'Corked' Financial Statements - Guest Article

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Guest article, contributed by Michael K. Shaub

The bat exploded in Sammy Sosa's hands as it struck the pitch, resulting in a weak ground ball to second base. The Cubs' announcers duly noted the run that had scored, mission accomplished for Sosa despite an unexpected setback. And then both announcers voiced concern as the umpires began to examine the bat. Perhaps the bat was not all it was cracked up to be. And, before long, the question of credibility shifted from the bat itself to the man who swung it.

The Chicago slugger's corked bat serves as a parable for today's financial world. Apparently explosive growth is followed by weaker than expected results, and questions arise about the quality of weapons a company possesses to prosper in the long run. Upon closer examination, it is discovered that the company has actually cheated in an attempt to impress Wall Street. The bright light of public scrutiny shifts to those who run the company. Even if they are competent, can we trust the historic numbers or future numbers that this company would report?

Sosa did not deny the undeniable—the bat was corked. But he denied that he had used it deliberately, indicating that he meant to use it only in batting practice to make his fans happy. His words echo those of corporate CEOs who admit that there is an ongoing investigation of aggressive accounting methods and the potential for restated financial statements, but claim that they were unaware of the practices. Sosa called what he did a “mental mistake.”

No, Sammy, a mental mistake is throwing to the wrong base or forgetting that there is only one out and tossing the ball into the stands to an eager fan. Corking a bat is a deliberate act, and the only thing in question is the motive. Was it simply to impress fans, or have corked bats been integral to surpassing 500 home runs?

Mental mistakes do not bring into question integrity, but competence. No one challenges Sosa's competence as a major league hitter. But the integrity question raises again the concern that first became a regular topic of conversation during Sosa's much-publicized 1998 home run race with Mark McGwire—steroids. Sosa's evasive answers about how he happened to use the bat and why it was appropriate for batting practice sound hauntingly familiar in retrospect.

One of the most common reasons for people to forfeit their integrity is to project competence. Sometimes incompetent people do this, but in general these charades are short-lived. Other signals indicate an individual's inability to perform critical responsibilities. More often, it is competent people who succumb to the pressures of outside expectations or the temptations of personal ambition to present themselves as more successful than they are.

I cannot say if this is true of Sammy Sosa. But the string of frauds that has haunted the business world in the last three years—Enron, WorldCom, HealthSouth—consists primarily of companies that have shown themselves competent, and even leaders, in their business sectors. Their failures have shaken the financial markets, undermining people's willingness to trust financial statements, even of reliable companies. People want to see clear signals from those companies that differentiate them from the fraudsters.

Baseball may experience a similar phenomenon. My local paper's headline about the Sosa story was, “Say It Ain't So!” Will baseball commissioner Bud Selig require x-ray machines in the dugouts to examine all bats? Hardly. But for a while, fans will think twice about the legitimacy of every 450-foot home run they see on Sports Center. And it is not hard to imagine that baseball players who have muscles on their muscles will be looked at differently than they were in the past.

Perhaps part of the blame is ours. Our hero worship of muscled sluggers and successful CEOs has made us willing to believe the unbelievable. We have enjoyed the returns in our retirement plans, the wins and records on the baseball field. We have been willing dupes for those who would tell us half a story.

We will get over it. Baseball will move on, as will business. Fans will forgive, and so will investors. But even as the financial markets themselves recover, they will continue for many years to pay the regulatory costs necessary to insure financial reporting reliability in a world where competence trumps integrity.

Michael K. Shaub is the Jurica Professor of Accounting at St. Mary's University in San Antonio, Texas.

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