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Accountants Not Getting Trust

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I’m starting to believe that the biggest obstacle to increasing trust in business is the conceptual confusion that exists around trust itself. We literally cannot agree on what we are talking about.

The latest case in point: Public Company Accounting Oversight Board (PCAOB) Chairman James R. Doty, keynoting on the subject of Integrity at the Seventh Annual Auditing Conference:

Item 1. “[Doty said] the worst thing a firm can do is to blame a problem on an individual, rather than recognizing it occurred as a result of the way the firm was operating.”

Apparently issues of trust and integrity in business are institutional.

Item 2. “[A] student asked, ‘What drives people to act unethically in the accounting profession?’ Chair Doty responded that a similar pattern is evident in other professions, as there are some who should not have become professionals because they have to deceive. However, other people get on a slippery slope when they know they are approaching the limits of professional practice, then step over the line, and then rationalize their behavior.”

Apparently issues of trust and integrity in business are personal.

Well, Mr. Doty – which is it? Is integrity an issue of institutions, or of personal character and ethics? Does it depend on whether the business in question is an accounting firm? If so, why? And above all – what problem are we trying to solve here?

Because the solutions are very different. You can’t expect a decent solution if you can’t first decide which problem you’re trying to address.

Personal vs. Institutional Trust

The right answer, had anyone asked Mr. Doty, should have been, “Both – and here’s how they fit together.” But this rarely happens; instead, too many business speakers on trust blithely go on talking about very distinct problems as if they were one. No wonder we make so little progress.

Here is the right answer, in two principles:

Principle 1. Integrity and trust must be personal traits: Citizens United notwithstanding, human beings do not “trust” policies, regulations, or ultimately even audits. They trust – or do not trust – that people are acting in trustworthy ways. The role of regulations et al is to articulate boundaries and principles underlying that behavior.

This principle is violated by focusing solely on rules and regulations, as if the regulations were a substitute for management itself. The result is what we see in the financial industry – a morally bereft place that confuses ethics with cat-and-mouse games. The regulators (and the auditors too!) are as much at fault as the regulated, because they focus only on the behaviors – not on demonstrated lack of character.

Principle 2. Integrity and trust are greatly influenced by corporate environments.  If unethical behavior is tolerated, of course it will increase. But the same is true if unethical behavior is simply treated as a cost-benefit calculation. And if ethical behavior is not modeled, people will (rightly) conclude it’s all hypocrisy.

This principle is violated by a calculus of economically matching the punishment to the crime. Industries who cynically compute violations as analyses of the cost of doing business are at fault, but even more so are regulators and legislators who set up that system. It is also violated by managers and leaders who don’t walk the talk. All corporate “values” lose their juice if not modeled; but in no case is this more important than in trust.

Solutions

A proper view of trust and integrity in business would squarely locate accountability on individuals. The penalties for violating rules should be in the range of 3X the ill-gotten gains, not 1X or less. Auditors may or may not be considered accountable for integrity and trust, but they shouldn’t think they can address these issues solely through risk assessment, monitoring and communications – not unless they address whether or not managers are clearly accountable (cf the recent GM mess), and whether or not the sanctions imposed on them for misbehavior are absolutely clear (e.g. swift termination for ethics violations, period).

Trust in business rests on trust-based organizations. Trust-based organizations are organizations in which people a) trust others, and b) are themselves trustworthy.

  • Organizational policies which encourage personal trusting and trustworthiness help create trust.
  • Organizational policies which eliminate personal responsibility and risk-taking destroy trust.
  • Management structures and policies which enforce accountability for trust-based behavior – including disproportionate sanctions for violations – are necessary. Management-by-policy-alone, however, is defaulting to mistrust.

Trust is both personal and institutional: but it’s critical to get the interface right. It starts with simple, clear thinking.

Integrated Reporting: Interview with Harvard Business School’s Robert Eccles

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Robert Eccles is a Professor of Management Practice at the Harvard Business School. For over three decades he’s been active in management accountability—linked to, but not limited to, more traditional concepts of financial-only reporting. He’s written several books before, perhaps most notably Building Public Trust: The Future of Corporate Reporting with Sam DiPiazza, former Global CEO of PricewaterhouseCoopers (PwC), but he may have finally hit a new level of interest with the arrival of his book One Report: Integrated Reporting for a Sustainable Strategy.

