connecticut. We regret the error.