Examination of Witness (Questions 360-379)|
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.
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
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.
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 tothe poor accounting on pensions,
stock options, leasingand 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
(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
(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
(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.
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
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.
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.
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
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
(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
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.