Bob speaks to us here a few months following a 100-person “Workshop on Integrated Reporting: Frameworks and Action Plan” sponsored by the school’s Business and Environment Initiative. You can download a free ebook from the event, The Landscape of Integrated Reporting: Reflections and Next Steps, with papers by about half the participants—it’s excellent.

Trust Quotes

Trust Quotes Series

Charlie Green: First, thanks very much for speaking with us. I first became aware of you from your work with Sam DiPiazza, but you’ve been working in performance measurement and reporting since long before that.

Might we say your expertise is the measurement and management of diverse indicators of corporate performance? How shall we call what it is that you do?

Robert Eccles: I’d say that I’m deeply interested in corporate performance measurement and reporting, with an emphasis on external reporting—a powerful lever for changing behavior and decision making by executives.

CHG: How did you get into this field?

RE: It goes back to my undergraduate thesis at MIT, but we needn’t go back that far! I was an Assistant Professor at HBS when I wrote a book on transfer pricing. After I became tenured in 1989, I started writing cases for a new first year course called “Information, Organization and Control.” I found companies getting interested in performance measures beyond the traditional financial ones.

Based on this I wrote a 1991 HBR article, with Sarah Mavrinac, called “The Performance Measurement Manifesto.” One year later Bob Kaplan published his famous article on the Balanced Scorecard, another indicator of interest in this topic. We both were focused on internal measurement. Bob remains so to this day, but I got interested in what companies were reporting and what information sell-side analysts and investors wanted from them.

This led to a 1995 Sloan Management Review article called “Improving the Corporate Disclosure Process.”

I left HBS to work in the private sector and this included researching and improving corporate reporting. I wrote The ValueReporting Revolution: Moving Beyond the Earnings Game with three PwC partners, including Bob Herz, recently retired as Chairman of the Financial Accounting Standards Board. I returned to HBS in 2007 and wrote One Report which was published in early 2010.

CHG: I’ve been aware for some time of movements like the Balanced Scorecard to integrate non-purely-financial metrics into the rubric of reporting. But I hadn’t heard of Integrated Reporting until just recently. How old is that term?

RE: Good question—I’m not really sure. Allen White used the term in 2005 in a piece for Business for Social Responsibility. That same year Solstice Sustainability Works wrote a white paper called “Integrated Reporting: Issues and implications for Reporters.” But even though Novo Nordisk has been publishing an integrated report since 2004, and Novozymes two years before that, those articles went unnoticed. The times just weren’t ready.

In March, 2010, about the same time my book was published, Southwest Airlines came out with their “Southwest Airlines One Report™.” Neither of us knew about each other’s initiatives until the summer of that year. I think the times are catching up.

CHG: What is Integrated Reporting? How do you define it?

RE: First of all, the term is still gaining acceptance so there is no general agreement on its meaning. Here’s my most basic answer. It is the publication in a single document of the material measures of financial and non-financial performance and the relationships between them.

It also involves leveraging the Internet and the company’s website to provide more detailed financial and non-financial information of interest to particular stakeholders, including shareholders, along with tools for analyzing this information. Finally, it’s about increasing dialogue and engagement with all stakeholders. It’s as much about listening as it is talking.

CHG: That begins to explain the connection with trust.

RE: Right—among other things, it’s about building trust between a company and its stakeholders. This trust comes from being transparent about all dimensions of performance—successes and shortcomings—and from active dialogue and engagement. For stakeholders to have trust, they need to know their expectations and concerns are being heard and that the company is honestly and forthrightly reporting on the meeting of expectations.

Of course, trust is a two-way street. Companies can’t optimize on every performance dimension, especially over short periods of time. Trade-offs are involved and must be accepted. Shareholders need to recognize the legitimate interests of other stakeholders; ditto for stakeholders and the need for companies to make financial returns.

Risk is relevant to trust too. Creating shareholder value requires risk taking. What’s required are candor about risk levels, systems and processes for risk management, and communication about the approach to risk management. Ultimately, risk management is about good corporate governance.

The “G” part of “ESG” (Environment, Social, Governance) typically gets less attention that the “E” and “S” part, because it’s harder to measure. But that doesn’t make it less important. What happens when they’re all missing? Consider big financial institutions in the meltdown of late 2008. Or BP in the Gulf of Mexico.

CHG: If the world had a robust system of Integrated Reporting—what would we have? What are the benefits, what’s the business case (or socio-business case?) for Integrated Reporting?

