Accounting for Disaster

Corporate contributions to tsunami relief; WorldCom directors settle shareholder suit out of their own pockets; does the American Jobs Creation Act encourage layoffs?; and more.

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The waves of destruction that pummeled Southeast Asia the day after Christmas left American companies in a quandary: how best to help a region halfway around the world just days before year-end and with many of their employees out for the holidays?

“We said, ‘We need to do something,’ ” says David Odell, CFO of Hyperion. And while the $622 million company was not set up to send blankets or water in the immediate aftermath, “we were set up to write a check,” says Odell, who gave $100,000 to the International Red Cross on December 30. Hyperion, like many companies, also offered to match employee contributions to the relief efforts.

Pam Scholder Ellen, a marketing professor at Georgia State University who studies consumer reactions to corporate philanthropy, says consumers normally give “greater credence to contribution of effort” than to cash, but in this case, “everybody screamed, ‘Where’s the money?’ “

As of January 10, an Associated Press survey put total corporate contributions at $110 million in cash, with an additional $192 million pledged in donations of products and services. “One of the industries most able to help in this case is the pharmaceutical industry,” says Ellen, “which has also been under fire for the past several years.” The result: one of the largest corporate donations came from Pfizer, which donated $10 million to local and international relief and pledged an estimated $25 million in needed drugs and health-care products. Others offered similar combinations of cash and drugs, including Merck ($3 million) and Bristol-Myers Squibb ($1 million).

Calculating how much to give is tricky. Companies that give nothing are rarely criticized, while those that do risk unflattering comparisons to competitors. Hyperion’s donation, says Odell, “seemed like a meaningful, healthy amount of money for a company our size.” Beyond that logic, however, not even the magnitude of the disaster provides much of a guide. For example, many of the larger cash contributions — such as those from Pfizer and from Wal-Mart ($2 million) — mirrored donations they made after the September 11 terrorist attacks.

Ellen says that despite the uncertainty, many companies will likely formalize their disaster-response process going forward. For example, American Red Cross spokesperson Kara Bunte says part of the unprecedented level of Internet giving was driven by employees who were encouraged by their employers to give through redcross.org. The Red Cross has set up more than 200 companies to tally their online employee contributions. —Tim Reason

Payback is a b….

Now it’s the shareholders’ turn to extract pain.

In early January, 10 former directors of WorldCom Inc. (now MCI Inc.) agreed to pay a collective $18 million out of their own pockets to settle a $54 million class-action suit stemming from the company’s infamous bankruptcy. Just days later, 10 of Enron Corp.’s former directors agreed to pony up $13 million out of a $168 million settlement.

How the amounts were determined was not fully disclosed. But for the WorldCom directors, the payout represents 20 percent of their aggregate net worth, excluding their homes and pensions. That’s on top of the $250 million they already lost from their WorldCom investments. In the case of Enron, directors paid out only 10 percent of their pretax profit from sales of stock in the energy trader.

The discrepancy is “problematic,” says Charles M. Elson, a professor at the Weinberg Center for Corporate Governance at the University of Delaware, who terms the Enron settlement “more appropriate.” For directors who were “conflicted,” he says, such penalties may be justified. But for those accused of just being sloppy, the message is muddied. Still, he says, “this is a potential template for other settlements.” —Lori Calabro

Overgrown Evergreen

When TIAA-CREF began encouraging companies whose stock it owned to drop dilutive evergreen provisions from their stock-option plans, it expected push-back. Instead, says Linda Scott, director of corporate governance for the financial-services firm, “we’ve had a number of conversations that concluded with ‘We’ll take this back to the compensation committee.'”

The firm’s chief concern over the provisions — which annually replenish the stock pool available for stock or options grants — is that their automatic renewal means they systematically dilute shareholder equity each year. Scott says the fund is focusing on 50 companies it believes have high dilution due to the provisions.

