Monday, September 30, 2013

Revenue Recognition

When should revenue be recognized in a given transaction?  This really should not be rocket science, but apparently it is.  It’s also an example of how regulations get created because some Tricky Dick Accountants. Lawyers, Salespeople or Executives decide that gaming the system is to be preferred over the reality.  Revenue recognition – pure and simple – is the accounting recording of either the increase in the value of an asset or the decline in the value of a liability (or some combination of both) as the consequence of a product or service transaction. 

It’s not carved in concrete though. Revenue could be recognized either before or after the delivery of an actual transaction in instances such as a contingency contractual arrangement, a bill and hold transaction, an installment sale or a multi-element software sales agreement. In each case, the percentage or partial transaction should define the parallel partial revenue recognized.  You don’t get credit for 100% of the revenue if only 2% of the software has been delivered and accepted by the customer.

Revenue recognition really becomes an accounting problem when management or executives “rig” the system for their personal benefit.  How many different ways are there to do this?  Many, it seems.
  • Shipment or transfer of assets to third parties, resellers, or company-owned facilities, while in fact retaining ownership, but counting revenue as if actually sold to customers.
  • Accounting for assets sold, but products/services transferred are partial, incomplete, have a right-to-return, or contractual commitments have not yet been fully performed.
  • Creation of fictitious accounts, customers, resellers or transactions.
  • Double billings, re-invoicing past-due receivables, or otherwise inflating transactions – existing or non-existent.
  • Artificial billings based on future sales – real or otherwise.
  • Recording additional sales invoiced and shipped after the end of a reporting period.
Why would anyone do this?  Because they seek to artificially inflate their performance compensation or bonus by falsely jacking up revenue recognition. Why would anyone risk losing it all?  Because the controls in place are not adequate to the task and the perpetrator knows it.

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have come together to propose a new regulation and definition of revenue recognition. Interestingly enough, they both agree that a new accounting standard is needed to simplify and reconcile the differences between U.S. Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS).

The new “core principles” for revenue recognition are pretty straight-forward:

Step 1. Identify contract(s) with the customer
Step 2. Identify separate performance obligations.
Step 3. Determine transaction price.
Step 4. Allocate transaction price to each performance obligation.
Step 5. Recognize revenue when each performance obligation is satisfied.

This is a case where the proposed standard actually is simpler and less confusing than the existing criteria with their numerous variations by industry, geography, and contract.  But, let’s see how much wailing and whining the new standard generates, in spite of its obvious principle-based simplicity.

Chicks, Broads, and B*tches

Not long ago, there was a company with a great idea – to provide facilities for rent as conference and board rooms for businesses.  Unfortunately, the founders chose Naked Ladies Realty as their company name.  I tried to reason with them.  Tried to tell them they would hit strong resistance when they asked clients to complete a Purchase Order made out to “Naked Ladies LLC.”   The company with the great product idea died a quick death, and their facilities were sold to The Church of Redemption.

Today’s young women entrepreneurs are bursting with the same “girls just wanna have fun” enthusiasm as they flaunt their right to “be who I wanna be” mentality.  But, brands have a way of biting entrepreneurs in the butt.  When today’s women entrepreneur adopt brand names that includes “Chicks” or “Broads” or “B*tches,” they take on the negative stigma associated with those derogatory words, just as did African Americans or Latinos or Irish or Swedes.  A slur is a slur is a slur.

Of course, these little girls know so much more and better, right?  They know this is just what they need to appeal to the viral marketplace of today’s mobile technology.  Little do they know about the people to whom they are appealing.

Imagine if women in the military were to adopt similar chosen names for their network of women-empowering-women in a unit of the Army, Navy, or Marines.  Can you predict the response they would elicit by adopting the name, “Chicks in Arms?” Or, perhaps, “Broads Ahoy” or even “B*tches Command.”  Everything good that women have achieved in the military would be washed down the drain by the choice of such “fun girl” nomenclature.  And, if you were aghast at the number of sexual harassment assaults documented against women in the military up to now, can you imagine the uptick that would follow from this abject flaunting of female sexuality?

Do women want respect? Then, perhaps, they will need to brand themselves and their networks with identities that foster respect.  Do women really expect that other women will view their organizations with pride? Do they expect that men will hold such gatherings in high or low esteem?

