Reed Kathrein | a matter of trust

a matter of trust

A Matter of Trust

by Lesley Kump Lacey Rose | Oct 18 '04----Forbes

There is more to corporate performance than what you see in the earnings reports. Could an investor have anticipated the trouble at companies like Enron, Adelphia, WorldCom and Tyco by looking more closely at how they were governed and how they kept their books? Their problems, to be sure, are far more visible in hindsight, but nonetheless each left telltale signs that all was not well. Robust reported earnings growth at both Enron and WorldCom was not supported by hard cash. The Adelphia board was stacked with company insiders who turned a blind eye to self-dealing by company executives. Tyco's chief executive raided the company's coffers, and its P&L statement was plagued by constant writeoffs.

In this, the third report in our Beyond the Balance Sheet series, we provide shareholders with scorecards on corporate integrity and earnings quality for the 30 largest U.S. companies based on market capitalization.

The integrity measure rewards companies with underpaid bosses (like Microsoft), outsider-dominated boards (Johnson & Johnson) and a history of responsiveness to governance proposals from shareholders (Altria). It docks those with antitakeover defenses (Amgen), problem directors (Bank of America) and legal or regulatory problems (Merrill Lynch).

The earnings-quality grade rewards companies for having high sums of operating and investing cash flow relative to reported earnings (Cisco). It penalizes those with lots of nonrecurring charges (Time Warner) or a habit of falling short of Wall Street earnings expectations (Wells Fargo). As the recent accounting debacle at Fannie Mae shows, how a company keeps its books is just as important as how it is governed.

Our sources: governance experts The Corporate Library and Institutional Shareholder Services; earnings-quality sleuths Criterion Research Group and Audit Integrity; and data-provider FactSet Research Systems.

General Electric

GE, run by Jeffrey Immelt since Jack F. Welch retired in 2001, is one of only two companies (PepsiCo is the other) in our table that scored in the top 10% for both corporate governance and earnings quality. The board meets frequently (13 times a year) and is independent (12 of its 16 members don't work at the company). GE has either met or exceeded Wall Street's earnings target for 19 of the 20 latest quarters. GE's shares have outperformed the By a 2-to-1 margin over the past ten years.

Microsoft

One reason Microsoft gets an A for corporate governance is that Chief Executive Steve Ballmer and Chairman Bill Gates, unlike their employees, do not get stock awards. Microsoft also gets high marks for shareholder responsiveness (earlier this summer the company announced that it will return $75 billion to shareholders over the course of the next four years, including a one-time dividend of $3 per share) and accounting (the company broke ranks with the technology sector by expensing stock options).

PepsiCo

While rival Coca-Cola has had to deal with charges relating to accounting irregularities, disappointing earnings and a stock that has fallen 6% during the past year, Steven Reinemund's PepsiCo has taken no such charges; its profitability has increased and its stock is up 7%. It's no accident that PepsiCo gets an A+ for corporate governance: Its board is dominated by outsiders, who frequently meet separately from management, an especially important indicator of overall board independence. According to Tom Lardieri, general auditor of PepsiCo, "… companies that have stronger governance practices generally demonstrate stronger financial returns."

Pfizer

Sometimes a company's business is more profitable than its reported earnings would lead you to believe. Pfizer's yearly net income through March, based on accrual accounting, was $1.6 billion. But the company's cash earnings (net cash flow from operations plus investment income) were $34 billion. Earnings were dragged down by $5 billion in noncash charges related to acquired research and development. CEO Henry McKinnell should be pleased: Absent those one-time charges, earnings per share are expected to increase an average of 12% annually over the next three years.

Find this article at: http://www.keepmedia.com/pubs/Forbes/2004/10/18/590824

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