vol. XV no. 3

				Investor Confidence in a Year of Wake-up Calls Lagging investor confidence reflects a dissolving faith in U.S. companies and the people who run them. Jason T. Greene, an associate professor in the Robinson College's Department of Finance whose research interests center on capital markets, market microstructure, investments and asset pricing, offers perspectives on regaining a sense of trust in the system. When the Enron situation hit the news late last year, few expected it to usher in an era of accounting malfeasance. Then came WorldCom. In the same week the WorldCom books were opened, Xerox restated $6.4 billion in revenues, Tyco's former CEO was indicted (again) and Martha Stewart fended off questions about insider trading. "The closer we look at their accounting practices, the worse these companies look," Greene said. "We're collectively bracing ourselves for the next scandal. While Enron seemed to be the exception that proved the rule ­ that big business was acting responsibly ­ these latest debacles have helped to disillusion American investors." Measuring Confidence "I generally rely on two sources to gauge investor confidence," Greene explained. "Yale University's investor attitude surveys - the longest-running effort to measure institutional and individual investor confidence - offer a good glimpse of how viewpoints change over time. I also look at stock mutual funds. High confidence usually means more money is going into these funds instead of the less risky ones. Both indicators currently point to low confidence. "Confidence and the level of the market feed on each other," Greene continued. "Economic news informs the market, and vice versa." Though the downturn has been termed relatively mild and consumer spending is still strong - pointing to rather vigorous consumer confidence - the economy may not be recovering as robustly as had been hoped. Some economists believe the Fed will cut rates soon to avoid a "double-dip" recession, and the recovery so far has created very few new jobs. Approximately 60 percent of U.S. households are invested in the stock market, largely through 401(k) retirement accounts that are consistently racking up substantial quarterly losses. The worst off ­ those whose retirement funds vanished along with their jobs - should serve as a warning against banking on company stock for financial security. A recent Gallup poll, however, indicated that nine out of 10 workers trust the executives that run their own firms as well as their accounting and financial officers; it's other companies they're not so sure about. "I strongly caution people not to buy their own company's stock to retire on even if the firm seems entirely trustworthy," said Greene. "The accounting scandals have shown us not to put all our eggs in one basket. Real harm was done by Enron, WorldCom and the others, and the financial impact doesn't tell the whole story. People who thought they had enough to comfortably retire on are out looking for jobs in a deflated employment market." Dwindling funds and postponed retirements can be explained by other factors as well. Those approaching retirement tend to have 401(k) plans, the primary retirement option offered by employers in the last 20 years. As the stock market boomed in the 1990s, funds in those accounts swelled as well. Big gains tempted people to put more money in the market as they neared retirement instead of shifting to investments that earned less but were much less risky. Instead of seeing their money grow, these older investors have watched it dribble away, and they don't have decades to recoup their losses. A Leap of Faith The most basic measure of a stock's worth is how much investors are willing to pay for projected earnings. But what if earnings reports can't be trusted? Greene remarked, "Investor confidence is being eroded in different ways than we usually think. Historically, confidence in a company's stock would diminish if earnings weren't healthy enough. Now we have serious questions as to whether the numbers themselves are believable. "Americans may not want to change business fundamentally, but they do want top executives to play by the rules," he said. Because some corporations are acting like bad guys, all corporations are being scrutinized by investors, consumer action groups and, most recently, the SEC, which will be seeing at least a $100 million budget increase to investigate corporate fraud and enforce tough new laws just now being enacted. On July 25, Congress responded to a scandal-plagued public by passing a sweeping reform bill intended to pull in the reins on corporate leaders. The legislation establishes an independent oversight board to inspect accounting firms and punish those who break the rules; it also bars accounting firms from offering consulting services to the companies they audit. Executives are required to forfeit any profits or bonuses they receive in the 12 months after an earnings report is filed if it results in a restatement. With this bill, Congress is sending two messages: big business isn't going to get away with another Enron, and America is still a good place for investors, both foreign and domestic. "The recent accounting scandals are really a case of us against us. Our demand for big returns has fueled corporations' drive to put shareholder value before everything else. We need a way to restore faith in a system that generally works well. Stricter enforcement is a step in the right direction. "It pays for corporations to play fairly," Greene added. "Most companies are run by hard-working people who do just that. In the current economic climate, however, companies are wise to proactively address any gray areas before investors get spooked. "Krispy Kreme is a good example. The company changed its financing methods in response to investor concerns about questionable accounting methods. This is costing Krispy Kreme now, but it's a move that other companies could follow to help rally investor confidence." Also on the reform bandwagon, The Coca-Cola Company recently announced it would begin counting employee stock options against its yearly earnings. Stock options, unlike salaries and bonuses, almost never show up on the balance sheet, enabling companies to report inflated earnings (provisions regarding options were removed from the new corporate reform bill before Congress voted on it). Coke and Krispy Kreme weren't required to change their methods to adhere to the letter of the new law, but in this case their actions speak much louder - and more convincingly - than words could to a worried investing public. Top | Stocking Up: Some rules of thumb to help steer clear of big losses.

Copyright © 2003 Robinson College of Business/Georgia State University.