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The Open Letter Main Street CEOs Should Write to Wall Street

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Dear Wall Street CEO:

You’ve been taking it on the chin lately. On the other hand, the only CEO Obama has fired recently came from my side of town–Main Street—so maybe you’re not so bad off.

I have a proposition for you. For both of us, actually.

I, a Main Street CEO, am going to show you, Wall Street, how to create some real value out of “thin air.” I know, you think that’s your schtick, but hear me out.

From here on out, I propose to tell the truth about our earnings.

It’s that simple. We tell the truth about our earnings–warts and all. You come to believe it. You then no longer shave your estimates of our quarterly earnings, because we will no longer smooth them by moving things offsheet, or by tweaking policies from our financial subsidiaries.

Call it the “truth factor.” It really isn’t, though. It’s simply reversing the “suspicion factor” you’ve always had in place. Remember “quality of earnings?” Well, we’re going to provide the highest quality of all; not conservative accounting, but transparent accounting.

That’s the kind of financial value creation I know you understand. But let me go further—this policy is also going to create real value—as in higher productivity, lower costs, greater customer retention, high quality, better customer service—all that good stuff that actually drives business. Here’s how.

This morning, I’m going to announce company-wide that we are no longer including short-term incentives in our performance assessment plans. Here’s why.

Every sentient businessman knows that the dumbest way to run a business is to change plans every 3 months. The smartest way to run a business is to develop a long-term plan, based on long-standing business principles and policies and on core values. Then execute on it.

It is long-term plans, executed well, that produce the best short-term results—quarter after quarter after quarter.

But somehow, in my firm and nearly all others on “Main Street,” we lost track. It started out by our saying, “if you can’t measure it, you can’t manage it,” and “what gets measured gets managed.” So we started measuring everything quarterly (OK, I admit–way shorter than quarterly).

Maybe we got that from you guys.

Now, it pains me to admit this, but somehow—I know, it sounds crazy—we just flat lost track of the simple idea that long-term management produces the best short-term results. And we started thinking that because we were measuring short-term, we had to manage short-term. After a while, nobody would take a 3-week risk. Or honor a 4-week deal. Or sign up for a 6-month customer plan.

Like I said, dumb. But it’s the truth. It’s what we did.

But no more. From now on, we’re managing for the long-term. That doesn’t mean we’re giving up on metrics—precise metrics are critical for all kinds of things, like trend analysis and trouble-shooting. It’s just that using them like a steel cable linking to performance pay and quarterly earnings is not going to be one of those uses.

Our CFO is going to stop focusing on quarterly numbers within and without the firm. Internally, we are going to very clearly explain the long-term basis for performance assessment and goal-setting we will be using. After that, anyone found to be rewarding behavior solely for the sake of short-term numbers will be hauled before the management committee and asked to justify it in strategic terms, or to explain, "What part of long term management for performance do you not get?"

And mark my word, our earnings will go up. Because long-term management fosters relationships, trust, continuity, efficiencies, effectiveness, scale economies, customer loyalty, and employee engagement. And that makes money the old fashioned way–by creating real value.

Externally, you and yours are going to have deal with greater earnings beta from us. The quarterlies are going to be more volatile. But we’re done interpreting numbers for you.

From now on, you have to be good enough at what you do to discern the underlying pattern and explain it (hint: it will be generally NorthEast). We’ll tell you up front our policies, and show you over time how we live up to our pledge of transparency.

So my question to you, Mr. Wall Street, is do you have the guts to play the new game? My cards are on the table, as of this morning. Where are yours?

 

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.