Brief Update on theMarriott School of

ManagementBrigham Young University

Ned C. Hill, DeanDFW Management Society

May 13, 2004

What BYU Team Did Beat Stanford & USC?

(not to mention UCLA, Notre Dame, Virginia & Utah)

Answer: The Marriott School of Management!

22. MIT

23. Emory

24. IPADE (Spain)

25. Ohio State

26. Brigham Young

27. Wake Forest

28. Washington (St. Louis)

29. University of Virginia

30. Stanford

WSJ Rankings

31. Notre Dame

34. Thunderbird

37. NYU

38. UCLA

39. London Business School

40. USC

What BYU Team Did Beat Stanford & USC?

(not to mention UCLA, Notre Dame, Virginia & Utah)

What the Wall Street Journal Said

• “Brigham Young’s Marriott School of Management stood out for its students’ integrity in this era of corporate scandals. ‘Our recruiters return to Brigham Young year in and year out because of the school’s high ethical standards,’ says Roger McCarty, corporate strategy development leader for Dow Chemical Co.”

• “Recruiters find that Brigham Young produces a particularly valuable type of graduate these days…the ethical accountant.”

…continued

• “Brigham Young, which is sponsored by the Church of Jesus Christ of Latter-day Saints, is considered one of the best schools for hiring students with high ethical standards.”

• “In addition to ethics and integrity, recruiters gave students very high marks for analytical and problem solving abilities, communication and interpersonal skills, fit with the corporate culture and team orientation.”

MBA Rankings

• During 2001-03, we advanced or maintained standing in every major MBA ranking for the third year in a row– 22nd worldwide in Forbes (17th in U.S.)

– 29th in U.S.News & World Report (2004 ranking was 39th)

– 1st bang for the buck in Business Week– 2nd for Ethics in The Wall Street Journal– 5th for Leadership in The Wall Street

Journal

Other Rankings

• 3rd Graduate Accounting (Public Accounting Report)

• 3rd Undergraduate Accounting (Public Accounting Report)

• 38th Undergraduate Management (U.S.News & World Report)

• No. 1 “Stone Cold Sober School” (Princeton Review)

Student Achievements

Undergraduates beat out MBA students nationwide to win Fortune Small Business Magazine’s first business plan competition.

MBA team wins 2003 Thunderbird Innovation Challenge, beating 154 other teams.

Student AchievementsMBA students win the D.A. Davidson & Co. investment competition— earning a 32 percent return on their investment.

Three students placed second at the Net Impact 2003 International Case Competition.

Student Achievements

An information systems student placed first and another student placed third in the school’s first appearance at the National Collegiate Conference.

An MPA student was the first in Utah to win an American College of Healthcare Executives Scholarship.

Student Achievements

Marriott School MBA team wins first place in U of Denver National Ethics Case competition—with invited schools known for their ethics programs.

Marriott School MAcc team wins first place in Deloitte national auditing case competition in March against all top Accounting programs.

Student Achievements

Undergraduate accounting students took first place and the graduates took second place at the Deloitte Tax Case Study Competition. This is the seventh time in the twelve-year history of the competition that both BYU teams placed among the top three—an unparalleled accomplishment.

Alumni Portals

• New portal service unveiled in September 2003

• Portals are customized by program and year (i.e. MBA 1996, MAcc 2001)

• Alumni portals are a powerful tool to renew connections and establish new relationships

Alumni Portals

Visit your alumni portal to:• Update your profile• Access a class directory• Participate in online forums• Connect to the Management Society• Search 40,000 Marriott School and

nearly half a million BYU alumni records

Web: marriottschool.byu.edu • Click “Alumni Portals”

Management Society

• Now a global organization• 40 Chapters in the U.S.• 17 International chapters

• Developed central membership database• Membership records• Online dues/events payment• Online calendar• Communication tools

• Formalized 5-year strategic plan

The Crisis in ConfidenceWhy the Public is Losing Faith in

American Business and What We Can Do About It

Part 1: The Problems*

*Much of this material from Associate Dean W. Steve Albrecht

What’s Gone On?

