Analyze This...Please

Why the separation of investment banking and equity research won't hurt small companies. Plus: executive recruiters looking deep into backgrounds of CFO candidates; China coming to Corporate America; how bribery increases the cost of doing business; more.


Received wisdom tells us that the separation of investment banking and equity research will hit small-cap stocks the hardest. Wall Street banks will no longer bother to research these firms, now that the implicit link between positive research and valuable corporate-finance mandates has been broken. The reality is starker: companies with revenues of less than $100 million have little to lose because so few are researched even now.

"Consolidation in the [banking] industry meant that small companies like ours lost their coverage a long time ago," says Barbara Remley, CFO of Nasdaq Small Cap­listed software provider MakeMusic Inc. Remley garners research from specialty investment adviser BlueFire Research Inc., but otherwise finds it difficult to get coverage. "You can't get investors interested unless you are proven, so there is little or no trading activity. But you can't get the activity without the coverage," she says.

Richard Kelecy, CFO of waste-management company Perma-Fix Environmental Services Inc., agrees that attention from Wall Street analysts has been scarce for years: "It's tough to get the big boys interested. They don't cover anyone with stock trading at less that $5." His company's stock has traded at between $2.50 and $2.70 in recent months.

This latest cutback in coverage could end the use of public equity markets as businesses' preferred funding source. "If I were planning an IPO," says Kelecy, "I would seriously consider whether it was cost-effective to go public." The more-detailed documentation that is required once a company is listed used to be worth the effort: the payoff was greater liquidity and access to funds. With the equity markets all but closed to new issues, that is no longer the case, he says.

Even for listed companies, the public equity markets may no longer be a viable financing source. "[The decline in small-cap research] will stifle small companies," says Remley, who is planning a private placement to raise funds. "They'll have to seek alternative methods of financing if they want to pursue growth."

Tom Freeze, CFO of food producer Poore Brothers Inc., is more optimistic. "In the short term, there will be reduced coverage of small-cap stocks, but analysts will continue to look for good ideas among smaller companies." —Tabitha Neville


The Securities and Exchange Commission is looking for a few good men and women to help with an onslaught of work at the anemic regulatory agency.

Yet help is slow in coming. And if President Bush gets his wish, it won't get as much as it needs. According to the New York Times, the Bush Administration is looking to roll back part of the 77 percent budget increase that Congress approved for the SEC in July but has yet to appropriate. That has critics buzzing. "It's stunning that they would consider anything less than a fully funded SEC, given the current backdrop," says John Giesea, president of the Security Traders Association.

Certainly the SEC has no shortage of work. On top of a well-documented rise in investigations, it has been given the task of putting the Sarbanes-Oxley Act of 2002 into action. "The SEC is in a desperate situation in terms of having the people needed to do the job in a reasonable time frame," says Alan R. Bromberg, a professor at the Dedman School of Law at Southern Methodist University. He estimates the SEC needs to hire an additional 200 to 400 staffers. But rather than add staff, the agency has lost employees. "Salaries are miserably low," explains Bromberg. —Joseph McCafferty

In Search of Skeletons

How nervous is Corporate America these days? Ask Gordon Grand, who leads the financial officers practice at New York-based executive recruiter Russell Reynolds Associates Inc. For the first time in his career, he says, he's fielding lots of requests to arrange in-depth background checks of CFO candidates.

Pinkerton's Inc., Kroll Inc., and other firms that do such checks say at least half of their referrals come from executive recruiters — and business is up. "We have seen an uptick in the CFO line," says Peter Turecek, a Kroll managing director.

Companies are going the gumshoe route not only because some CFOs have been accused of fraud, but because some weren't even who they were supposed to be. Veritas Software Corp.'s CFO, Kenneth Lonchar, for example, resigned in October after admitting he had lied about having an MBA.

Educational records, says David Grossman, man-aging director at Pinkerton's due-diligence unit, are a standard part of checks that dig far deeper, even looking at sex-offender databases.

Do CFOs really need to be checked for sex crimes? "We recommend it," states Grossman, an ex-FBI agent. "The CFO is often a public face of the company."

Background checks would have turned up Lonchar's phony MBA, but can they screen out a potential Andrew Fastow or Scott Sullivan? That's where "developed references" come in, says Grossman. References supplied by candidates are used as a starting point to identify a broader pool of people for questioning. "The most-thorough checks include reputational inquiries," adds Turecek. Barry J. Nadell, president of Chatsworth, Calif.-based InfoLink Screening Services Inc., says such checks of one CFO candidate turned up evidence of embezzlement from a previous employer.

CFO candidates should know the law offers them certain protections. Under the Fair Credit Reporting Act, companies can't investigate candidates without permission, they must share the results if asked, and candidates have the right to dispute the findings. —Tim Reason

Putting the Squeeze on Retirees

With the economy stalled and prospects for a quick recovery dim, employers have little patience for double-digit growth in retiree health-care expenses. Increasingly, cost-conscious managers are cutting so-called other post-employment benefits (OPEBs) — mostly retiree medical care — or forcing retirees to shoulder a larger portion of medical bills themselves.

