CEOs and Fraud: A Solution

BY STANLEY H. HOUSE

With the spate of high-profile, multi-billion-dollar frauds, the responsibility and focus must be shared by CEOs and CFOs, as well as outside auditors.

First, let’s look at the environment and mind-set in which public companies are viewed and measured today. Financial analysts continually press company officials for revenue-related projections. The financial markets operate like casinos with a horizon comparable to the roll of dice, so it’s no surprise that boards of directors are rewarding CEOs for hitting short-term revenue and earnings targets.

The CPA profession clearly has problems of its own which must be resolved to regain public confidence. However, anyone who has taken Auditing 101 knows that despite admonitions to have checks and balances and segregation of duties, internal controls are easily overridden by senior management acting collusively.

CEOs/CFOs have a fiduciary responsibility to thousands of stakeholders. A mechanism must be put in place to assure these executives do not wittingly or unwittingly succumb to pressure.

The solution, in part, is a major change in the dynamics of compensation. CEOs/CFOs should not own stock in companies they manage, nor should they receive stock options or other indicia of ownership. Such presently owned stock should be held in a blind trust until the CEOs/CFOs conclude their terms of office.

They should receive very handsome base compensation. Bonuses should be based on the executives’ achieving sound financial goals over an extended period of perhaps three years.

Further, bonuses so earned should be unfunded liabilities of the company, to be paid beginning one year after the conclusion of the CEO’s/CFO’s term of office. The bonus money would become deferred compensation subject to the claims of creditors in the event of business failure. CEOs/CFOs would be at risk just as their employees and other stakeholders.

Some might argue that such a system would discourage talented men and women from aspiring to senior management positions. However, if all public companies were mandated to subscribe to such a system and if the base compensation was attractive, the playing field would be level.

We cannot legislate ethics or integrity, but we can design systems to deter the massive fraud that has permeated our society.

Stanley H. House, CPA
Kansas City, Missouri

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