Trust QuotesRE: The greatest benefit would be a sustainable society—able to meet the needs of a growing number of citizens all over the world, mostly from developing countries, while still being able to meet the needs of future generations. Neither developing nor developed countries can continue consuming natural resources at today’s rate, creating negative environmental and social externalities, and practicing poor risk management and corporate governance.

CHG: But certainly reporting can’t fix that by itself?

RE: No, certainly not. Management practices, technologies, intelligent regulation and individual decisions play an important role as well. But Integrated Reporting is central, because reporting is a major determinant of behavior. It establishes discipline for the integrated management of financial, natural and human resources. It meets stakeholders’ information needs, along with processes of engagement, to help them help the company build a sustainable strategy. A sustainable society requires that all of its companies have a sustainable strategy. Integrated Reporting is central to this.

CHG: I get the sense that recently, things have changed a bit. Is this perhaps an idea whose time has finally come? Are you still feeling quixotic, or are there some genuine causes for optimism?

RE: “Quixotic” is a good choice of words. I have been working at this for over 20 years now and I can relate to Don Quixote tilting at those windmills. But today I feel extremely optimistic. First, companies have started to do it. They came to this largely on their own, and for pretty much the same reasons. No one had written a book and the topic was still fairly obscure.

Prince Charles started his UK-based “Accounting for Sustainability Project (A4S)” a few years ago. Starting June 1 of 2010 all Johannesburg Stock Exchange listees must file an integrated report as their annual report. France and others have passed similar laws, and it’s being considered by the entire European Union.

In August of 2010 the International Integrated Reporting Committee (IIRC) was formed. The Secretariat of this group is A4S and the Global Reporting Initiative. On its Steering Committee (of which I am a member and we had our most recent meeting in Beijing on January 17) and Working Group are prominent experts on corporate reporting from many different disciplines, and from all over the world. We hope to get Integrated Reporting on the agenda of the G20 meeting being hosted by France in November 2011.

Momentum for Integrated Reporting—driven by both market and regulatory forces—is growing and growing rapidly.

CHG: Dean Nohria at Harvard Business School recently opened up your conference with some very clear and strong language about the critical nature of trust to business. You know Nohria personally, but let me ask you institutionally as well: what does it mean for the Dean of Harvard Business School to be talking trust?

RE: I can’t tell you how significant I think it is that our new Dean is talking about trust. Though he’s a close personal friend of mine, I think I can objectively say that he is a man of the highest integrity and with a strong belief of the good business can do in society. The fact that his opening remarks at the HBS workshop on Integrated Reporting you mentioned at the beginning of this interview were focused on the need for business to rebuild trust in society pretty much says it all. His opening remarks are the basis of the introduction he wrote for the EBook and I would encourage all the readers of your blog to read what he had to say.

CHG: I’ve noticed a continued effort on the part of most people in arena of ESG (environmental, social and government issues) to try and justify their work in financial terms. At least one says that’s because business will never listen unless they can clearly see the profit value tightly demonstrated. But the tighter the justification in corporate profits, the less powerful the argument for a non-profit-based accounting, much less ethos, don’t you think? What’s the right way to think about Integrated Reporting and corporate profitability?

RE: I would frame this a little differently. I don’t think the issue is profits per se. Every corporation with shareholders needs to make a profit if it is going to stay in business. Rather, the issue is how those profits are earned, what social and environmental costs are created in earning them, how much risk is being taken and how well it is being managed, and the time frame management is using in making its decisions. The latter is a key issue. A focus on short-term profit maximization and ignoring all negative externalities and excessive risk as long as the letter of the law is being followed does not lead to a sustainable strategy for a company. If most companies have a short-term orientation, and the capital markets are as much at fault as the companies are, we will not have a sustainable society.

The fundamental issue—raised but not answered by integrated reporting itself—is “What is the role of the corporation in society?” There were some very thoughtful pieces on this topic written by some of the HBS workshop participants. Society as a whole needs a big rethink about what it expects out of its corporations, especially the largest global ones that control so much and have such impact on resources.

We need to develop a collective understanding about how companies identify the needs of all stakeholders, the processes they should use to make decisions regarding performance targets and performance trade-offs, and the time frame involved.

What I’m talking about is a massive societal undertaking. But until it happens, trust in business will remain fragile, and easily lost every time we go through a crisis, even when the fault is not business’s alone.

CHG: What role can education play in helping improve trust in business? Is this mainly a role for MBA programs? Or can other programs play a useful role as well?