Probably the only way the little girls will understand the consequences they face with such choices is to let them have their way and see what happens.  Just like Naked Ladies LLC.

Where's The Beef??

On October 4, 2011, I posted an entry on the 3D (Diversity Director DataSource) blog which challenged us all to begin to put performance metrics behind our efforts to increase the numbers of diversity candidates actually sitting on corporate boards of directors. See:  http://gmiratings.typepad.com/3dblog/2011/10/to-ensure-that-we-succeed.html

So, what has happened in the past two years?  Where’s the beef in this bun?

I challenged the leaders of the GMI 3D Registry in several specific ways:

1.       First, we have to define what we envision “success” to be.

One measure of success would be if the 3D Registry “attracted competent, capable, experienced and willing director candidates from a diverse pool.”  I have no idea whether or not that happened did because they don’t give us “the number” – they don’t talk about who they have, whether they are competent, how they measure competence. The 3D Registry does not report on candidates. 

2.       Second, we have to determine who is using this resource. 

How many companies of what size or what size of boards actually tapped this resource?  How many diversity candidates were placed in each of the past two years?  I have no idea, again, because, the 3D Registry only talks about all of the other so-called “research” which fails to be specific about candidate headcount.  The 3D Blog is yet another litany of how wonderful are the small handful of sitting women and minority directors (something I do NOT challenge) and how stupid corporations must be not to increase their diversity headcount. Didn’t we expect better from this resource? Or did we expect just more of the same?

3.       Third, we might consider some form of anonymity for director searches, at least in the early stage of board consideration of basic credentials and initial due diligence about qualifications.

This was a general suggestion to provide more “neutral” strategies for nominating committees to identify candidates: anonymity of candidates before the nominating committee. Like the orchestras of today, holding “blind” auditions for candidates.  We don’t know if visual clues are the barriers to entry or if we are simply not seeing women and minorities putting themselves forward in the auditions in the first place.  I’d like to see real data on this, not just search firm anecdotal tales. Nothing has changed with the 3D Registry – no innovative suggestions based on their experience, no novel proposals based on their finding.  Just the same ol’, same ol’.

4.       Finally, we should expect reportage from the 3D registry administration about the growth in headcount and successful placements.

Is it really too much to expect some data from this well-hyped tool during the past two years? I suggested we could expect, at a minimum, at least the categories of those who used the 3D registry as well as (perhaps later) the scale or size of entities inquiring. There are many ways to “scrub” the data to ensure it neutrality.  What we have to start doing is to measure positive growth in headcount, placements and inquiries, and we should have been doing this for each of the past two years.

After studying many director databases over the years, I am not convinced we are using them as effectively as we could.  I have seen a host of such registries disappear without any track record of the lessons or experience using it.  Is the current crop of 3D registries also destined for demise? To my mind, if we do not know anything about their performance, then we are simply wasting economic resources and fostering misleading hype.  It’s also re-enforces the concept that, to the hammer, every problem is a nail.  Another way to describe it is that “we are doing the same thing, again and again, expecting a different result.”  We all know what that is.

Beginning in 2010, I documented the trends reported by Directors and Boards (D&B) magazine, which tracked the quarterly new appointments of directors, including the share of women directors.  I updated that information recently, covering their 1st Q 2013 results (and updating other metrics contained in that report).  See: http://www.championboards.com/DandB2013.htm

The most significant trends were the slow erosion of the US business economy and the parallel loss of leadership in the form of director seats.  D&B now reports that women are being named to corporate boards at above-35% shares of quarterly nominations, but that the number of companies and the number of seats are continuing to decline.  We see the same downward trend persisting in total US listed companies, commercial banks, and federal and state credit unions. We could also point to the associated decline in the number of top tier executive (C-level) which is associated with the loss of corporate entities.

Included in that summary is a chart showing the results of another Director Diversity Initiative – from the University of North Carolina’s School of Law - which has been working in this same field since 1992 and reporting on their 3D survey results since 2006.  At least UNC has the courage to report their results. 
Their data reflects the same overall downward trends. And, while we do see small upticks in diversity appointments, the real challenge persists in that we still have no assessment of what is happening on the inside – how many candidates are added? How many inquiries into the directory? Are inquiries satisfied or not? Are companies providing feedback on the credentials of the candidates? What are we learning from this resource? And, most importantly, why don’t we care about the decimation of the American business economy?

