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Accounting
is Broken. Here’s how to fix
it: A radical manifesto
Abdulrazak Abyad
Correspondence:A. Abyad, MD, MPH,
MBA, DBA, AGSF , AFCHSE
CEO, Abyad Medical Center
Chairman, Middle-East Academy for
Medicine of Aging http://www.meama.com,
President, Middle East Association
on Age & Alzheimer’s http://www.me-jaa.com/meaaa.htm
Coordinator, Middle-East Primary Care
Research Network http://www.mejfm.com/mepcrn.htm
Coordinator, Middle-East Network on
Aging
Email: aabyad@cyberia.net.lb
Citation:Please
cite this article as: Abdulrazak Abyad.
Accounting is Broken here’s how
to fix it: A radical manifesto. Middle
East Journal of Business. 2018; 13(1):
32-34 DOI: 10.5742/MEJB.2018.93232
Background
Background
The progression of globalization
is one of the largest social developments
humanity has ever tackled. That’s
why its influence on the global economy
is enormous and therefore the accounting
sector is critical. The author stresses
that accounting and corporate governance
are in an immense dilemma but not
due to a few companies that have overlooked
the regulations. The crisis is that
the accounting rules are old and wrong,
and corporate governance is enduring
the consequences. Accounting is not
yet close to measuring economic reality.
In an effort to serve many masters,
it is not helping any well and is
deserting its most critical community
— the intelligent, professional
shareholder.
There are large points of criticism
of conventional accounting. The criticism
started soon after accounting began
to rise in eminence and stature in
the early part of this century: this
was especially the case in the USA
and the UK. The problems of conventional
accounting can be summarized as follows:
• The aims of conventional accounting
are centered on decision usefulness
therefore it seeks to concentrate
and accumulate wealth for certain
sections of society.
• Neither the conjectures of
perfect liberal economic democracy
nor the developed exchange economy
with a developed stock market are
valid for many societies.
• The accounting principles on
which conventional accounting reports
are prepared may be inappropriate
for the direct and indirect equitable
distribution of wealth.
• The negative economic and social
consequences of conventional accounting
on the environment, society and individuals
are unacceptable.
One of the central theme of this paper
is to show that conventional accounting
does not provide accurate information.
The author stresses that the conventional
method ignores changes in the purchasing
power of the dollar. For example,
a piece of property is purchased for
X dollars and, some years later, when
the purchasing power of the dollar
has declined to half its prior value,
the property is sold for 2X dollars.
Conventional accounting says that
is a 100% gain in the amount of capital
that has occurred, but common sense
tells us that it is the measuring
unit that has changed, not the amount
of capital.
The author spearheads the idea that
EVA is one of the most popular measures
of performance and has widespread
application across industries and
continents. It is critical to remember
that the nature and number of accounting
adjustments done for calculation of
EVA is tailored to suit the needs
of the company that is implementing
it. No two companies calculate EVA
in the same manner. EVA as a tool
for value enhancement does motivate
managers to perform better and take
decisions that are consistent with
the shareholder value maximization
goal of corporations.
EVA offers a more full measure of
profitability than traditional measures
because it indicates how well a firm
has performed in relation to the amount
of capital employed. It is based on
the notion that a thriving firm should
earn at least its cost of capital.
Firms that earn higher returns than
financing costs help shareholders
and account for increased shareholder
value.
In its simplest form, EVA can be expressed
as the following equation:
EVA = Operating Profit After Tax (NOPAT)
- Cost of Capital
EVA, on the other hand, through its
adjustment efforts, aims to reduce
the effect of accounting alterations
while healing the influence of financing
costs more comprehensively in its
capital cost charge. Hence, a truer
measure of economic profit is provided
by EVA than that provided by the use
of traditional GAAP-based measures.
This may be important since some companies
spend heavily on R&D and the accounting
treatment for this and certain intangibles
is not included on GAAP-based balance
sheets. EVA provides a way to compare
performance among firms impacted by
these accounting weaknesses.