RE: Business schools can play a role in helping students understand society’s expectations about them as stewards of social assets. This goes beyond “ethics” (I will ignore the age-old question of whether ethics can be taught to 20-somethings if they haven’t already learned them from parents, churches and communities) and gets at the fundamental issue of the role of the corporation in society.

This topic should be part of every business school curriculum, undergraduate or MBA. It will require directly challenging the prevailing view based on financial economic theory in the western world. One hundred years ago “shareholder primacy” was not the prevailing ideology; there is no reason to think that it will or should be in 100, or even 10 years from now, particular since the concept of “shareholder” has become so loose in an age of hedge funds, technical trading programs and relatively short-term holdings by mutual funds and even pension funds.

But remember, trust is a two-way street. Citizens need a basic understanding of the social role of business, how companies work, and the trade-offs they have to make. They must commit themselves to engage as employees, customers, shareholders, and members of civil society. Too often other programs (such as in the liberal arts, engineering, science, architecture, law, and medicine) include nothing about business in their curriculum even though all of these groups are dependent on and must work with business organizations. It’s no surprise they are often hostile to business.

Hostility is not a good foundation for trust. It’s good to be skeptical, but in a constructive spirit with a desire to build trust, not to destroy it.

CHG: What’s the biggest implementation challenge facing Integrated Reporting? And what do you think is the biggest challenge to trust creation in the business world? Do those two overlap?

RE: Challenges exist at the level of individual companies, and of society. I see four major corporate challenges.

1. A company must truly have a sustainable strategy, not just say it has, which is more often the case.

2. The process for producing an Integrated Report must itself be collaborative and multifunctional.

3. Internal control and measurement systems for non-financial information are typically not as sophisticated and robust as those for financial information.

4. Internal skeptics need to be persuaded. Executives need to accept that greater responsibility will entail greater accountability and, when they fail, they will pay the consequences—just as they do with financial performance. Users, both shareholders and other stakeholders, will require a lot of education.

At the level of society as a whole, Integrated Reporting is a necessary but not sufficient condition for creating a sustainable society; that’s a giant collective action problem. Companies are the entities doing the reporting and so they clearly can and should take the lead. After all, no country has any laws preventing Integrated Reporting.

But for Integrated Reporting to be as effective as possible, other groups need to get involved too. Measurement and reporting standards for non-financial information need to be developed so that analysts and investors have confidence in them and can compare the performance of companies, at least within a sector, and over time. These analysts and investors must then incorporate those measures into their financial models, turning them into business models.

Accounting firms need to develop the methodologies and capabilities for doing integrated audits. This may require some liability protection from legislatures and regulators, who also have a codification and specification role to play. NGOs need to collaboratively engage with companies to make the processes work. They also need to take a more holistic view themselves. Educators also have a role, as I’ve already discussed.

Finally, every member of civil society—and that is each and every one of us—needs to commit to a sustainable society and to do whatever he or she can to support the Integrated Reporting social movement. We only have one planet and we’re all in this together. If we don’t work together for the long term, we’ll have no long term.

CHG: This sort of brings us full circle, does it not?

RE: Yes; both Integrated Reporting and trust are about transparency, accountability and engagement. As companies practice it, they will gain trust from stakeholders. Society-level efforts will also help build trust from the shared vision, commitment and understanding that emerges between all groups.

And, as I’ve said, ultimately effective Integrated Reporting and trust in business by society requires a new view and consensus of the role of the corporation in society.

CHG: Bob, thanks again very much for taking this time with us, it’s been fascinating.

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Robert Eccles on Integrated Reporting is number 18 in the Trust Quotes: Interviews with Experts in Trust series.

Robert J. Kueppers on Trust and Regulation (Trust Quotes #14)

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For most of you, Bob Kueppers is someone whose influence (high) is inversely related to the likelihood you’ve heard of him.

As Deputy CEO of Deloitte LLP, Bob Kueppers has responsibility for regulatory and public policy affairs. That means he rubs shoulders with government and industry leaders who determine regulatory and public policy matters in this country and the world. Bob Kueppers was recognized in 2009 by Directorship Magazine as one of the top 100 most influential professionals in corporate governance and the boardroom. 

Bob is refreshingly direct and candid in his interactions; combined with a mastery of a field both wide and deep, he’s a fascinating interview.

Bob has a number of other additional roles at Deloitte, but we’ll focus mainly on his perspective on trust and regulation.

