306 Part Three Best Practices in Capital Budgeting
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He ought to be watched by another Hawtch-Hawtcher!!
The thing that we need
is a Bee-Watcher-Watcher!”^6Fortunately, the company’s directors are not the only people that scrutinize management’s
actions. Several other groups act as bee-watcher-watchers.Auditors The board is required to hire independent accountants to audit the firm’s financial
statements. If the audit uncovers no problems, the auditors issue an opinion that the finan-
cial statements fairly represent the company’s financial condition and are consistent with
Generally Accepted Accounting Principles (GAAP).
If problems are found, the auditors will negotiate changes in assumptions or procedures.
Managers almost always agree, because if acceptable changes are not made, the audi-
tors will issue a qualified opinion, which is bad news for the company and its sharehold-
ers. A qualified opinion suggests that managers are covering something up and undermines
investors’ confidence.
A qualified audit opinion may be bad news, but when investors learn of accounting irregu-
larities that have escaped detection, there can be hell to pay. In September 2014, the British
supermarket giant Tesco announced that it had discovered material accounting irregularities
and had overstated its first half profits by about $420 million. As the scandal unfolded, Tes-
co’s share price fell by some 30%, wiping $8 billion off the market value of the company.Lenders Lenders also monitor. When a company takes out a large bank loan, the bank
tracks the company’s assets, earnings, and cash flow. By monitoring to protect its loan, the
bank generally protects shareholders’ interests also.^7Shareholders Shareholders also keep an eagle eye on the company’s management and
board of directors. If they believe that the corporation is underperforming and that the board
is not holding managers to task, they can attempt to elect representatives to the board to
make their voices heard. For example, in 2011 billionaire shareholder activist Carl Icahn
believed that the management of Oshkosh was not acting in the shareholders’ interest when
it did not pursue a merger with fellow vehicle manufacturer Navistar. He therefore purchased
nearly 10% of the stock of each company, and nominated six associates for election to the
Oshkosh board.
Smaller stockholders cannot justify the time or money for a proxy battle. However, if they
are disgruntled, they can take the “Wall Street Walk” by selling out and moving on to other
investments. The Wall Street Walk can send a powerful message. If enough shareholders bail
out, the stock price tumbles. This damages top management’s reputation and compensation.
A large part of top managers’ paychecks comes from stock options, which pay off if the stock
price rises but are worthless if the price falls below a stated threshold. Thus a falling stock
price has a direct impact on managers’ personal wealth. A rising stock price is good for man-
agers as well as stockholders.Rival Companies A company’s management is regularly monitored by other management
teams. If the latter believe that the assets are not being used efficiently, then they can try to
take over the business, and boot out the existing management. We will have more to say in
Chapters 31 and 32 about the role of takeovers in changing corporate control.(^6) Dr. Seuss, Did I Ever Tell You How Lucky You Are? (New York: Random House, 1973), pp. 26–28.
(^7) The interests of lenders and shareholders are not always aligned—see Chapter 18. But a company’s ability to satisfy lenders is
normally good news for stockholders, particularly when lenders are well placed to monitor.