Values-based Decision Making

Assume you are the controller of Nuts & Bolts Company and are approached by the chief financial officer about $100,000 costs incurred related to the acquisition of a new machine to be used in the production process. Since these costs are essential to get the assets in place and ready for use, you tell the CFO that they should be capitalized (added to the asset account) and depreciated over the lifetime of the equipment. The CFO tells you that’s not going to happen and the costs should be expensed against income this year because the newly-hired chief executive officer wants to reduce profits for the remainder of the year by as much as possible.

In a reversal of what is normally to be expected, that is, to always increase profits whenever possible, you ask why? It seems the CEO was hired as a turnaround artist on September 1 of the year and he figures no one will blame him if another $100,000 is added to the loss to be reported for the year. Basically, you are borrowing expenses from the future (i.e. depreciation) to further reduce reported losses in the current period thereby improving operating results down the line. We even have a name for it in accounting – “The Big Bath Theory”. The company already is losing money this year so why not make it look worse since you won’t be blamed in the first four months of your tenure as CEO. And then you look better going forward.

This has happened before and in a big-time way at Sunbeam Corporation. Back in June 1996, Sunbeam hired Al Dunlap to turn around the company after a series of annual losses. Dunlap manipulated the financial results to show greater losses in the year he was hired by accelerating the recording of expenses that would have hurt the bottom line in 1997 had he followed generally accepted accounting principles. After being named CEO of Sunbeam Corporation in June 1996, Al Dunlap brought about dramatic change in the firm’s reported financial performance. In 1996, Sunbeam reported a loss in excess of $200 million --- followed the next year by net income of almost $110 million. We call this “managed earnings.”

Let’s go back to the original example. You are the controller and are asked to go along with the financial manipulation. What would you do? You know the CFO and CEO have views opposing your view of the proper accounting. Your next step should be to go to the board of directors and discuss the matter even though you are internally blowing the whistle on wrongdoing. In fact, if you are a certified public accountant this is exactly the step required by the profession’s ethical standards. Your goal should be to enlist the help of the board whose responsibilities include, through its audit committee, to oversee the proper functioning of the financial reporting system.

The board may not support you because they feel beholden to the CEO for their position or otherwise have conflicts of interest. It may not happen for you in this instance, but you should try to convince the board anyway. Let’s face it by going above your superiors you already have risked your job. However, you have kept faith with your values and it will be easier for you to do the right thing if similar situations occur down the road. Ethics is not easy and it takes practice to develop the skill.

Values-based decision-making requires that we incorporate core values into the decision-making process. You know what the CFO is asking you to do is wrong. There is no doubt about it. However, the hard part is to act on your beliefs and stand up to the pressure to deviate from accounting norms. It takes real leadership skills to pull it off. Leadership and the accompanying core values are rooted in who you are and what matters most to you. When you truly know yourself and what you stand for, it is much easier to know what to do in any situation. It always comes down to doing the right thing and doing the best you can.

It takes a person of integrity and strong character to stand up to your superiors. On the surface you may think to do so would violate your loyalty obligation to the organization. Not so. You may be seen as disloyal to your superiors. However, loyalty in an organization requires that we look at the bigger picture and decide what’s best for the organization and its stakeholders. No one gains by manipulating earnings to make one period look better than another. Typically this leads to further manipulations to maintain or increase the higher earnings level in the second and subsequent years. The shareholders are deceived into thinking the same or better results will continue whereas ultimately the scheme will fall apart when the company runs out of ways to manipulate earnings.

Three critical core values are required in values-based decision making. These values can help you to do the right thing after you’ve realized what the right thing to do is. Here they are:

Gather all the ammunition you can to support your position

• In accounting this means to understand and be ready to explain the implications of the premature expensing on reported results and its effects on shareholders and other stakeholders.

Be prepared to discuss shared values with your superiors

• The company most likely has a code of ethics and possibly a values-based vision statement. Use it to convince your superiors the intended action goes against these values. Play up the need to establish an ethical organization culture.

Think in the long-term and not for short-term gain

• Most corporate managers have a short-term perspective and that’s why earnings are manipulated early on. You should point out the possible long-term negative effects of decision-making based on a short-term-gain perspective.

Perhaps most important is to realize you are not alone. Try to enlist outside support by contacting other professionals who can objectively discuss your position. After all, if others would do the same thing as you in similar situations for similar reasons then your decision has universal appeal -- an essential element in ethical decision-making.

Blog posted by Steve Mintz, aka Ethics Sage, on June 5, 2012