CHG: Bob, I’m delighted to have you join this series. I hope you’ll forgive us delving into just two subsets of your expertise: trust and regulation. Let’s start with regulation. Regulators aren’t getting great press these days. Is it a necessary evil? Or does regulation play a more constructive role in our business and society?

RJK: Regulation in a free enterprise system is one of the essential checks and balances in three different scenarios:

1) When parties in the market may not be equals;

2) When the nature of the market activity is susceptible to fraud or abuse; and

3) When public health and safety are involved.

Even true believers in free markets must acknowledge that a certain amount of regulation actually helps to preserve the credibility of the markets, which helps the market to operate and thrive. 

The debate over regulation often has to do with striking the right balance—finding the right degree of regulation. Like with “Goldilocks and the Three Bears,” it’s hard to get it “just right.” The appropriate degree of regulation often varies depending on the times, current events, and lessons learned.

The formation of the Securities and Exchange Commission in the 1930s, following the crash and market abuses of the late 1920s, is often viewed as a regulatory success. The orderly functioning of the capital markets provided the financial fuel to fund the post World War II expansion that redefined America in the 1950s and 60s.

When things go wrong, the natural reaction is to call for more regulation. But how can you tell when you’ve gone too far? For instance, critics say the recently enacted financial regulatory reform legislation, informally known as the Dodd-Frank Act, goes too far. Others claim it doesn’t go far enough. The truth is that we still don’t know the answer and likely won’t for several years—until the hundreds of regulations needed to make the reforms operational are written and implemented.

 CHG: What should be the role of regulation in the mixed economies we have today in the US and Western Europe? 

 RJK: It depends on the priorities of the country in which that regulation operates.

For instance, the US is often viewed as having a more litigious environment than other countries; as a result, our regulatory environment can be quite different than that of other countries.

Leaving such differences aside, I see the role of regulation as twofold:

1) Help to protect the interests of stakeholders, or, said another way, help to build and maintain trust in the markets that make up the economy; and

 2) Help to improve or maximize the quality and efficiency of the product or service through the establishment of standards and the related enforcement of those standards, such as through consequences for certain instances of non-compliance.

Regarding regulation beyond our domestic borders: because there is no global government system, a truly global regulatory structure is unlikely in the foreseeable future. Differences among geographies in this increasingly global economy are inevitable. It’s natural for countries to want to reserve the right to do what they believe is in their best interest given the unique circumstances of their nation.

Nonetheless, it’s important to recognize the inter-connectedness of our global markets—reinforced by the recent financial crisis. It’s helpful for regulators around the world to collaborate and work together—through forums, organizations, or otherwise—to achieve consistency in approach. We see such coordination in my profession through IFIAR, the International Forum of Independent Audit Regulators.

Again, my own view is that regulation should serve to assist fair markets to operate because regulation helps foster trust in such markets by the market participants and the related stakeholders.

CHG: Are there several key types or roles of regulation, which vary perhaps by industry? Or is the role of regulation universal and essentially the same, whether it’s the SEC, the FDA, the EPA, or the NHTSA?

RJK:  In theory, while the consequences of failures in regulation and poor execution by the regulated vary (ranging from mere inconvenience to potential loss of money, physical suffering, and health and safety consequences), the role of regulators is similar: to help to protect consumers and stakeholders and maximize quality and efficiency.

In practice, there are differences. Think about regulation of an industry which produces goods or provides a goods-based service—like the airline or pharmaceutical industries, compared to the regulation of a profession, which generally covers standards of behavior or performance.

What these disparate forms of regulation have in common, however, is that stakeholders operate with a level of confidence that compliance with regulation—whether by an airline adhering to safety standards or a public company audit firm following professional standards—builds confidence in the markets.

CHG: Let’s hop over now to trust. What’s the relationship of trust to regulation? How does regulation help trust? Or is it a substitute for trust? Does the presence of one reduce, or enhance, the other?

RJK:   Regulation isn’t a substitute for trust, but the existence of regulation plays a key role in helping to build and maintain trust, particularly in times of crisis. Examples include the creation of the Public Company Accounting Oversight Board to directly regulate my profession following the Enron and Worldcom scandals, as well as what we are seeing now with financial services regulatory reform in response to the recent financial crisis.

This suggests we could view a regulatory failure as one that doesn’t garner trust from the intended beneficiaries of the regulation. Such an outcome may indicate that there is a cost to society, without the concomitant benefit.

