Select Committee on Treasury Minutes of Evidence


Examination of Witness (Questions 360-379)

PROFESSOR SIR DAVID TWEEDIE

TUESDAY 2 JULY 2002

  360. Is your major concern on this issue that this reporting of stock options and the way it has been done at the moment is leading to a misreporting of the financial strength of the companies? Or is it that you fear that it is creating incentives for people to distort the performance of the company in the short term in order to realise huge profits for particular individuals at the expense of the long-term strength of the company itself.
  (Professor Sir David Tweedie) It is both. Alan Greenspan is very concerned that it is very difficult to manage an economy when you find that profits might be 50 per cent overstated in certain sectors. It is not as though all the sectors are even. The high-tech sectors, the communication sectors give far more of these things than some of the more traditional industries. The other thing is that you have this huge temptation on executives who might be a bit greedy to manipulate the numbers to make sure these things stay above water so they can exercise them.

Dr Palmer

  361. I am very enthusiastic about what you are saying and I think it is a breath of fresh air, but do you think there is any chance at all of persuading the Americans to agree?
  (Professor Sir David Tweedie) It is going to be interesting. We have had words from Europe coming forward from the industrial companies saying what we must never do is put them at a commercial disadvantage with the United States. We must not have any standards which are tougher than the United States. We have told them, and I suspect you will come under pressure to say the same things to us, that we are actually going to ignore that. If we did not ignore it, the best we could do would be to be equal with the United States or perhaps slightly below, in which case why not just use the American standards and be done with it. Stock options is a classic case. The American standard setter believes it is an expense, Congress forced them to show it merely as a disclosure. I think it would help the United States if we were to go way past them and do what we think is right and what they think is right too, to be honest. If they do not do it, they are going to be under pressure, partly because I shall enjoy going to America and saying what lousy standards they have.

  362. That is going to be fun, but in the last resort our colleagues in Congress are probably going to be more influenced by lobbyists and do you not think that for the foreseeable future they are going to carry on the same path?
  (Professor Sir David Tweedie) The interesting thing about it is that there is almost a climate of change. The analysts in America did a survey and 82 per cent of them think these things should be expensed. Various of the pension funds are now campaigning, which they never did before. America, watching corporate greed, is pretty horrified. There is a chance this time round. It is going to be a brave Congressman who says these things must be kept secret.

Mr Mudie

  363. Apart from the reference to greed, which is acceptable, you referred to stock options committed to income. You say they are in every company. Are they quite easy to spot in the balance sheet?
  (Professor Sir David Tweedie) They would not be on the balance sheet. What happens is they are part of share capital basically, so you would not see them. You would see them in the income statement, the profit and loss account; that is where it is very visible. It is remuneration and we are not showing it that way. The trouble is that some of these people get most of their remuneration in share payments and even pay suppliers in share options and things like this. If you went on that basis, that you had no cost at all, you could just show revenue and profit and nothing in between. You just hand out these options all the time. The whole thing is farcical. In the States, for example, they have brought in this rule that if you pay a supplier with share options, say the lawyer, you pay him with share options then you charge it as an expense, but if you bring the guy inside and pay him the same in share options, that does not count because he is an employee. I do not understand the logic of that.

  364. There are two things. One is the share option itself, the sheer volume and value which is going out of the company. The second is that it gives them an incentive to manipulate the stock price for personal big gain.
  (Professor Sir David Tweedie) Absolutely.

  365. Is there a third thing? Is there a way of doing this which affects the company within the books which has not been picked up by auditors, or has this been openly known about in the States and lived with?
  (Professor Sir David Tweedie) They have to disclose the number. It is there in the notes. The trouble is that people are not deducting it from the profit figure and that is purely a political decision on behalf of Congress.

  366. Should the auditors, or did the big auditors in the States, spell out what was happening?
  (Professor Sir David Tweedie) It is clearly spelled out. The firms cannot do anything about it. The law will not let them change it, so there is nothing they can do.

Mr Tyrie

  367. What you have been saying is hardly a ringing endorsement of current valuations in the US. To what extent do you think the markets have priced in, and made estimates of, what you have been alluding to—the poor accounting on pensions, stock options, leasing—and that this is already priced in. To what extent do you think a lot of this, as it becomes exposed, is going to have a deleterious effect on prices?
  (Professor Sir David Tweedie) It is difficult to answer that question. Share options are probably now being priced in because the awareness is starting to rise, mainly because of the fact that internationally there is a campaign to charge these things, so people are more aware of it and they are now starting to focus on the number. I wonder whether they really understand how much is off balance sheet with leasing. They probably do not. To be fair, I would not know. It is very difficult to see. They may knock down various companies because they know they have major leased assets and their gearing might be more suspect. You can just take an example, it is the heavy equipment industries where the leasing issues are. For example, I doubt very much that you have ever flown in a plane which is on the airline's balance sheet. Most of them are leased. That is the issue. They have the aircraft and they have a liability to pay for it, so they have the right to the 747 plus the liability for seven years to pay this thing. We do not reflect that.

  368. So even without fraud, the US market is very vulnerable to the exposure of accounting practices which will lead to a weakening of the share price and vulnerability of the market.
  (Professor Sir David Tweedie) We are too. I would not go so far as to say that these things had not been considered. Some estimates will be made but I have no idea how accurate these estimates are. The information is not really there on which to calculate exactly what we would probably want to record on balance sheet. It just is not in the accounts.

