Berkshire Annual Letter 1998 (Part 4)
Michael Kinsley has said about Washington: “The scandal isn’t in what’s done that’s illegal but rather in what’s legal.”
Many CEOs have no hesistation about manipulating earnings to meet the desires of Wall Street.
Their first assumption is that their job is to encourage the highest stock price possible, something which Warren Buffett disagrees. To get a high price, operational excellence is required failing which they will resort to accounting gimmicks.
One trick used is the “restructuring charge”. This huge chunk of expense, which should be attributed to a number of years, is charged into a single quarter. This is a quarter that is already bound to disappoint investors.
No one seems to mind if earnings fall short by $5 per share in a given quarter, as long as earnings in the future consistently exceed expectations by five cents per share.
CEOs who engage in this game tend to become addicted to it. It becomes easier to fiddle with the accounts than to really improve the business.
This game is taken to a whole new level with acquisitions. It is used to dishosnestly rearrange the value of assets and liabilities to smoothen and increase future earnings.
For example, when a property-casualty insurer is purchased, the buyer sometimes increase its loss reserves. This move sets up the possibility of “earnings” flowing into income later on as reserves are released.
A tally of special charges taken or announced during 1998 showed that it was about $72.1 billion. This is quite high if you consider that the 1997 earnings of Fortune 500 companies was only $324 billion.