Unfortunately, this seems to happen more often than we may realize. Our society goes through cycles of regulation and deregulation. But, regulation tends to be cumulative over time, and the result can be layers of regulation, not all of which may be effective. In some instances, conscious decisions are made to forgo regulation. Is that because a significant level of trust already exists or is it a perception about cost and benefit? Or, is it a combination of both?

Having said that, regulation is a large part of what makes our markets the best in the world. It helped our markets recover well from the loss of investor confidence that followed the scandals that gave rise to Sarbanes-Oxley and is aiding in the recovery from the most recent financial crisis, though we still have a long way to go.

Unfortunately, it’s really in times of crisis when the issues of regulation and trust are considered together the most. That’s when there’s pressure to act quickly, and hopefully strategically, to learn lessons and act on them. The answers under these circumstances may be different than what you’d get outside of a crisis environment.

CHG: What do you find are the biggest misconceptions that businesspeople hold about regulators? Conversely, what misconceptions do regulators typically have about business?

RJK:  Businesses may perceive that the regulator has different objectives than the regulated. They may lose sight of the fact that as a regulated entity, they generally have shared objectives with the regulator.

It is not implausible that regulated businesses may see compliance with regulation as an impediment to success in terms of competitive advantage or speed to market. Businesspeople are largely quite ethical and certainly want their products to be safe for consumers, for example. But at the same time, as a general matter, if you lose sight of the shared objectives and focus more on short-term success, rather than long-term sustainability of the business, you can become frustrated with regulations.

Regarding the regulators, it’s important that they understand the trends and developments affecting the markets or industries they regulate. It can be counterproductive to develop changes in regulation without staying in close touch with the regulated entities and other stakeholders.

This communication helps to inform issues like the cost of implementation, the need to modify proposed rules to make them more understandable, and unintended consequences of changes in the regulatory regime. There needs to be a level of trust between the regulator and the regulated to help prevent the regulator from implementing proposals that are unlikely to work in practice.

CHG: The regulation model for the public company auditing profession is interesting in that there is government oversight, but the PCAOB is a private sector body. Why does this model work?

RJK: The government, through the SEC, oversees the PCAOB, but in the Sarbanes-Oxley Act, Congress explicitly established the PCAOB as a private-sector body. The SEC’s oversight role was effectively reinforced by a recent Supreme Court decision in a case about the constitutionality of the PCAOB.

The SEC oversees the PCAOB through the appointment of PCAOB members and supervision of the Board’s activities.  This makes sense, given the public company auditing profession’s role in the capital marketsand the SEC’s overall mission to maintain fair, orderly, and efficient markets, as well as to facilitate capital formation while protecting the interests of the investing public. The main reason the model works is the alignment of the PCAOB’s mission with the regulatory mandate and statutory authority of the SEC. If there were substantive differences, it probably wouldn’t work as well as it does. 

This private-sector regulation working side by side with government regulation isn’t unique to the accounting profession. The Financial Industry Regulatory Authority is another example of a private-sector regulator that works closely with the SEC on issues important to the markets.

CHG:  Let’s forget about regulation for a moment and talk about another realm of trust—trust between professionals and their clients. It’s something you know a great deal about within your business. What’s the role of trust in client relationships?

RJK: In general, trust and mutual respect form the foundation of the most effective client relationships. Those clients who understand our role and respect it are the clients with the best relationships.

For example, clients who identify issues early in the audit, and auditors who are upfront with clients when they are not comfortable with an issue, tend to have the most effective relationships. A good client relationship doesn’t mean there are never any issues to resolve; to the contrary, it means that issues get resolved on a timely basis because they are identified early and there’s a mutual understanding of the need to work through a resolution process.

Over time, greater trust fosters a stronger and more successful business relationship. When you’re a trusted professional advisor, you can be more effective in your own responsibilities. Let me be clear, this doesn’t mean we always agree with the client. 

To the contrary, we draw the line when necessary.   Sophisticated clients—I don’t mean in terms of size and scale, but in terms of thinking and attitude—not only understand this, but appreciate it, even if it’s stressful at times. In the end, investors benefit from credible information.

Auditing is unique, though; to do our job and fulfill our professional responsibilities, we strive to thoroughly understand the client’s industry, business, and current circumstances. This requires management and the audit committee to trust us.

Yet we cannot take things at face value or trust without support; we must be professionally skeptical. Our independence and objectivity, coupled with our knowledge and experience, are key to the value that we bring as auditors and we don’t put those at jeopardy for any client relationship.