• Misstated financial statements: Qwest, Enron*, Global Crossing, WorldCom, Xerox, etc.

• Executive loans and corporate looting: John Rigas (Adelphia), Dennis Kozlowski (Tyco--$170 million—the $15,000 umbrella stand), Bernie Ebbers (WorldCom), Stephen Hilbert ($175M from Conseco)

• Insider trading scandals: Martha Stewart, Sam Waksal, etc.

• IPO favoritism, incl. spinning and laddering: Bernie Ebbers, etc.

*For the fascinating story of the fall of Enron, read Pipe Dreams by Bryce or The Smartest Guys in the Room by McLean & Elkind.

What’s Gone On?

• Excessive CEO retirement perks: Delta, PepsiCo, AOL Time Warner, Ford, GE, IBM (consulting contracts, use of corporate planes, executive apartments, maids, etc.)

• Exorbitant stock options for executives• Loans for trading fees and other quid pro quo transactions

(Citibank, Chase, etc.) • Bankruptcies and excessive debt• Massive fraud by employees• Mutual fund scandals (1/6 of all funds may have been

involved)—Note: Marriott School faculty member, Bernell K. Stone is working at SEC on this issue.

Example: Making Earnings at Enron

• “Mark-to-market”—book future profits today and don’t worry about delivery

• “Revisit” deals to generate higher profits• Delay losses (even hide them in SPE’s)• Mark up value of non-traded assets “They knew that they stretched and twisted the rules to

Enron’s advantage but they saw their actions as creative not misleading.” – from The Smartest Guys in the Room

Example: Personal Loans at Conseco

• Stephen C. Hilbert, chairman and CEO– 33-acre estate in Indiana with 25,500 sq. ft. mansion– 18,500 sq. ft. vacation home in St. Martin– Race horses, etc., etc.

• Financed by $175M in loans from company• Now owes over $200M• Claims that loans are forgiven when ownership

changed hands—has transferred >$100M in assets to his sixth wife

• He built up $8.2B in debt at Conseco

Consequences of These Problems• Lost confidence in capital markets• Lawsuits—one company has over 3,000• Bankruptcies• Lost reputation and bad press• Longer and more expensive audits, special inquiries• Fines & investigations• Damaged employees & reputations• Lost retirement and pension funds• Directors with personal liability, forced resignations• Losses from fraud

The Cost of Bad Press

Largest Bankruptcy Filings

Company Assets (Billions) When Filed

1. WorldCom $101.9 July 2002

2. Enron $63.4 December 2001

3. Conseco $52.3 December 2002

4. Texaco $35.9 April 1987

5. Fin. Corp of Am. $33.9 September 1988

6. Global Crossing $25.5 January 2002

7. Adelphia $24.4 June, 2002

8. United Airlines $22.7 December 2002

9. PG&E $21.5 June 2002

10. MCorp. $20.2 March 1989

Some Specifics• Several indictments and guilty pleas

– WorldCom• Scott Sullivan (CFO): Pleaded guilty• David Myers (Controller): Pleaded guilty• Bernie Ebbers (CEO): Indicted in March, also indicted in

Oklahoma– HealthSouth

• William T. Owens (CFO): Pleaded guilty, faces 30 years and $5.5 million in fines

• 14 other former executives pled guilty• 4 former CFOs agreed to plea bargain• Richard Scrushy (Chairman and CEO): No federal charges;

SEC complaint—$1.4B accounting fraud

Some Specifics• Several indictments and guilty pleas

– ImClone• Sam Waksal: incarcerated (7 years), fined ($4.3 million)• Martha Stewart: found guilty, case under appeal• Peter Bacanovic (broker): found guilty, case under appeal

– Enron• Andrew Fastow (CFO): pleaded guilty, 10 years prison• Lea Fastow(Assistant Treasurer): plea bargain—1 year prison• Ben Glisan (Controller) and 5 others: Guilty pleas• 17 other individuals indicted• Not indicted:

