Saturday, 10 August 2002

David Copperfield and his troops are masters of illusion. They make things appear and disappear, with consummate ease. Copperfield made the Statue of Liberty disappear once before millions of live and television audiences. How he does it only he knows, but it is a feat not to be easily duplicated, maybe for a long time to come.

The financial markets have their own share of David Copperfields. They do not train at academies of magic like David went to anymore. More often than not, they will have Harvard or Wharton, rather than Hogwarts diplomas hanging from their walls. Today’s magicians wear pinstripes rather than coattails, weave magic with gold Mont Blancs instead of magic wands. Like true magicians, they have audiences breathless and spellbound, and their abilities at the smoke and mirrors game are no less stunning.

One big difference, though. In Las Vegas, the audiences are there for the magic show.

They know that the rabbit has not actually disappeared; it is still in the hat.

Or maybe not in the hat, but somewhere close by anyway. Animals do not really disappear. Nor do statues of liberty. They just appear to. That is the trick of the master illusionist. And he gets paid for it. Big time, as in the case of the David Copperfields.

On Wall Street, however, a different kind of magic goes on entirely.

Normally, it is the reverse illusion, with things appearing rather than disappearing. Billions of dollars of revenue seem to just materialize from nowhere, exciting the markets and making demigods out of the chief financial officers that made it happen.

But while the people in the seats in Vegas know that completely blinded by the magic tricks. They entrust the magicians with billions of dollars of their life’s savings, only to see a substantial amount of it disappear completely, unlike the rabbit that is still in the magician’s hat. Magic of the most deceitful kind. Something David Copperfield would never contemplate doing.

The magic word is not, as David would exclaim—”Abracadabra.” The new mantra is EBITDA, that harmless line at the bottom of the company’s profit and loss statement that proclaims to the world how much money it has made, before giving the banks and the government their share, and prior to allocating something to cover for the cost of their capital investments.

NOT SO SIMPLE. As we explained in our column last week, earnings should really be intuitively simple to measure. Simply the difference between how much you sell your products and services for, compared to what it cost you to acquire those products, and provide for those services.

The fish vendor knows the concept well. She buys fish from the market for P1,000, and sells it to her customers for P2,000. As far as she is concerned, her earnings for the day are P1,000. She sees the money actually going out of and coming into her pocket. No illusions are necessary. No tricks are required. Business is at its most transparent.

In today’s complicated organizations, measuring earnings is anything but a simple and intuitive process. The time difference between capital investments and their expected revenue streams are often far apart. Outlays for expenditure are many times intended to benefit future periods, and not always when they are paid for. And revenue streams do not often pay for products and services delivered or rendered in the current period—frequently they represent deliveries of goods or provision of services far off into the future.

Complexity like this makes earnings measurement difficult to understand.

Only the experts could navigate their way through the numbers. This environment provides fertile ground for the smoke and mirrors tricks that many companies today play.

Published in the Sun Star Daily, Saturday, August 10, 2002 (

Saturday, 3 August 2002


VAGUE. The accounting profession loves acronyms. EBIT, EBITDA, EAT, EPS, and their kind are common sightings in corporate annual reports. Acronyms are convenient in the best of times, but could be vague and confusing in the worst of them. This is where the accountant is most at home, in a situation so ambiguous that nobody understands what anything is all about anymore.

I should qualify the previous statement. Not all accountants have lost their sense of integrity. Not everyone has turned his back on the principles of GAAP (Generally Accepted Accounting Principles), to which they are eternally sworn to uphold. But some have, as the recent stories of corporate fraud have only too visibly demonstrated.

I have no problems with this dichotomy. It mirrors real life, after all. There are the good guys, and then there are the bad. My issue is with the confusion between the good and the bad in the financial world.

In the real world, the bad guys go to jail. Here, the bad boys get the glory. They have all the pay rises and the fat bonuses. Treading on the thin line between honesty and the absence of it is applauded at the highest corporate circles, encouraging even more dangerous financial acrobatics.

We remember Nick Leeson, or at least some of us must do. Who would forget the boy who single-handedly brought down the venerable Baring Brothers, and had it bought from the receivers for one pound by ING?

He was the perfect example of values gone horribly wrong. He fiddled his reports, fooled his superiors and broke all the rules that ever existed. Yet he had a luxury apartment in Singapore’s most affluent district, drove flashy cars, wore nice suits, and vacationed where most of us could only dream to be. He got caught out in the end, but instead of universal condemnation, there was even adoration from some. His life became a movie, several books were written about him and his exploits, and he is now a cult hero of sorts.

Welcome to the new world of professional depravity!

Until very recently, the bad boys still got all the glory. Only this time, even if their tricks had gotten simpler, no one seemed to notice until the harm had been done.

Fiddling with the books—the simplest trick of accounting magic there is, had the experts looking the other way. Everybody was too busy watching the trend graphs, the obvious escaped their attention. Or maybe the not so obvious.

Nick Leeson actually lost cash, real money. By investing in complex swap transactions that bet on the Nikkei the wrong way, he bankrupted Barings, his bank.

The accountants at Worldcom, meanwhile, merely painted a different story to what was really happening at the company.

But the world is now all the worse for it.

All because of an acronym. EBITDA. An innocuous acronym. Earnings Before Interest, Taxes, Depreciation and Amortization. Between what the company first reported and what its restated earnings report now owns up to, is a hole a few billion dollars deep in EBITDA.

The routine? Move normal repairs and maintenance expenses into fixed assets, and defer their recognition for a few years. EBITDA increases. Share prices go up.

Everybody is happy. Happy at least until the whole scam is uncovered. Then misery ensues, affecting everyone, you and me included. All because of EBITDA. (More next week).

Published in the Sun Star Daily, Saturday, August 03, 2002 (