Backdating: Culture Makes All the Difference...

Looking back upon your last stock option exercise, did you realize the price you were granted was backdated? If you did, then your ethical misbehavior is just another example of how corporate compensation is bringing the house down. The question now remains, how many more companies will be announcing that they need to restate their numbers for the latest financial period.

Affiliated Computer Services replaced CEO Mark A. King and CFO Warren D. Edwards on Monday, saying they had violated the company’s "Backdating" code of ethics for senior financial officers, as the company completed an internal investigation of its stock option-granting practices.

The Dallas-based outsourcing company named COO Lynn Blodgett as the new chief executive, and John Rexford, the company’s executive vice president of corporate development, as the new chief financial officer.

Mr. King and Mr. Edwards are just the latest of about 60 corporate executives who have been pressured to step down as companies have probed their stock option grants and the backdating of those grants to benefit executives. The options fallout has ensnared more than 150 companies so far.

The two ACS executives resigned effective Sunday and entered into separation agreements with the company.

You can bet that anyone who is now considering a new position where stock options will be part of the compensation package will question the ratio between incentive in stock and the cash bonus. Incentive compensation is the root of much of the corporate malfeasance we have all witnessed over the past five years. And if you look at where this story really begins, you have to look hard at the compensation consultants, head hunters or just plain human resources processes.

When you look at the way people are compensated, you generally can figure out what type of behavior you are trying to influence. The corporate governance of our companies continues to see new fraud, new corruption and a continuous stream of finger pointing. A Code of Ethics is easy to create and yet much more difficult to get people to follow. What would Warren have to say about it?

Warren Buffett's "Tone at the Top"

A few months ago, Warren Buffett sent this memo to managers at Berkshire Hathaway:

To: Berkshire Hathaway Managers ("The All-Stars")
From: Warren E. Buffett

Date: September 27, 2006

The five most dangerous words in business may be "Everybody else is doing it." A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale.

Even worse have been the consequences from using that phrase to justify the morality of proposed actions. More than 100 companies so far have been drawn into the stock option backdating scandal and the number is sure to go higher. My guess is that a great many of the people involved would not have behaved in the manner they did except for the fact that they felt others were doing so as well. The same goes for all of the accounting gimmicks to manipulate earnings - and deceive investors - that has taken place in recent years.

You would have been happy to have as an executor of your will or your son-in-law most of the people who engaged in these ill-conceived activities. But somewhere along the line they picked up the notion - perhaps suggested to them by their auditor or consultant - that a number of well-respected managers were engaging in such practices and therefore it must be OK to do so. It's a seductive argument.

But it couldn't be more wrong. In fact, every time you hear the phrase "Everybody else is doing it" it should raise a huge red flag. Why would somebody offer such a rationale for an act if there were a good reason available? Clearly the advocate harbors at least a small doubt about the act if he utilizes this verbal crutch.

So, at Berkshire, let's start with what is legal, but always go on to what we would feel comfortable about being printed on the front page of our local paper, and never proceed forward simply on the basis of the fact that other people are doing it.

A final note: Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That's inevitable: We now employ well over 200,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. And culture, more than rule books, determines how an organization behaves. Thanks for your help on this. Berkshire's reputation is in your hands.

What kind of culture exists in your organization?

operational risk