So, I’m feeling a little like Clara Peller from the 1984 Wendy’s hamburger commercial.  Like Clara, it seems like there’s a lot of fluff and pomp around the latest offering, but what we are missing here is some old fashioned substance in the diversity director database dialog.  “Where IS the beef??”

Monday, September 23, 2013

Over Boarding

While I definitely am a fan of John Chiang, California State Controller, I had to take a moment to digest the news that, in that capacity, he is required to sit on a grand total of 81 boards and commissions. See: http://www.sco.ca.gov/eo_about_boards.html.

This is the same political leader who has argued for years that we need more diversity in our corporate boardrooms, who was an instrumental supporter of the formation of the 3D Diverse Director DataSource, now housed at GMI Ratings (formerly The Corporate Library: http://www3.gmiratings.com/home/our-products/3d-diverse-director-datasource/ ). I did check he is NOT on the board of that entity, though.

I know how he gets added to those boards. Some bright legislator decides to create yet another board or commission to oversee some economic or social activity and then decides that somebody with financial expertise is needed on the oversight board or commission. So, they add the position of State Controller to the entity's board. John's position adds another director notch to his belt.

But, Controller Chiang is so overwhelmed with boards he doesn't even know that some of them have been decommissioned (like the Technology Services Board) by the The General Government Trailer Bill (SB 1038) effective July 2012. California doesn't need a technology oversight board because it implements such wonderful massive high-tech public projects on time and within budget.

Then too there are the host of redundant boards like the Prison Construction Committees of 1984, 1986, 1988 and 1990, the board of the New Prison Construction Committee-Bond Act of 1981, the County Correctional Facility Capital Expenditure Finance Committees of 1986 and 1988, and the boards of the County Jail Capital Expenditure Finance Committee-Bond Act of 1981 and 1984. Why not just ONE board to oversee Prison Construction or Finance? Or is that too obvious?

We have a choice. We can continue with the way we have done this for years - naming the State Controller to every board or commission that might need financial expertise, and thereby so over-board the Controller that he cannot possibly bring adequate financial expertise to bear for those positions. Alternatively, we could require the Controller to name an independent board/commission member with appropriate financial expertise from resources like the 3D Registry or from top tier college/university business school director candidate lists or even from director candidate lists prepared by top tier financial professional associations, mandating that their lists roughly approximate the percentages of their last (2 to 5 year) profiles. We might see a marked improvement in the quality and effectiveness of government boards/commissions if the public sector were to implement a little of that diversity that they insist that businesses "ought" to provide.

Dear John, I would not be so sure it is a good idea to flaunt the fact that you are "attempting" to serve on 81 boards or commissions these days when the credibility of public oversight of financial entities has reached rock bottom lows and when the public sector's financial credentials are so wanting.  

Monday, September 16, 2013

Asymmetrical Information Risk

The discussion at Directorship 2020 focused, in part, on what boards could do to bridge the gap created by “asymmetrical information risk?”  (Where “asymmetrical information risk” is defined as the situation where management has more and/or better information about the company than the board.)  One solution suggested was that boards should go out and get more information about three key types of leading indicators to overcome the gap:

                Customer satisfaction
                Operational efficiency and
                Talent management.

The ability to highlight or point out challenges facing boards of directors does not always translate into effective solutions to those shortcomings.  In fact, too often we keep coming back to the same ol’, same ol' solutions. 

For example, the assumption behind “asymmetric information risk” is that there is an inherent adversarial relationship between boards of directors and management (i.e., all C-level executives from the CEO on down).  “They know more than we do about the company; we cannot trust them; they are not keeping us adequately informed; they are hiding the truth from us; or they are inundating us with data rather than providing us with information meaningful to the company’s need to ‘drive long-term value creation.’”

With “asymmetric information risk,” we have taken “healthy skepticism” overboard into the realm of suspicion and blatant distrust of the company’s management.  Once advisers have pinpointed the latest offending “boogie man” (asymmetric information risk), those same counselors become the go-to expert resources for bringing solutions to this New Nemesis of a problem.  As financial advisers became the answer-men to the evils of accounting fraud, so too compensation consultants became the answer-men to the evils of excess executive pay. Now, the latest “best practice” is to tap outside independent expertise, hire a consultant, read reports from buy/sell analysts, and use internal auditors to assess and control risks related to this knowledge gap for directors.