The openness to dropping evergreen provisions may be a matter of good timing. Now that stock-option expensing is inevitable, many companies are looking to amend their stock-option plans in favor of other long-term compensation. If they can make a big institutional shareholder happy in the process, so much the better.

Some companies, such as Cupertino, Calif.-based Symantec, have already removed the provision. Others self-monitor to prevent dilution. NCR spokesman Jeff Dasler says that although the Dayton-based tech firm’s plan took effect in 1997, NCR has replenished the option pool at a level that’s “significantly below” the shares authorized by the evergreen provision. “It’s a matter of good corporate governance,” he says, adding that the firm has not received any institutional shareholder push-back about its program. Nor has Sprint, according to a spokesperson.

The reason for the lack of outcry from shareholders, says Paul Hodgson of The Corporate Library, is that many shareholders may not know a company has the provision. “It’s hard to determine who does and doesn’t have one,” he says. The companies that are asking for specific numbers of shares to be reserved each year, says Hodgson, are acting as if they have an evergreen provision. “The difference between that and an evergreen plan is very small, but at least if you ask, shareholders get an opportunity to see what is happening.”

Many companies have had evergreen provisions since the mid-1990s, and most came with 10-year expiration dates. According to The Corporate Library, about 2 percent of public companies have evergreen provisions, and many will be up for renewal in the next couple of years. —Kris Frieswick

A New Loophole

What’s in a name? Not much, apparently, when it comes to the American Jobs Creation Act, which features a provision that may actually encourage layoffs.

Signed into law in October 2004 by President Bush, the goal of the legislation was to create jobs by offering tax breaks to U.S.-based companies. For multinationals, those breaks include a one-year tax holiday during which companies could repatriate their overseas earnings at a much lower rate — 5 percent versus 35 percent. The problem? There are no rules specifically earmarking those savings for new jobs back home.

Not surprisingly, the act has had wide appeal. Diversified manufacturing company 3M, for example, announced in its November 1 10-Q that it will likely repatriate approximately $800 million in 2005. The H.J. Heinz Co. was more vague, citing in its late November filing a range between zero and $1 billion. And food and tobacco company Altria Group Inc. is exploring its own plans.

Economists at J.P. Morgan Chase & Co. predict that the tax holiday could yield as many as 600,000 new jobs. But without specific guidance, the repatriated amounts may be used to pay down debt or buy back stock, moves that might create jobs only as a side effect by potentially strengthening companies’ finances. In fact, 46 percent of the 28 companies surveyed by JPMorgan Chase planned to use the funds to pay down debt. “For better or worse, Congress has enacted a law that really doesn’t require much in terms of how the money would be spent,” says John M. Peterson Jr., a partner at Baker & McKenzie LLP in Palo Alto, Calif.

There are many possibilities. For example, a firm could use repatriated funds to pay for research and development, but it would not need to increase its existing R&D budget incrementally, and instead could buy back stock. Then there is the worst-case scenario: a company might be able to use the funds to finance an acquisition, a move that could actually eliminate jobs.

Such a scenario is what Sen. Dianne Feinstein (D-Calif.) and former senator John Breaux (D-La.) sought to avoid when they proposed an amendment to limit the uses of the repatriated sums to job-generation activities. But the amendment was defeated, and now the Treasury Department is working on further guidance. —Kate O’Sullivan

What Jobs?
Uses of repatriated funds (respondents could choose more than one answer).

Pay down outstanding debt
46%
Finance capital spending
39%
Fund R&D, venture capital, or acquisitions
39%
Buy back stock
18%
Use for working capital
11%
Might pay dividend (if double taxation ends)
11%
Fund underfunded pensions
4%

Source: JPMorgan Chase

Not Making It in New York

Some foreign listers are getting tired of trying to make it in New York. With new governance rules at the stock exchanges and Sarbox compliance looming on the horizon, foreign companies are joining the chorus of domestic complaints about the price of admission to the U.S. equity markets (see “Go Ahead, Delist Me!” NewsWatch, April 2004).