CHG: Are there a few key things that people in business can do to improve trust with their clients?  

RJK:  Here are some lessons that come from my audit background, but which I think hold true in many business relationships:

·      This one is obvious, but first and foremost, deliver high-quality services and bring the right resources to the assignment.

·      Facilitate open dialogue—the earlier, the better—if a problem looms.

·      Don’t be afraid to deliver the difficult news; in my experience, handling that candidly and proactively goes much further in building trust than delivering the good news or raising a problem at the last minute when deadlines loom.

·      Finally, stick to your guns when the going gets tough; clients respect the fact that we have to do that. They may not like it, but they will come to value it when you are clear as to the “why.”

 CHG: What about clients—not just in your service lines, but more broadly. What should they expect in terms of trust—and what should they be bringing to the party as well?

 RJK:  I think it’s the same on both sides of the equation. Both service providers and clients should bring integrity, forthrightness, and strong ethical values to the table. This is especially true when it comes to auditing, but it holds true more broadly in other instances as well. 

Finally, it comes down to people. You could have a company with a great brand and corporate reputation, but if the management team lacks integrity, you do not want them as a client.

I have worked in a partnership for over thirty years. One way I gauge people is to consider whether I would want them to be my partner. Would I trust them with our brand and our reputation? That’s the acid test for me.

CHG: Bob, thank you so much for the gift of your time. Yours is a valuable and unusual perspective, and we appreciate your sharing it with us so forthrightly.

Robert J. Kueppers on Trust and Regulation

is number 14 in the

Trust Quotes: Interviews with Experts in Trust

series.

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Is it Personal? Or Is it Business?

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In The Godfather, Michael Corleone famously says to Sonny, “It’s not personal, it’s strictly business.”

What about trust? Is it possible to separate them? Can you be trustworthy in your personal life, but not in business? Does one imply the other? And what do we think of someone we trust personally who is turns out to be untrustworthy in business?

Cue Bernie Madoff again. (No, we’re not done with him yet; Madoff is a rich vein of material).

Eric Wiener in the LA Times:

the reason so many Wall Street players couldn’t believe their ears was they couldn’t accept that Bernie Madoff, of all people, would have pulled something like this. "Not Bernie!" was a typical refrain.

And, from the New York Times:

Indeed, in the world of Jewish New York, where Mr. Madoff, 70, was raised and found success, he is largely still considered as a macher: a big-hearted big shot for whom philanthropy and family always intertwined with — and were equally as important as — finance.

It seems increasingly clear that Madoff was greatly aided in this by dozens of willing accomplices—aka banks, funds of funds, hedge funds, “feeder” funds. People who took their own percentage for assuring “due diligence” so that the fraud that took place could never take place. People who claim to be anguished "customers," but who willingly sold the snake oil downstream.

And always, they too are characterized by those who knew them as people of integrity, people you could trust. And, I suspect, they believe it of themselves.

Now, there is a code by which you lie to one group and are trusted by another. It is the code you can hear recited in Huckleberry Finn by the Shepherdsons and the Grangerfords. The Hatfields and McCoys. The Montagues and the Jets, the Capulets and the Sharks. Or as it’s taught in competitive strategy and too many sales programs: the Sellers and the Customers.

I continue to be astonished that the largest Madoff “victim,” Fairfield Greenwich Group, who made hundreds of millions from Madoff, is considering suing PricewaterhouseCoopers—its own auditor. Reportedly because, channeling Willie Sutton, that’s where the money is.

How does Fairfield’s Walter Noel explain that to the partner at PwC’s Stamford office in charge of Fairfield’s audit?

Hint, Mr. Noel: you can buy The Godfather here and start rehearsing the line. "It’s not personal, it’s business. It’s not personal, it’s business." Click your heels three times while you say it. And tell him ‘trust me.’ That way it’ll sound personal, even when of course it’s not.

 

Selling Problem Solving by Solving Problems

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One thing about accountants I really like. They learn awfully fast.

I had breakfast the other day with an old friend, a forensic accountant—call him Joe the Accountant. He’s a bit of a loner, motivated by achieving results, and impatient with what he sees as bureaucratic and procedural focus. And he is very sharp.

He’s a bit like a bloodhound; don’t point him toward the scent and expect him to back off. Perhaps that’s why he tends to rotate employers every 6 – 8 years.