We have become intimately aware of asymmetric information risk ever since Alvin Toffler popularized the concept of “information overload” in his 1970 book, Future Shock. Today, we simply are encountering the continued progression of hyper-complex financial instruments and accelerated transactional activities.  While these new forms of information glut present unique challenges and risks for oversight of large scale corporations, effective means of handling the information deluge rarely resides “outside” of the boardroom – delegating the job of a director to other advisers. 

The first “key agreed principle” of the boardroom (according to the National Association of Corporate Directors) is: “Board responsibility for governance.  Governance structures and practices should be designed by the board to position the board to fulfill its duties effectively and efficiently.” [Emphasis added.] In other words, boards own the solution to their own governance problems; not outside experts. That includes the specification of what information is needed, when, and in what form.

Pilots of modern airplanes are examples of individuals who also face potentially overwhelming complexity in their domain and who are surrounded by others - on whom they must depend – for assurances and information to perform their jobs perfectly. How do modern pilots navigate ever-more-complex and hugely larger aeronautic monstrosities?  What they do NOT do is pass the buck to external consultants or even ask others to provide more controls over their activities. 

Modern pilots do several essential things.  One, they strip the pre-flight checklists (the information specification and review process) down to their critical essentials, then rigorously and methodically go through each and every key element, one at a time – every single time, as if their lives depended upon the satisfactory completion of each step.  As a point of fact, their lives and those of their passengers DO depend upon a safe, complete, and accurate completion of this information review.

Do boards have a key checklist of their 3, 10, 50, or 100 absolutely essential items they must know about their ship of state?  How often do they actually review them – not because they predict a quarterly up- or down-tick in the value of their shares, but because the long-term viability and value of the company are defined by these essential items.

Second, the critical items are not “given” to pilots; rather they are developed collaboratively by pilots and crew-members based on their real world experience, drawn from their examination of where things went wrong, and what they believe would prevent re-occurrence of those events in the future. If a step does not contribute to the safety of the journey, it is dropped. If pilot and crew believe a step should be added to ensure better communication, coordination, and safe operations, then it is included.   Checklists are developed to address scenarios of the major potential disasters (risk factors) they are likely to face – events which would critically endanger the air ship and its valuable contents (both people and cargo).

Do boards develop checklists and scenarios to address highly probably, highly risky contingencies? Or do they develop proxy paragraphs, templates, and legal pro forma statements with little relation to the business operations that management must deal with on a day to day basis?  Do boards collaborate with management to identify and sketch out information needs based on what would best serve board strategic guidance for the company to achieve its best potential?

Third, when pilots and crew design response strategies that will be used when they encounter problems, those strategies are realistic and “bought into” by all participants. It is not “if” they might encounter problems, but rather “when” such problems will occur because leaders and support personnel do not deceive themselves into thinking they operate in some perfect fairy tale world. If events have any likelihood of putting the craft or contents at risk, then assuredly it is worth their strategizing a full, safe, and corrective recovery.

Finally, it is not just the Superman Scenario - the lead pilot, the CEO of the cockpit. All parties concerned are prepared to put their shoulders behind the strategy as one. It is a team-based recovery strategy that distributes ownership of the solution among all involved players – even to the passengers’ roles and responsibilities to listen and follow instructions. 

Management in companies is like the crew in the back with the passengers.  They absolutely must be an integral part of both pre-flight checklist review and emergency scenario collaboration and implementation. For the sake of appropriate control and the long-term viability of the firm, there had better never persist an information gap between what management sees and knows is going on in the body of the craft (the firm) and what the leadership is doing to push the craft forward toward its destination (its strategy).

Therefore, it would appear to be accurate to say that if “asymmetrical information risk” exists in a firm, in all likelihood that, in and of itself, is a leading indicator suggesting that the company is in trouble because communication between leaders and implementers is broken and because information that is essential to take the company to its destination is not being exchanged, effectively, between the parties responsible for ensuring a safe arrival.

