Yesterday, in the wake of the AIG bonuses scandal, I made an argument for the creation of a Corporate Honesty Index. I continue that theme today by listing a few methods for judging the honesty of publicly traded companies.
My suggested inputs yesterday were:
- CEO compensation
- Number of SEC investigations in the past 10 years
- Tax rate?
- Number of lawsuits from employees, clients, or suppliers in past 10 years
- Spread between cash flow and earnings
- Corporate Honesty Index of other companies represented on the board
The spread between cash flow and earnings is the only factor that is easily quantifiable, and this number is useful because, if earnings are consistently above cash flow from operations, it’s possible that the company is claiming revenue on contracts that haven’t yet materialized (a la Enron). If, on the other hand, cash flow is significantly above earnings, it’s possible that the company is cheating the government out of taxes.
Of course, there are legitimate ways to cut your tax bill, but at some point the government has to get its due. And, increasingly, corporations are finding sneaky ways to shift the tax burden to the consumer. Check out this quote from Berkshire Hathaway’s 2004 Annual Report:
Corporate income taxes in fiscal 2003 accounted for 7.4% of all federal tax receipts, down from a post-war peak of 32% in 1952. With one exception (1983), last year’s percentage is the lowest recorded since data was first published in 1934.
A corporation that shelters money from the government (and, in theory, saves more for shareholders), may not, ironically, be the kind of corporation that you want to entrust with your retirement. That’s because cheating the government is a hard road. Dropping a giant corporation’s tax rate by 1% could be the life’s work of a tax attorney or lobbyist. If a company is willing to go to those measures, what kind of back flips will they do to squeeze shareholders?
The other factors on my list take a little more work, but thankfully there are a few resources available for investors:
Executive compensation database – The AFL-CIO’s CEO compensation database goes beyond SEC filings by estimating the value of additional perks, such as stock options and future bonuses.
SEC Litigation releases – The SEC does not make public its investigations until it decides to pursue a company in court, but once in court, those records are fairly easy to find on this page, and there’s even an xml feed.
2008 World’s Most Ethical Companies – Ethisphere collected this list of companies that were perceived to have the highest ethical standards in the following categories: “Corporate Citizenship and responsibility; Corporate governance; Innovation that Contributes to the Public Well Being; Industry leadership; Executive leadership and Tone from the Top; legal, regulatory and reputation Track record; and Internal Systems and Ethics/Compliance Program.”
The following companies also turned up in a more quantitative survey conducted by The Association for Investment Management and Research in 1994:
- National Fuel Gas
- Placer Dome
- Cummins Engine
- Southwest Airlines
- Safeco Corp
Dated? Yes. But honesty is one of those things that age well.