The victory of the EVA framework and
its constant growth necessitates that
CPAs appreciate not only its basic
characteristics, but also the complex
underpinnings of its derivation. As
more companies go on to adopt EVA,
the role of accountants as consultants
and independent auditors of EVA is
likely to increase. In addition, as
more investors and other external
users come to rely on EVA as a performance
measure, companies will be more inclined
to disclose their EVA and components
of its calculation.
A series of international accounting
standards will allow the original
prospect for development owing to
the fact that comparative examination
of the rates of returns recognized
based on the balance sheets and profit
and loss account between the companies
being in competition, become relevant.
The author suggests that accounting
rules need to be modified on a continuous
basis rather than following a conventional
approach of reviewing after long periods
which usually continue for years.
The Capitalist
manifesto
Shared capitalism intends to stimulate
employees by offering them a bigger
financial stake in their companies.
There are diverse forms of employee
ownership, by which workers are rewarded
for firm performance. Together, these
ample sets of ownership and compensation
models have been named by researchers
as “shared capitalism.”
• Employee stock ownership program
(ESOP): A firm-sponsored trust that
works as a tax-qualified, defined-contribution
retirement plan for worker-owners.
• Stock options: In heart this
is an offer of ownership. It gives
a worker the prospect or opportunity,
to buy or sell company stock by a
specified date and at a specified
(and usually advantageous) price matched
up to fair market value.
• Employee stock purchase plan
(ESPP): Analogous to stock options,
an ESPP allows workers to buy company
stock at a predetermined and discounted
price from fair market value. Whereas
stock options require no action or
investment until they’re exercised,
ESPPs are a direct and immediate purchase
of company stock, but at a discounted
price.
• Profit sharing: A compensation
agreement where an employer distributes
some of its profits to employees.
Normally made in cash, this compensation
can also come in stocks or bonds.
It can be dispersed directly or deferred
until retirement. Gain sharing is
an alternative of this form and is
based on departmental or plant contributions
to company performance.
In the extreme competitive marketplace
of the global economy, policymakers
and managers carry on to fight with
alternatives to encourage and reward
employees that endorse competitiveness
and worker well-being. One approach
championed by some clouds the traditional
lines between capital and labour.
It augment workers’ financial
stakes in their companies through
pay-for-performance and stock ownership
plans and increases employee decision-making.
This has been called “shared
capitalism” (1,2).
At the EU level, employee financial
participation has been the focus of
two PEPPER (Promotion of Employee
Participation in Profit and Enterprise
Results) reports (1991 and 1996),
a Commission Communication (“On
a framework for the promotion of employee
financial participation”), and
additional activities by the European
Economic and Social Committee and
the European Parliament.
“Worker capitalism” sounded
promising when Congress approved the
ESOP program in 1974. Any company
could transfer some or all of its
stock to a trust, which then allocated
the shares to workers. Employees would
feel they had a stake in the firm’s
success and build up savings with
their own stock. Since 1975 about
3,000 firms, most of them small, have
begun ESOP programs by turning over
some stock to employees.
Studies are inconclusive as to whether
workers are more productive as shareholders
rather than ordinary time-clock punchers.
A University of Michigan project indicated
that employee-owned companies can
be 1.5 times as profitable as competing
firms because there is less waste
and absenteeism and greater productivity.
But when worker ownership is spread
out among hundreds of employees, and
outside managers run the firm’s
operations, there is little benefit.
Concludes James O’Toole, an associate
professor of management at the University
of Southern California: “Few
companies have found a measurable
effect on worker motivation, performance
or productivity resulting directly
from stock ownership. Little increase
is visible in job satisfaction, morale
or company loyalty.”
Broad-based employee share ownership
(ESO) is a significant economic phenomenon.
The two most common types of plans
which encourage ESO are Employee Stock
Ownership Plans (ESOPs) and 401-K
plans with employer stocks. Earlier
studies have revealed that worker
productivity increases following adoption
of ESO plans (3,4). The finance literature
reveals positive stock price reactions
to the declaration of ESOP adoptions
that are not implemented under takeover
pressure (5; 6). On the other hand
there is little data on how ESO plans
affect employee compensation.
