Published June 2003

Make it clear: faking numbers is intolerable

Investment decisions are driven by three forces: greed, fear and the herd instinct. The first two pull in opposite directions, of course, and the third joins in on one side or the other, depending on “what everybody else is doing.”

In the workplace, ethical decisions seem to be affected by the same forces — and that is important to those of us who wish to understand how to raise ethical standards in business. We cannot achieve any real improvement in business ethics until we understand the mechanics of how bad decisions are made. And, in the workplace, greed-driven lapses are different from fear-driven ones.

Over the past few years we have been treated to a parade of large-scale ethical lapses by businesses. A litany of corporate names is now linked to accounting finagles, flimflams, and frauds that would make a grifter blush.

The defining characteristic of these ethical lapses was that they were all “top down” schemes, driven by greed and augmented by an inadequate knowledge of how accounting systems work.

The greed part is easy to understand. Many of the top executives who concocted these frauds either owned substantial blocks of the company’s stock or were compensated in some way tied to the price of the stock. And it was a time when investors would pay irrationally high prices for stocks, but would also punish severely any company that could not keep up with the market’s expectations for it.

The result was that any downturn, or even a minor slowing in the rate of growth, produced a disproportionate drop in the stock’s price — and put top management’s compensation at risk. The answer, for them at least, was to give the market what it wanted: constant growth in sales and profits.

Many executives who engaged in this kind of deception probably believed, the first time at least, that they were just “smoothing out” a soft sales quarter, and that it would all work out over the year’s progress. But that’s not how accounting works.

If you falsify this quarter’s revenue numbers, for example, by counting orders as actual sales, you blow a hole in next quarter’s revenue, when those orders you’ve already counted would normally become actual sales. So, next quarter’s books have to be falsified, too. And on and on it goes, until it gets found out.

In the business environment of the 1990s, the herd instinct came in decidedly on the side of greed. The market almost seemed to prefer fiction to fact, and it was not difficult to believe that “everybody” was reshaping their financials to keep the market happy.

In today’s economic environment, fear is a stronger force than greed. People are afraid of losing their jobs, and they recognize that the company’s performance makes the difference between their getting a paycheck or a pink slip. This can drive them to “cook the books” to make the company’s operations look better.

The big difference in this situation is that fear-driven ethical lapses don’t have to be “top down” in nature. They can, and do, occur at all levels of the business, from the warehouse crew who pads the “shipped” tallies at the end of the month, to the accounts payable specialist who “loses” an invoice so that the balance sheet will look better. Top management may not even know about it, at first.

These fear-driven actions are also different from the greed-driven type because there is, generally, no direct benefit to the individuals involved. In one sense, these actions could almost be considered “well meaning.” Unfortunately, that doesn’t help to make them less pernicious.

But even if the process of making the numbers look better seems relatively small compared with the multi-billion dollar corporate scams we have all heard about, management has to discourage and prevent these ethical lapses — for two good reasons.

The first is that the accounting system will treat the lapses the same, irrespective of the motives behind them. Anything used to colorize this month’s numbers will come out of next month’s results.

And that leads to the second reason. To avoid being caught — another source of the fear factor — in most cases the number-fudging has to continue. The nature of accounting systems quickly converts a one-time lapse into a long-playing serial fiction. And when you have people doing things like that in your business, no matter what the original motivation was, the workplace ethical atmosphere is poisoned. That is extremely difficult to turn around.

If your business is under pressure because of lethargic sales or eroding profit margins, make sure that everyone on the team knows that faking the numbers will not make things better. They also need to know that you will not tolerate any cooking of the books, no matter how well intentioned.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

Back to the top/June 2003 Main Menu