Finance executives who revel in arcane forms of financial modeling may soon get a rude lesson in a far more basic precept of economics: the law of supply and demand.
While colleges report a small rise in the number of accounting majors and degrees awarded, the number of recent graduates in such programs is near a 30-year low. Demand for accountants, on the other hand, has reached a high point, due to the requirements of Sarbox. The American Institute of Certified Public Accountants projects double-digit growth in hiring by most of its member firms for the next three years. Filling those jobs won’t be easy: the increase in accounting degrees awarded between 200102 and 200203 (the most recent data available) was just 11 percent, and the total number of graduates—around 37,000—was well below the average of more than 50,000 students who regularly graduated from 1989 to 1996.
Add to that some anecdotal evidence that entry-level and early-career accountants are leaving the profession for other opportunities, and a bona fide labor shortage may be at hand. “This is one of the tightest markets I’ve seen in many years,” says Brent C. Inman, partner for recruiting at PricewaterhouseCoopers in New York. “We’re meeting our goals, but it requires much more work. We have to engage students earlier and more often.” If the economy picks up, he adds, it will get even harder.
Some recruiters say that even without an economic uptick, the situation is grim. “The nature of the work is driving out the person with two-to-five years of experience,” says Kent Burns, a partner at the Indianapolis office of Management Recruiters International. “For public accountants, the busy season never ends—people are kept running all year long.”
While the private sector is more appealing for such people, Burns says that candidates are leery of internal audit or positions devoted to Sarbox requirements. “I advise companies to position such jobs as entrées into the organization,” he says, “or as rotational positions.”
Not everyone is pessimistic. Randolph Beatty, dean of the Leventhal School of Accounting at the University of Southern California, says the quality of students in the discipline has gone up, and demand for them is high. “Section 404 of Sarbox has created an industry,” he says.
Colleges are not obliged to match demand, of course, and in fact it is in their best interest to fall short so that students can enter the workforce with plenty of prospects. But with Burns and others predicting intensifying competition among employers of all types for entry-level and early-career accountants, companies may soon pay more for their own hires and for the services of outside help.—Scott Leibs
Companies are dishing out more dough to settle securities suits these days. While the number of suits settled in 2004 was up 23 percent from 2003, the total cost to settle those cases more than doubled, to $5.5 billion.
Even after factoring out the hefty $2.9 billion to be paid in conjunction with a suit filed against WorldCom in 2002, the average settlement still climbed from $21 million to a record $25 million in 2004, based on a study by Cornerstone Research. And six other cases, including suits filed against Global Crossing, Honeywell, and Raytheon, settled for more than $100 million.
The larger settlements are mostly due to larger losses incurred by the plaintiffs and pressure to settle quickly to focus on regulatory issues. “The claimed damages are massive,” says Steve Scholes, of law firm McDermott Will & Emery LLP.
Laura Simmons, a principal at Cornerstone, says she expects the trend to continue. Already this year, former WorldCom shareholders settled claims with Citigroup for $2.6 billion and with J.P. Morgan for $2 billion, bringing the total value recouped from underwriters to more than $6 billion. That figure eclipses the prior record settlement of $3.1 billion by Cendant, approved in 2000.—Joseph McCafferty
Terrorism Coverage Lapse?
With the Terrorism Risk Insurance Act (TRIA) set to expire at the end of the year, insurers are getting antsy, and CFOs are getting worried that their capital-risk safety net could fail.
Enacted in 2002, TRIA established a federal program to provide partial compensation for insured losses in the event of a massive terrorist attack, but only recently has Congress begun to debate extending the act.
“Without the government backstop, there’s not enough capital in the industry to cover massive terror-attack claims,” says Robert Hartwig, chief economist at the Insurance Information Institute. Insurance companies say they are in a difficult position because they are beginning to negotiate terrorism-coverage contracts for coming years, but aren’t sure they can count on the backing of the federal government.
Experts say the worry is justified. “If TRIA is not renewed, we’ll return to the situation just after 9/11, when there was a substantial decrease in terrorism coverage from the insurance industry,” says Suzanne Douglass, managing director of Willis Risk Management, in New York.
Without federal support, terrorism coverage may be too expensive for some. For example, the Cleveland Museum of Art was forced to scrap a major exhibition scheduled for 2006 because of the high cost of terrorism insurance to cover artworks valued at more than $1 billion.
Since 2002, the amount of business losses insurers are obligated to reimburse has increased, while government responsibility has decreased. Currently, insurers are obligated to pay the first $15 billion and then 10 percent of the next $100 billion, with the government picking up the remainder, up to $100 billion. Hartwig predicts that if TRIA is not extended, insurers will be forced to exclude coverage in many cases.
A bill that would extend TRIA until 2007 was introduced in the House by Democrats in March, but it has been blocked by Republicans who say they are waiting for the Treasury Department to give its June report on the program.