– Kenneth Lay (Chairman and CEO)– Jeffrey Skilling (CEO and President)

Some Specifics

TYCO• Dennis Kozlowski (CEO): Indicted, mistrial declared

• Mark Schwartz (CFO): Indicted, mistrial declared

Adelphia• John Rigas (CEO): Indicted

• Timothy Rigas (CFO): Indicted

• Michael Rigas (Exec. VP of Operations): Indicted

Fines and Settlements– Goldman Sachs $9.3 million– SG Cowen, Lehman Brothers $7.5 million– Citigroup, JP Morgan Chase $305 million– Visa USA and Mastercard $3 billion– Merrill Lynch $86 million– FleetBoston Financial $33 million– U.S. Bancorp $32.5 million– Bear Sterns & 9 other firms $1.335 billion– Household International $484 million– Bank of America $490 million– WorldCom $750 million

Mutual Fund Scandal– Putnam, Bank of America, Bank One, Janus Capital Group,

Invesco, Strong Financial Corp., Charles Schwab, etc. and hedge fund Canary Capital Partners, etc.

– Illegal trading occurs in at least one out of every six mutual fund families and costs investors about $400 M per year

– “If you discovered your favorite race-track allowed big gamblers to place their bets after the horses crossed the finish line, you would probably take your wagers elsewhere or give up gambling altogether—that is what has happened with many mutual funds (funds are valued at 4:00 p.m. daily but large customers were allowed to trade much later and have their trades time stamped with earlier times.”

(Stanford Professor—Eric Zitzewitz)

New Frauds Under Investigation

• A few more big frauds and SEC investigations– Health South ($1.4 billion)– Home Store ($46 million in 2001)– Bristol-Meyers Squibb ($2 billion)– Ahold ($1.05 billion)– Fleming Co’s– Phelps Dodge– Interpublic– Parmalat

• FBI currently has 30 corporate fraud investigations in which losses to investors exceeded $100 million

Fraud Triangle

O

ppor

tuni

ty

Pressure

Rationalization

Why So Many Financial Statement Frauds Recently?

1. Opportunity• Booming economy hid many problems • Nature of accounting—rule-based • Auditor conflict-of-interest—non-audit services vs. audit itself

2. Pressure • Misplaced executive incentives • Unachievable Wall Street expectations—rewards for short-term

behavior• Large amounts of debt

3. Rationalization• Moral decay in society—weakened family/church structures • Failures in management education• A culture of greed by executives, bankers, and investors

Greed: How to Value a Dot.com

• Take their loss for the year• Multiply the result by negative 1 to

make it positive• Multiply that number by at least 100• If stock price is less than the result…

buy• If not, buy anyway

Executive Incentives

• Remember T. Boone Pickens?– Complained about Newmont Mining executives

• Now executives have significant stock options– Stock prices are tied to meeting Wall Street’s earnings

forecasts– Focus is on short-term (quarterly) performance only– Stock price heavily punished for not meeting forecasts– Stock options may far exceed salary-based compensation

• Bernie Ebbers (WorldCom)– 1997 Compensation--$935,000 per year– 1997 Stock options—1.2 million shares at $26 per share

—stock went to $64.50 ($46.2 million in profit)

Pressure: Meeting WS ProjectionsFirm 1st Qtr 2nd Qtr 3rd QtrMorgan Stanley $ 0.17 $0.23Smith Barney 0.17 $0.21 0.23Robertson Stephens 0.17 0.25 0.24Cowen & Co. 0.18 0.21Alex Brown 0.18 0.25Paine Webber 0.21 0.28Goldman Sachs 0.17Furman Selz 0.17 0.21 0.23Hambrecht & Quist 0.17 0.21 0.23

Actual Earnings $0.08 $0.13 $0.16Fraud 0.09 0.09 0.07Reported EPS 0.17 0.22 0.23Fraud (Millions) $62 M $61M $71M

Wall Street expectations were especially high for certain industries such as the telecom industry (e.g. Global Crossing, ATT, WorldCom, Quest)

How Costly is Financial Statement Fraud?