Lastminute.com, a leisure and travel group that operates mainly in Europe, left Nasdaq last summer after four years, and is in the process of deregistering from the Securities and Exchange Commission. “The cost of maintaining the U.S. listing compared with the number of U.S. shareholders just didn’t make sense,” says CFO David Howell, who notes that many of the company’s large U.S.-based stockholders hold shares directly on the London Stock Exchange. “If we had half our registration in the U.S. and were doing business there, we might have reconsidered,” he says. German software firm LION Bioscience AG delisted from Nasdaq in December for similar reasons, citing low trading volume and the expense of compliance.

Even large foreign listers have voiced concern. Executives from such companies as British food conglomerate Cadbury Schweppes, German electronics giant Siemens, and German chemicals maker BASF recently met with the SEC to seek changes. Of particular concern is the rule requiring companies with 300 or more U.S. stockholders to maintain an SEC registration, which requires compliance with Sarbox and U.S. generally accepted accounting principles, even if the company has delisted from a U.S. exchange.

Rhian Chilcott, head of the Washington, D.C., office of the Confederation of British Industry, says the SEC was receptive to the group’s concerns. “We support Americans’ right to regulate their market,” says Chilcott. “But if you don’t want to play by [their] rules, you’ve got to have an escape route. For some companies, it’s well nigh impossible to get out.” The group has proposed that companies with less than 5 percent of their trading volume in the United States should be able to deregister.

“There’s some concern about the cost of compliance with the new regulations,” admits a New York Stock Exchange spokesperson. “The strategic benefits [of an NYSE listing] are harder to quantify.” But despite rumors that large foreign issuers like Siemens (which refused comment) are thinking of leaving, the NYSE believes most will maintain their listings. In addition to access to the world’s most liquid market, a New York listing provides a currency for U.S. acquisitions, a mechanism to provide stock options to U.S.-based employees, and significant press coverage. —K.O’S.

Legalizing Ethics

The Walt Disney drama is not the only one to unfold in the Delaware Chancery Court system lately.

Last May, directors of telecommunications company Emerging Communications Inc. (ECM) were found to have breached their fiduciary duty in a case involving a buyout of the firm by its majority owner, Innovative Communications Corp. The directors’ crime? Offering and accepting a share price in the deal that was too low.

The judge in the case, which originated in the Delaware Supreme Court, agreed with minority shareholders that shares in the U.S. Virgin Islands-based company were significantly undervalued at $10.25, and later decided that they were worth $38.05. Moreover, two board members were found personally liable for their involvement. And Judge Jack Jacobs cited one — Salvatore Muoio, a principal at an investment advisory firm — for having “a specialized financial expertise and an ability to understand ECM’s intrinsic value that was unique to the ECM board members.”

This case is significant because it means directors and officers who possess specialized knowledge may be held to a higher standard in lawsuits. “It’s part of the evolution that started with the scandals,” says Steven Schreckinger, a partner at Palmer & Dodge LLP in Boston, adding that “people are going to be held accountable for [such things as] financial inaccuracies.” Not surprisingly, “the first person on the list will be the CFO,” he says.

While former CFO Debra Smithart-Oglesby, an audit-committee member at Denny’s Corp., thinks the judge in the ECM case may have responded to an unfair process of valuation, she believes the decision serves as a warning. “It means more homework and time to fully understand the implications of transactions,” she says. As a CFO and a director, she adds, “you [must] never forget you are there to serve the shareholders, be objective, and know the facts.”

The good news, says Michael Hickey, a partner at Kirkpatrick & Lockhart LLP in Boston, is that future litigation will have to “consider whether or not the CFO adheres” to his specialized knowledge. It will not be the basis of a suit, he adds, “but will be a factor in determining whether or not a director has breached his or her duty.” —Nicole Rusinack

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