Do you know the warning signs of companies going south? How about corporate meltdowns? Know when they are coming?
According to a Standard & Poor's report, "Red Flags in Management Culture, Strategies, and Practices," fraud itself is not the barometer because by definition it is designed to deceive which makes it very difficult and many times impossible to actually detect.
Okay, so what are those red flags? The report cites seven specific areas that signal if a company may be heading for trouble:
1) Disclosure and Accounting Practices. An aggressive history of income recognition, use of 'pro-forma' adjustments, and a history of understating costs, overstating revenues, and accounting errors. Add to this list a large percentage of revenues and net income from non-operating or non-recurring sources.
2) Legal and Tax Structure. Too much concentration of management time and resources on complex structures along with an aggressive financial leverage including an over-reliance on short-term debt and overly structured financing arrangements. And, let's not forget a big reliance on tax shelters.
3) Corporate Culture. Here you go, a management of self-enrichment (let's call that greed) and a lack of meaningful long-term corporate planning and focus together with no internal debate and no bad news. These companies usually have a heavy-handed approach to customers, employees, suppliers, business partners, accountants, and regulators. Oh, you can also throw into the pot a history of litigation and considerable use of lobbyists and lawyers.
4) Senior Management. How about an over-reliance on a CEO who is unwilling to delegate coupled with a weak management team immediately below? And, let's add a CEO pay package that is materially above the peers plus perhaps a link between company performance and compensation that is built around the short term. Moreover, look out for special payments and unusual fringe benefits or loans. Also, let's not forget that clincher: lavish lifestyles at the top.
5) Equity Culture. This usually has aggressive positioning as a growth stock and an over-preoccupation with short-term share-price growth. There is usually low or no common dividend policy and management taking out shares and options in the company at a rapid rate and at levels in excess of peers. You might toss into the mix an ownership structure that is convoluted and a growth in price-earnings ratios and market capitalization in excess of peers.
6) Business Strategy. Watch out for any aggressive pursuit of growth through acquisitions or rapidly expanding into new business lines and markets--usually dovetailed with frequent shifts in strategy and aggressive growth targets, not to mention growth materially in excess of peers and the broader market.
7) Track Record. Especially of litigation, regulatory, and governmental actions.
Of course, as S&P likes to point out, bad governance on its own is not a promise of imminent corporate crisis. The report simply outlines seven areas that are indicators of crisis or the likelihood of crisis. As we all know, unwillingness to delegate and those lavish lifestyles at the top are generally among indicators that something is rotten in the State of ......
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