• Financial statement fraud causes a decrease in the market value of a stock of approximately 500 to 1,000 times the amount of the fraud.

$7 million fraud $2 billion drop in stock value

How People Got Involved

• The CFO instructed the chief accountant to increase earnings by $105 million. The chief accountant was skeptical about the purpose of these instructions but he did not challenge them. The mechanics were left to the chief accountant to carry out. The chief accountant created a spreadsheet containing seven pages of improper journal entries, 105 in total, that he determined were necessary to carry out the CFO’s instructions. Over 20 people were involved in making or instructing to make similar entries.

250 companies announced financial restatements in 2002

High Amounts of Debt• During 2000, Enron’s derivates-related liabilities

increased from $1.8 billion to $10.5 billion• Enron hid billions in off-balance sheet (SPE) debt• Enron’s on-balance sheet debt was huge• WorldCom had nearly $100 billion in debt

– Not only did Bernie Ebbers borrow $100 billion for WorldCom but he also racked up over $1.3 billion in personal debt while CEO of WorldCom

• Every company that committed financial statement fraud had huge amounts of debt

186 public companies with $368 billion in debt filed for bankruptcy in 2002—includes WorldCom, Conseco, Global Crossing, United Airlines

Auditors—the CPAs

• If auditors aren’t the watchdogs, then who is?• Became greedy--$500,000 per year per partner compensation

wasn’t enough; saw everyone else getting rich (Andersen’s partners were jealous of Accenture partner’s income)

• Audit became a loss leader– Easier to sell lucrative consulting services from the inside– Became largest consulting firms in the U.S. very quickly (Andersen

Consulting grew to compete with Accenture)• A few auditors got too close to their clients• Entire industry, especially Arthur Andersen, was punished

for actions of a few

Problems in Management Education

• AACSB moved to “mission based” standards—ethics (and other subjects) no longer required

• Result—fewer and fewer ethics classes– Other subjects crowd the schedule– Ethics may be seen as unconnected with business

• Ethics began to be “integrated” into the curriculum• Excesses of dot-com economy impacted business

schools

Part 2: Possible Solutions

Areas of Change

• Improve auditing

• Improve management

• Improve boards of directors

• Improve business school education

RestorePublic Confidence

RestorePublic Confidence

What the Laws/Guidelines Attempt to Accomplish

Align Directors More TowardsShareholders

ImproveQuality ofFinancial

Information

EncourageEthical & Legal

Behaviorin Management

and Boards

Why Should Sarbanes-Oxley, NASDAQ, NYSE and SEC Concern Everyone?

• These laws and guidelines may help us avoid problems and improve oversight

• We may be rated, reviewed, evaluated by outside agencies

• If problems do arise, must show we did all we could to prevent them

• May open new jobs and careers

Focus of the New Guidelines and Laws

1. The Auditors

2. Top Management

3. Boards of Directors

4. Investment Banks

I. The Auditor: Sarbanes-Oxley

• Creates a Public Company Accounting Oversight Board (PCAOB)

• Prohibits certain non-audit services – Bookkeeping, IS, appraisals, internal audit, management functions, etc.

• Limits lead and concurring partner to 5 years on an audit

• Requires a one year “cooling off period” before audit partners can work in key positions for clients

• Increases liability of auditors

II. Top Management: Sarbanes-Oxley

• Requires management “certification” of appropriateness of financial statements (penalty < $5 M, 20 years prison)

• Prohibits officers or directors from fraudulently influencing or misleading an auditor

• Requires an officer code of ethics• Requires forfeiture of bonuses after restatements

or if fraud is discovered• Prohibits loans to executive officers and directors• Includes officer and director blackout periods on

trading

III. What Sarbanes-Oxley Says about Board Audit Committees

• Requires independence– All members must be external directors– Members may not accept any compensation other than director

fees • Appoints company’s auditor• Requires a procedure to protect “whistleblowers”• Must have authority to engage outside counsel if needed• Must disclose whether at least one member of audit

committee is a “financial expert”• Receives reports from auditors re alternative treatments of

accounting information and all material communications between management and auditor