  369. So there is no way that reasonably an analyst can price a stock which may have huge amounts of leasing, for example, hidden in the accounts.
  (Professor Sir David Tweedie) He would make a guess at it. The sort of disclosures you have are the number of leases which are two years' old and the cost there and how many are more than five. The trouble is, what does "more than five" mean? He can make a stab and say maybe it is seven and he will take it as a seven-year lease, but he does not know. He will get a rough estimate, but he will not be accurate.

  370. Is this not an appalling state of affairs, that we have trading, buying and selling going out on a massive scale in the world's major markets on the basis of rather crude information?
  (Professor Sir David Tweedie) Absolutely. You watch the leasing industry when we start banging this in. They will say it is the end of Western civilisation as we know it. They will oppose it because a lot of people like things off balance sheet. It is better that way. It is still going on. We have a constant fight to try to get these things on and the accounting is very complicated in a lot of situations, but a lot of it is not rocket science. If you are going to have to cough up money, it is a liability and why is it not on balance sheet.

  371. A lot of people are going to hear what you have said today and conclude that it is a sell signal, Sir David.
  (Professor Sir David Tweedie) They do not know the analysts and how much the analysts have already impounded these numbers into the accounts.

  372. You are saying they do not know, they cannot know.
  (Professor Sir David Tweedie) I am saying they make rough estimates. They do not know exactly what it is. They may be relatively good; I do not know.

Mr Mudie

  373. Andrew cut you off when you were explaining the vulnerability and you used the words "We are too", before you were cut off. What did you mean? The British are too?
  (Professor Sir David Tweedie) I cannot remember what I was saying now.

  374. You were talking about leasing and you were explaining the vulnerability and Andrew went on to another question, but before he did, you said "We are too", which I took to mean that the British are vulnerable to this sort of practice as well.
  (Professor Sir David Tweedie) We all have the same leasing standards throughout the world and we are perfectly harmonised in our work. This is the issue. We really have to start again. Mary's Board is actually working on it right now with us. They are doing a lot of the pioneering work and that is what we are looking to bring forward. You wait for the squeals when it comes out.

  375. I just want to look at your contract of employment. Is it a good one?
  (Professor Sir David Tweedie) I can only be fired by the trustees.

Mr Cousins

  376. You have given us a very sparky performance but are you trying to tell the Committee that this is almost entirely a United States problem? Secondly, do you think that in terms of market confidence, you have until 2005?
  (Professor Sir David Tweedie) It is not just a US problem. I think it has been exacerbated because of the events in the United States. We could have these problems too and that is one of the reasons we are working pretty hard at getting these things right. By 2005 we will have the major issues out on the table and we know they are very urgent. The answer really to nervous markets is full transparency so people do not get frights. That is what our job is, to make sure as quickly as we can that we do not get frights. The problem of course is that when you do that sort of thing people do not like the glare of the spotlights. You will be hearing how we are doing it all wrongly and we should compromise here and compromise there. You never win in this game. If you do not compromise then you are intransigent. If you do compromise you have caved in. It is a case that we just do what we think is right and just crack on. That is one of the advantages of being an independent standard setter.

Chairman

  377. You mentioned in your report that the publication of a standard requires approval by eight of the Board's 14 members. Do you consider that eight individuals is an adequate basis to compile international standards?
  (Professor Sir David Tweedie) I think so. It was put in quite deliberately. The American standard setter was a board of seven and about ten years ago there was a lot of pressure from industry to stop being a bare four/three majority and it went to five/two and they slowed right down. I think you have a far better chance of putting out tough standards if you do not need ten votes because you can lose four or five. When you only have eight, that means you can put out something which is pretty tough and biting.

  378. In an earlier answer to a question on stock options you mentioned that it would have a very considerable impact on market valuations. That implies a huge re-adjustment by a lot of American companies and, given the fall-out in the market with Enron and WorldCom, there have been implications for the UK market. Do you see that turbulence continuing?
  (Professor Sir David Tweedie) I suspect, after Alan Greenspan's comments about share options and the analysts and the pension funds, that people are starting to deduct the amount which is shown in the notes from the various profit levels. The trouble is the effect on different sectors; it is not across the board. In the high-tech sectors it is very, very big. So there is possibly a misallocation of resources, pouring into something which looks much more profitable than another area. For an efficient economy this is exactly the sort of thing we need. In the UK the issue is not so big. That is the big consolation we have here. It is a very big issue in the US. We do not have the measurements as they do in the American situation because they have a standard which requires them. We had other priorities because it was not such a big issue across here. Now of course we are coming into the frame and that will start showing the effect in the UK. I do not think the effects are big here.

  379. The year 2005 has been mentioned. How confident are you that international standards will have been adopted by 2005?
  (Professor Sir David Tweedie) You will certainly have all the core standards there plus two or three of these ones. I reckon share options will be in. Leasing will be on the way if we are not there. I think 2005 has made the SEC sit up and look because this huge economy over here is now starting to use a different set of standards. We are trying to get them together and I know the SEC have said publicly that the closer we can get then they could just wave them through straight onto the New York Stock Exchange and that ultimately is one of the major steps forward for us.

  Chairman: I felt you were giving us food for thought this morning, but I change that to saying you have given us a feast on which to dwell. We shall look at the implications of your remarks and it has been fascinating for us this morning. Thank you very much.





 
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