Before Enron, I'd been an obscure professor of accounting at the Graduate School of Business at the University of Chicago, (recently ranked 2nd by Business Week, one step ahead of the formidable competitor on the Charles River), with some visibility in both the profession and the academic community.
My independence, or orneriness, had led to my being auditioned for the powerful job of Chief Accountant of the SEC by both Democrats and Republicans, on two separate occasions, but being rejected by both.
In the last year, I've been on national and local TV many times and been quoted in major newspapers and magazines. My role is to explain what went wrong and how to fix it. By May, I was telling people that I'd had my 12 minutes of lifetime fame; now, maybe I'm up to 17 minutes.
I've dealt with reporters from big-time and smaller-time radio, TV and newspapers from all over the country. Most of them want to win a Pulitzer, so seek scandal and controversy. Otherwise, it's hard to generalize. Only a few really want to know what is going on, so think about what they ask and what I answer. A few try to learn and I give them as much time as they need. The one who annoyed me the most was David Wessels of the "Wall Street Journal." He interviewed me at length, used the material I gave him, quoting me verbatim but gave no attribution, making all of the information his own.
Henry Kissinger put it best many years ago when he said that the reason academics' arguments are so vicious is that the stakes are so small. All we have is our egos so when the press takes our specialized knowledge and experience to its own ends, without attribution, it hurts. Nobelist George Stigler, a mentor, told me many years ago that the only time it hurts to have your name in the newspaper is in your obituary, and then you may not notice.
I think that the unifying theme of the accounting and auditing surprises of the last year lies in the failure of the audit committees of the corporate boards. Audit committees are supposed to comprise directors who are both independent and financially literate. In every case you've heard about in the last year, the audit committees failed to be either independent or financially literate, or both.
What does financial literacy mean? How literate are current audit committees? What are they doing to increase the financial literacy? These issues unify my current work.
What does financial literacy mean? I think being financially literate means that you both understand the transactions your company undertakes and the accounting issues surrounding those transactions. Simple enough? No. I get push back from current audit committee members because; in my view, most do not have the knowledge and don't want to study hard enough to get it.
I want the financially literate board members to understand, on their own, the issues, not to have to rely on consultants or experts to provide guidance or re-assurance. Even now, the hotshot lawyers such as the eponymous Marty Lipton of Wachtell Lipton are advising audit committees not to worry about financial expertise, but to hire consultants. While we may need to struggle along with consultants knowing what audit committee members should understand themselves, I hope we shall aim higher.
In recent weeks, as a result of meetings with senior officers of several giant American companies I've sharpened my definition of the transactions and the accounting that the financially literate audit committee member should understand. They should fully understand the transactions noted by management in a new section of Annual Reports called, "Critical Accounting Judgments," which the SEC recently requested from companies. If a Board member doesn't understand the transactions that management identifies as critical for shareholders to know about, then he or she shouldn't be on the audit committee for those shareholders.
A world famous, former CEO of a trillion-dollar company provides the quintessence of the opposition: How can you expect me to know 700 pages of detailed accounting rules for financial derivatives? And I don't need to, because I know how to ask the tough questions.
What good does it do the CEO or anyone with corporate and shareholder responsibilities to know how to ask the tough questions if she or he can't understand the answers and ask the appropriate follow-up questions.
Earlier this year, I wrote the chairs of the audit committees of the 1,100 largest companies in the United States asking two sets of questions.
- Is your committee taking steps to assess the financial literacy of its members and, if so, what?
- Is your committee taking steps to improve the financial literacy of its members and, if so, what?
Roman with granddaughter
So far, I have received about 30 responses. I can imagine corporate general counsels giving advice that the company will get no benefit from disclosing such information to a nosy professor, even one who promises anonymity. Still, the responses indicate no attempts to measure, and only feeble attempts to improve financial literacy. Hence I've entitled a research report I am writing, "Financial Literacy, A Work Not Yet in Progress."
Starting about a year ago, some colleagues and I developed a thorough test of financial literacy, which we have given in organized classes and seminars to several hundred corporate board members, many of whom serve on audit committees. As of now, about 150 have provided answer sheets that we can score. By the most generous grading, the median score is about 60 percent. Take the quizzes yourself, which can be found in the box just to the right and e-mail me your answers and any questions to email@example.com. I'll get back to you to tell you how you did.
By the time you read this I will have given those questions to my students as part of their final examination. I won't be surprised to learn that the better, say top quartile MBA students in beginning accounting do better than the corporate board members. I suppose that is both the good news and the bad news.
What's your view?