Enforcement of Sarbanes-Oxley

• Increases the budget of the SEC -- 200 more professionals• Makes it a felony to “knowingly” destroy or create

documents to “impede, obstruct or influence” any existing or contemplated federal investigation or to defraud shareholders (up to 25 years of imprisonment)

• Extends the statute of limitations on securities fraud– Earlier of five years from the fraud or – Two years after the fraud was discovered (was three years and one year, respectively)

• Increases the maximum penalty for mail and wire fraud

Implications of Guidelines from NASDAQ/NYSE/SEC

• Shareholders must approve stock option plans

• Requires majority of board members to be independent

• Requires regular “executive sessions” for independent directors

• Prohibits independent directors from receiving more than $60,000 from company (except board compensation)

• Independent directors to determine executive compensation

• Mandates continuing education for directors

• Requires a code of conduct for senior management

Generally Accepted Guidelines for a Good Board

• Skilled board members – “at least one with experience in core business” and “one who is CEO of equivalent-sized company”

• Equity interest in the firm – “at least $150,000”• Independence – “no more than 2 inside directors” and “none should do

business with the company”• Focus – “attend at least 75%” and “≤ 4 boards for fully employed and ≤ 7

for retired members”• Small size (9 or fewer)• Existence of certain committees (audit, nominating, compensation)• Executive sessions – “independent directors should meet regularly without

management”Many of these from Business Week’s analysis of good and bad boards

Some of these may be necessary but, by themselves, are not sufficient for a great board.

Whose Board Was This?

• Two insiders, 14 outsiders • Skilled directors

– Former Stanford Business School dean (accounting professor)– Former CEO of insurance co.– Former CEO of international bank– Former head of Commodity Futures Trading Commission– Hedge fund manager, etc.

• Equity stake: all board members owned significant shares in company

• Right committees: audit, compensation, nominating, etc.

Compensation =

$381K in 2000!Conflicts of interest

IV. Investment BanksUnder Discussion at SEC

• Split research and sales of securities (Eliot Spizer’s $1.4B settlement against 10 IBs)

• Prevent banks from using IPOs as rewards– Lowball price so favored clients get a bump

• Change rules to allow an auction system for IPOs

• Open “road shows” to public

Some Good News

• Baylor studies– Significant shift in attitude toward more ethical

behavior: 1985 vs. 2002– The more students attend church, the more

disapproving they are of unethical behavior• AACSB issued new standards requiring

institutions to develop a code of conduct for students, faculty and administration

• However—schools may decide whether to have stand-alone course or integrated program

Improving Management Education at BYU

• Require ethics course for all students– Taught by business school faculty– Reinforce in other classes

• Have a code of conduct for students, faculty, staff– BYU Honor Code– Considering adapting it to business environment

• Discuss ethics frequently at all levels• Offer specific fraud courses• Cover cases that involve students in ethical issues• Have consequences for unethical behavior

Fraud Triangle Revisited

FraudTriangle

O

ppor

tuni

ty

Pressure

Rationalization

SarBox, etc.

may help here

SarBox, etc.

may help here

What can wedo here?

What can wedo here?

Will this g

o

away?Will this g

o

away?

Can Ethics be Taught in Business Schools?

Level 1: Ethical Framework—Personal understanding of ethical principles, right and wrong behavior

Level 2: Ethical Courage—Ability to apply that understanding, even under pressure

Level 3: Ethical Leadership—Ability to cause others in an organization to live ethically

Here and Now

“We can afford to lose money, even a lot of money.”

“We can’t afford to lose reputation—not even a shred of it.”

Counsel to Berkshire Hathaway-owned companies:

Quote from Scott Hymas, CEO of RC Willey, 6/19/03