Scott Hogan, CFO of Wausau Insurance Cos., says he hopes for a more permanent solution. “A long-term program will better protect against the market disruption that a sudden end to the program would certainly produce.”—Laura DeMars
When the Price of Fuel Is Cruel
These days, it’s not just airlines and overnight-delivery companies that worry about fuel prices: everyone is in the energy-management business.
Recent increases in the cost of retail and industrial energy—natural gas, electricity, and especially oil—have affected all areas of commerce, from hospitals to packaging companies. And prices are expected to keep rising.
Crude-oil prices, which are up 66 percent from last year as of April 1, could continue to escalate. Goldman Sachs energy analyst Arjun Murti recently increased his upper limit on estimated oil prices to $105 a barrel. In adjusted dollars, that would be almost as high as prices during the oil crisis of the 1970s.
Rising costs are pushing some companies to tap into creative ways to cut energy costs, including dusting off some older ideas. For example, Caraustar Industries Inc., one of the largest manufacturers and converters of recycled paperboard, uses a system that allows production to move between fuel oil and natural gas. The company, which uses an energy-intensive production method, can switch to the cheaper of the two. “We can switch within hours,” states CFO Ron Domanico. The company also buys forward contracts on natural gas. “Last year we were hedged about 30 percent of our natural gas requirement,” he says.
Costs related to energy increased $207 million in 2004 at aluminum producer Alcoa, with about $125 million in additional costs predicted for 2005. “In the short term, we plan to make improvements in productivity, better procurement, and restructuring of operations, including staffing,” says Alcoa director of corporate communications Kevin Lowery. “Long-term plans include exploring expansion opportunities in areas with lower cost or globally competitive energy.” Alcoa recently broke ground on a smelter in Iceland to capture glacial run-off, which can be used as a source of hydropower.
While high energy costs will hurt profits at lots of companies, others are finding they can ease the pain. Caraustar’s combination of focused hedging and reduced usage, for example, has produced a result most companies would envy. Claims Domanico: “Year over year, energy costs have been flat for us.”—Harlyn Aizley
Don’t Bet Your ARS
Beware auction rate securities (ARS). In December, Big Four auditors began issuing accounting treatment recalls, essentially advising clients that invest in ARS to reclassify their holdings. The auditors changed their collective mind about how to book the securities, claiming that the long-term, floating-interest bonds should be treated as investments for accounting purposes rather than cash or cash equivalents, which was the more common practice.
The accounting about-face is likely to dampen companies’ enthusiasm for using ARS as a cash-management tool, which could push up interest rates on the bonds as a consequence of lower demand at auctions, says Neri Bukspan, chief accountant at Standard & Poor’s. And finance chiefs will have to rework balance sheets and regulatory filings to comply with the accounting adjustment. Recently, in fact, companies as diverse as Deb Shops, Steelcase, and Procter & Gamble moved $3.8 million, $80 million, and $4 billion, respectively, out of the cash column when reclassifying ARS. Treasurers had favored them because they often provide higher yields than similar cash-management alternatives, such as money-market accounts or commercial paper. Contractually, ARS have 20- and 30-year maturities, but are priced and traded like short-term bonds because they feature interest rates that are reset during predetermined auction periods that usually occur every 7, 28, or 35 days.
Some investment advisers are now warning corporate treasurers that ARS may no longer provide the level of liquidity they seek. Lance Pan, director of credit research for Capital Advisors Group (CAG), in Newton, Mass., which counsels corporate treasurers, says he is unsure if the ARS market can retain enough liquidity to weather supply-and- demand “rough patches” brought on by the accounting change and regulatory scrutiny.
The ARS market is already under pressure from rising interest rates and investigations by the Securities and Exchange Commission over deal bid “rigging.” As a result, the $200 billion market has begun to flatten. Thomson Financial reports that in 2004, 431 new bonds were issued, only 6 more than in 2003.
The balance-sheet shift could also affect cash-based ratios at some companies, which could trigger technical loan defaults if debt covenants are pegged to cash ratios, says CAG’s Pan. No one expects a less robust market to lead to ARS auction failures, but many advisers, as well as the SEC, are reportedly calling for reform to assure more liquidity. Meanwhile, treasurers may have to rethink where they park their cash until the market calms.—Marie Leone
Here’s Looking at You
Ever get the feeling you’re being watched? Well, you may be. The Internal Revenue Service is taking a close look at the tax returns of executives and officers during the course of corporate audits.
The crackdown comes on the heels of a compliance pilot project in which agents studied the tax returns of top brass at 23 companies over the past year and uncovered significant problems. “We found everything from aggressive but legal tax treatments to illegal tax shelters to those who haven’t filed a return at all,” says Deborah Nolan, commissioner of the IRS’s large and midsize business division.