There are usually four non-mutually
exclusive motives to establish ESOPs:
(1) an attempt to improve incentives
and team efforts to enhance worker
productivity,
(2) management-worker alliance to
thwart hostile takeover threats,
(3) cash conservation by poorly performing
firms by substituting stocks for cash
wages, and
(4) tax benefits.
A. Productivity gains
The most over and over again mentioned
goal of ESO is to augment firm value
by improving employee incentives.
Shareholders normally do not supervise
non-managerial employees; instead,
they entrust the monitoring to management.
As a supplement to delegated monitoring
and to better align employee incentives
with shareholder values, firms may
encourage ESO as an incentive device.
B. Employee compensation
How are these productivity gains shared
between employees and shareholders?
When ESOPs give marked control rights
to employees, as in large ESOPs, workers
may use their improved negotiating
power to extract higher compensation
and benefits.
ESOPs may lead to employees embracing
less diversified portfolios and have
liquidity fears. ESOP shares cannot
be sold until employees leave the
company, with the exception of diversification
requirements triggered at 55 and 60
years of age. Usually this will lead
to augmenting employee compensation.
C. Cash conservation
Core and Guay (7) pointed out that
stock option plans for non-executive
employees are usually employed at
firms which look cash-constrained.
Likewise, issuing stocks through ESOPs
may be the result of cash constrained
firms substituting stocks for cash
wages. Since sales is the primary
sources of cash inflows, we define
an ESOP restructuring if it is adopted
by a firm suffering sales decline
in the year of the plan initiation.
Such ESOPs are likely to lower cash
wages without changing total employee
compensation. While the decision to
substitute equity for cash wages may
be optimal for firms facing cash shortage,
it is doubtful that such plans will
have the same strong uplifting effect
on employee morale, team effects,
and collective behavior as non-restructuring
ESOPs will. Therefore , we expect
no marked productivity gains from
having restructuring ESOPs and, hence,
no compensation increases or shareholder
value gains.
D. Tax effects
ESOPs are usually established through
a trust which borrows money to buy
company stock. Over time, the company
repays the loan taken by the trust
which, in turn, distributes its shares
to employee accounts. These loan payments
(interest and principle) are treated
as wages and, thus, are tax deductible,
within certain payroll limits. Tax
benefits unique to leveraged ESOPs
arise when dividends paid to stocks,
held by the trust, are used to pay
down debt. These dividends are effectively
deducted twice from the firm’s
taxable income, once as wages and
then again as interest payments.(7)
If this tax benefit has an important
impact on shareholder value, leveraged
ESOPs will have more favorable impact
on firm valuation than non-leveraged
ESOPs.
Conclusion
In this paper the author discussed
whether adopting broad-based employee
stock ownership enhances firm performance
by improving employee incentives and
team effects. That is, does employee
capitalism work? If so, how are gains
divided between shareholders and employees?
Our results suggest ESOPs increase
productivity, which, by a process
of elimination, we attribute to incentive
and team effects.
References
1. Gates, Jeffrey R. 1998. The Ownership
Solution: Toward a Shared Capitalism
for the Twenty-First Century. Reading,
MA: Addison-Wesley.
2. Freeman, Richard B. 2001. “The
Shared Capitalist Model of Work and
Compensation.” Reflets et Perspectives
de la vie Economique, vol. XL, pp.
169-181.
3. Jones, D., Kato, T., 1993. The
scope, nature, and effects of employee
stock ownership plans in Japan. Industrial
and Labor Relations review 46: 352-367.
4. Jones, D., Kato, T., 1995. The
productivity effects of employee stock-ownership
plans and bonuses: Evidence from Japan.
The American Economic Review 85:391-414.
5. Gordon, L., Pound, J., 1990. ESOPs
and corporate control. The Journal
of Financial Economics 27:525-555.
6. Chang, S., Mayers, D., 1992. Managerial
vote ownership and shareholder wealth:
Evidence from employee stock ownership
plans. Journal of Financial Economics
32:103-132.
7. Core, J., Guay, W., 2001. Stock
option plans for non-executive employees.
Journal of Financial Economics 61:253-287.
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