“Maybe I should just do free-lance work,” he mused to me. “I don’t mind selling. I just don’t know how to do it well. I could get appointments with several well-positioned past clients. I could just ask them if there’s some work I could do for them, I suppose.”

“No,” I said. “Talk to them about what problems need solving.”

Joe: Of course, silly me. Then I can pitch how I might be able to solve them.

Me: Congrats, you just went from weak salesman to average salesman in ten seconds.

Joe: So–how do I get to the next step? (Joe’s pretty impatient too).

Me: Pick one problem and solve it in that meeting.

Joe: Hmmm. I like that. But will the client do anything if I just give him the advice?

Me: You just went from pretty good to almost really good. So answer your own question.

Joe: I see, he’s got to be involved in getting the right answer in order to act on it it. So—you’re saying just do the work right there in the meeting?

Me: Pretty much.

Joe: So when do you make the sale?

Me: After you solve the problem together, you say, “This is great fun. We ought to do more of this. Though after one more session, you need to pay me. I can’t just be having fun for free. So how shall we set this thing up?”

Joe: Hmmm. Yes, that works, doesn’t it? Give ‘em a taste of your wares, so to speak. Just do it–then ask for the sale. Right?

Me: That’s about it.

Joe: Great, thanks. Gotta run; this breakfast is now interfering with scheduling my first sales call.

One thing about accountants I really like. They learn awfully fast.

Quarterly Earnings and the Addiction to Lying: Can Mattel Show the Way Out?

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If you lie, the best time to ‘fess up is immediately. “Immediately” is the only time that “oops” can constitute a full apology.

The longer you wait, the more “oops” looks like a dot in the rear-view mirror. Soon, to make amends, you have to confess. And probably explain. And the longer you wait, the more you have to express remorse, do penance (or pretend that you are) and other forms of disaster recovery.

No wonder CEOs have a hard time with quarterly earnings: the more quarterly earnings increases they show, the harder it is for them to show a quarterly loss; the more they’ll lie to keep the string going.

That’s the conclusion of a very clever study in the spring 2007 issue of the Journal of Accounting, Auditing and Finance. Its authors are James N. Myers and Linda A. Myers, and reported by Mark Hulbert, in the September 22 NY Timess, How Many Quarters In A Row Can Quarterly Earnings Grow? (Hulbert is a rarity—an analytical finance type who speaks completely in common English).

The profs analyzed the heck out of tons of data to answer the question: “absent manipulation, how many companies over a 42-year period would have been expected to put together a 20-consecutive quarter string of increased earnings?”

The professors calculated that no more than 46 companies during that 42-year period should have had earnings-per-share growth for 20 consecutive quarters. But 587 companies actually reported such strings of growth, so the professors conclude that their findings constitute “prima facie evidence of earnings management.”

Additionally: companies that had increased the same percentage over five years but in less linear fashion showed six percentage points less in stock appreciation.

Finally, the longer the string of positive earnings reports, the sharper the plunge in stock price on announcement of a losing quarter. As the professor says:

Together, these various findings paint a picture of extraordinary pressure on corporate management to sustain strings of consecutive earnings increases for as long as possible.

When I was in b-school, we talked about volatility of earnings—basically, a straight line is better than jagged. But we also talked about “quality of earnings,” which suggested that cooking the books (I don’t mean illegal, just, you know, cooking) was worse than not.

I don’t recall realizing there was a tension between those two goals, but it’s clear to me in retrospect that the more powerful of the two in the market was the appearance of low volatility.

In other words, cooking the books is rewarded by Wall Street; and the more you cook them, the more you’d better keep on cookin’.

Is that yet more proof for the cynics? It certainly sounds that way.

Then again, just because everyone’s lying doesn’t mean truth-telling doesn’t work; it could just mean no one’s willing to really try it.

Which brings us to Mattel, whose CEO apologized to China on Friday, September 21, saying China had gotten a bum rap for manufacturing flaws, when design was at fault.

Mattel’s stock price gapped up Friday about 4%, and stayed up on the day. A vote for quality of earnings? One day proves nothing, but as Rick Newman at US News and World Report says,

Mattel messed up, but now the company is bringing a welcome degree of transparency to an issue that seems complex and murky to most of us. So hurry up and pay attention, before the politicians and fearmongers muddle it up.

Was Mattel’s apology genuine, or forced by the Chinese?  I suspect the markets couldn’t care less.

 Could transparency actually be worth financial returns? Now there’s a thought.