Friday, September 13, 2013

Directorship 2020

The National Association of Corporate Directors (NACD) invited comments on its recent Directorship 2020 gathering held in Los Angeles, the third such event over the past few months – following New York and Chicago. See Kate Ianneli's summary at: http://blog.nacdonline.org/2013/09/future-boardroom-processes/ 

As a participant in the West Coast event, I’d like to thank the NACD and its supporting partners for organizing this peer-group exchange. The highest accolades for Directorship 2020 relate to the deliberative exchange -- the opportunity to share experiences among participants in a free-wheeling small group setting (tables of about 8 persons each).  This is a welcome change from the all-too-typical “talking heads” events with experts on the dais. There is tremendous untapped value in directors’ experiences.  It is satisfying to participate in that exchange of insight and struggle.

Another noteworthy distinction was made, toward the end of the day, by the panelists who had the opportunity of viewing the experience in all three cities.  They said that there were significant differences in perspective and tone as the event migrated from New York to Chicago to Los Angeles.  If it is accurate that “no one-size-fits-all solution” exists in governance practices – that governance is an art crafted by each firm – then it might follow that significant governance process differences exist elsewhere: across industries, across the private to public spectrum, and now regionally-differentiated enterprises.  We in Southern California also recognize there are worlds of difference among firms in Northern California compared to those in San Diego or Baja California or Los Angeles area firms.  Even the purported “best practices” concepts may now need to be modified by the challenge of “best for whom or for what business purpose?” At a minimum, this conclusion suggests that NACD might benefit from more events outside of the New York-Washington corridor.  What could we learn from Austin, TX or Portland, OR enterprises?

Another relevant point is that Directorship 2020 is trying to anticipate what governance might look like in 7 plus years.  If the average age of directors in 2020 is 65 years, roughly as it is today, then we would just begin tapping that vast unpredictable resource pool of 78 million individuals who constitute the Baby Boomer Generation (those born between 1946 and 1964, who graduated from college between 1968 and 1986).  Roughly half of them grew up during the Vietnam War era (1946 to 1955) while the other half grew up in the Trailing Edge Boomer era (those born between 1956 to 1964).  If this pool is not tapped directly as directors, they most certainly will be investors, shareholders, business owners and stakeholders.  They also undoubtedly will be activists of all scenarios – as they have been in the past.

This is the generation that introduced sustainability, the climate change debate, Benefit Corporations, and not merely the Internet, but every technology change up to and including online board and proxy meetings and the cloud. This generation pushed the redefinition of healthcare coverage with all of its technology and service consequences.  This generation is toying with crowd-funding which may yet prove to be a direct competitor, if not an clear alternative, to the traditional IPO.

As we sat at our round tables of eight NACD participants in LA, talking and taking notes with pen and paper, a few of us wondered how will we train and educate the future directors of 2020 to admire and respect the concept of governance, as we have? Unlike today’s directors, tomorrow’s directors will be tapping their mobile devices, expecting to draft summary notes on electronic devices and transmit the conclusions of their table’s conversation to live overhead projection displays. Will governance be ready for them?

We give “leadership development” a great deal of lip-service, but what are we doing to prepare the non-sitting director candidate (female and male) to understand, as senior c-level management, how to communicate effectively with sitting directors? How well are they informing directors by reaching beyond the limits of their “silos” of technical expertise (financial, technology, legal, global) to effectively inform directors and companies how to address unforeseen risks? How well are directors communicating to their leadership bench directors’ needs for comprehensive information and insight – not just numbers?

What are we doing today to instill in those yet-to-be-seated directors both confidence and trust in “this fragile institution of governance,” as Harvard’s Dean of Corporate Governance, Jay Lorsch, once described it? Will anyone know who IS Jay Lorsch? Will there be enough interested executives and managers with quality board-level experience coming forth from that richly diverse candidate pool? Will they be willing to serve on boards to guide future growth, employment, and innovation?  Or will our boards of 2020 consist of a few scared minions, cowering before the intimidation of regulatory might that was required in 2007 to right that financial ship of state which came so close to sinking and which continues to wobble in many sectors even today?

My peers and those just behind me, age-wise in the cohort pool, are the individuals we need to step up and serve in a governance role.  We owe them the best governance education and insight we can possible fashion. That is the true challenge of Directorship 2020.