While the inspection of corporate officers’ returns has “long been part of our general practice,” says Nolan, there has been a marked increase in enforcement recently. Between 2000 and 2004, the IRS doubled the number of audits of high-income individuals, and an 8 percent increase in enforcement spending for 2006 has been proposed by the Bush Administration.
Dean Gardner, CFO of International Garden Products Inc., isn’t surprised by the closer inspection of executives’ returns. “CEOs and CFOs have been demonized in the last few years for the sins of a few,” he says. Still, Gardner doesn’t think executives have been unfairly targeted.
Certainly it’s not the first time the IRS has looked at a specific group, says Timothy McCormally, executive director of the Tax Executives Institute. “If you’re a card dealer in Las Vegas, you know that once in a while the IRS focuses on [that profession],” he says.
Nolan says the service has concentrated on particular industries or occupations in the past when they have identified areas of high risk for noncompliance. “Sometimes illegal tax shelters are being marketed specifically to these highly paid executives,” she says. She stresses that the IRS is not interested in the amount of compensation, but only in its tax treatment.—Kate O’Sullivan
They’re Doing It Again
In the wake of massive corporate scandals, most companies are doing everything possible to provide accurate portraits of their financials. Right? Not necessarily.
A new report from Richard Bernstein, chief U.S. strategist at Merrill Lynch & Co., accuses many companies of continuing to report inflated earnings numbers. “The quality of earnings has again begun to deteriorate,” argues Bernstein in a research report issued in March.
That assessment is based on his study that tracks the difference between GAAP earnings and operational or other pro forma numbers, which companies continue to tout in their earnings releases. A large gap between reported GAAP earnings and announced earnings, after exclusions, could indicate poorer-quality earnings. While the GAAP gap has narrowed greatly since it reached its height in 2002, it has begun to widen again. “Although stock market valuations might not be as stretched as they were in March 2000, the quality of earnings appears to be worse,” says Bernstein.
For example, Eastman Kodak Co. lost 4 cents a share for the last quarter of 2004, according to GAAP accounting. Yet the photography giant announced “operational” earnings of 78 cents a share, after taking out restructuring charges. Georgia-Pacific Corp. reported GAAP earnings of 6 cents a share for the same quarter, but went on to tout earnings of 51 cents “before unusual items.” Those items include $159 million for asbestos costs and $38 million “related to asset impairments, facility closures, and employee severance.”
Marc Siegel, director of research at the Center for Financial Research and Analysis in Rockville, Md., isn’t surprised by Merrill’s findings. “Not only do problems still exist with the quality of earnings, but [companies] are managing other metrics as well,” contends Siegel. As investors have focused on measures like cash flow, he says, some companies have begun to “manage” them to hit expected targets. “The metrics have changed, but the behavior hasn’t,” he asserts.
But the allegations are surprising to many, given the scrutiny earnings announcements have received lately. Regulation G, which took effect in March 2003, requires firms to put GAAP numbers first in earnings releases. It also forces them to reconcile all non-GAAP numbers back to GAAP. “Reg G has certainly improved transparency,” says Chuck Hill, former research director at First Call and president of Veritas et Lux, an investment firm in Ipswich, Mass. “But we’re still seeing a lot of stuff that companies want to exclude.” Hill says the Securities and Exchange Commission hasn’t enforced Reg G as vigorously as some other rules, such as Reg FD.
The use of pro forma numbers alone isn’t necessarily an indication of low-quality earnings. Hill says it depends on what they are excluding. “A large write-down of goodwill could be a good thing,” he says. “But if they are taking a restructuring charge every few quarters, that’s another story,” says Hill. While a gap between GAAP earnings and operation earnings deserves a closer look, he adds, “pro forma shouldn’t be a dirty word.”
Lou Thompson, president of the National Investor Relations Institute, agrees. “Non-GAAP numbers have a place as long as companies don’t overemphasize or abuse them,” he says. He also thinks that most firms are following Reg G. “The quality of earnings should have improved.”
The extent to which companies are willing to exclude charges will be tested next April, when the first earnings reports for many firms are expected to include stock option expensing. “It should be interesting to see how analysts treat them,” says Hill. He argues that stock options should probably be included, but he is not sure that will be the consensus view. To no one’s surprise, Hill predicts that technology companies are going to push pretty hard to exclude them.—J.McC.
Falling into the Gap
S&P 500 companies with the largest gap between GAAP and published pro forma earnings for Q4 2004.
|Company||Published EPS||GAAP EPS||GAAP “Gap”|
|Equity Office Properties||$0.62||$0.15||313%|
|Computer Assoc. Int’l||$0.19||$0.06||215%|
|Sources: Merrill Lynch and Standard & Poor’s|