According to Merrill Lynch estimates, OPEBs for the S&P 500 are underfunded to the tune of $317 billion this year — just slightly less than the $323 billion in pension shortfalls that have been the focus of much recent investor concern. OPEBs were hit hardest at companies in labor-intensive industries, such as automotive and airlines. Last year General Motors alone reported an OPEB liability of $52 billion, more than 17 percent larger than in 1999.

Almost no assets are set aside to pay off OPEB promises, because there is no legal requirement to do so. Even firms that are inclined to prefund are dissuaded by the lack of tax breaks on OPEB contributions. Worse still, OPEB liabilities are very likely understated, because company estimates assume that today's double-digit health-care inflation rates — 11.2 percent in 2001, according to Mercer Human Resource Consulting — will soon fall to a long-term rate of 5 percent. "The big issue is health-care inflation," says Roger Freeman of Lehman Brothers. "Companies are aggressive in assuming they can quickly get back to long-term inflation rates."

To cut costs, employers have raised employee contributions and scaled back retiree health-care promises on a wide scale. According to Mercer, since 1993 there has been an average 1 to 2 percentage point drop per year in the number of employers offering retiree health-care coverage to new hires.

In unionized industries, a backlash is brewing. General Electric faces its first nationwide strike since 1969 over its decision to boost copayments for retirees by 15 percent starting in 2003.

One option with nonunion workforces has been to renege on retiree health-care promises. But is this truly a solution? "OPEBs are part of compensation — and how long can you skimp on compensation before it impacts a firm's operations?" asks Adrian Redlich of Merrill Lynch. —Joanne Ramos

Shanghai Surprises

A small piece of history was made in New York City this past fall. On October 21, the Huayi Group, a Shanghai-based conglomerate, inked a deal to buy tiny Moltech Power Systems Inc., of Gainesville, Fla., marking the first time a Chinese state-owned company has acquired a controlling interest in a U.S.-based business.

Huayi's $20 million offer to buy Moltech out of bankruptcy was the most attractive of several offers for the company, according to Martin Higgins, Moltech's CEO. With its proprietary technology for long-lasting, lightweight, "high-drain-rate" batteries, Moltech made an attractive candidate for Huayi, which has its eyes on the electric-bicycle market in China.

For Higgins, the acquisition by Huayi marked the end of a long, difficult road. When he joined the company in early 2001, it was on the verge of collapse, and filed for bankruptcy protection in May of that year. By the following fall, though, Higgins had turned the company around — but it still needed volume to be profitable. Enter Huayi, which was introduced to Moltech by Business Data International Ltd., a firm that facilitated the deal by providing advice, translation services, and support.

Huayi, which was initially interested in buying just a subset of Moltech's business, decided to buy the entire company after getting to know management and seeing firsthand the company's lean operation. The match made sense: Moltech had excess capacity that could be transferred to Shanghai, giving the company manufacturing platforms on three continents, and Huayi would get Moltech's technology plus full control over the rechargeable batteries that are integral to the quality of an electric bike. The deal also gave Huayi some intangible benefits, such as a foothold in the United States.

Does this deal signal a trend? Denis McCusker, a partner at Bryan Cave LLP, Huayi's law firm, thinks so. "With China's accession into the [World Trade Organization] and a focus on reforming China's state companies, this type of transaction will become increasingly common." He notes that the one stumbling block in the deal, the conversion of Chinese currency into U.S. dollars, was difficult only because it required a license from the Chinese government. The Moltech deal created a template--and paved the way. "The next one won't be so tough." —J.R.

Where Credit Is Due

Some companies that "do good" aren't doing as well as they could by their actions. Specifically, few of the companies that offer child-care benefits take advantage of tax credits offered by 24 states. The credits permit employers to offset part of their expenditures for child-care benefits for their employees.

A recent report by the National Women's Law Center (NWLC) found that the tax-credit programs are rarely used even by those already offering child-care benefits. In fact, in 16 of the 20 states examined, five or fewer companies claimed the credits, and in 5 of those states no companies bothered to claim them. "This particular strategy for funding child care has failed," insists Christina Smith FitzPatrick, senior policy analyst at NWLC and co-author of the study.

The reasons companies are not taking advantage of the credits vary. For one, many of them may not know about the tax benefits. "These programs aren't always widely promoted," notes FitzPatrick. And while the programs differ broadly from state to state, many states provide credits that are barely worth the paperwork, she says. Arkansas, for example, provides a credit of only $5,000 to companies that have child-care programs. Perhaps the biggest reason the credits go mostly unused is that many companies don't have state tax liabilities. FitzPatrick says that, on average, 57 percent of state corporate filers have no tax liability. "It raises questions about the effectiveness of using tax-based mechanisms to influence business behavior," she adds.

"Faced with this information, states need to reexamine their programs and decide if there are more-effective approaches to funding child care," says Judith Presser, senior consultant at WFD Consulting, a work/family advisory firm based in Boston. —J.McC.

For the Taking

Utilization of tax credit for child care, in the 20 states where data is available.
Source: NWLC Report


Corporate filers claiming credit

























New Mexico








Rhode Island


South Carolina






Protecting Against Violence

The figures are grim. Each workday, approximately 16,400 threats are made on the job, 723 workers are attacked, and 43,800 are harassed, according to the Workplace Violence Research Institute. More than 1,000 workplace homicides are committed annually.

Beyond the high human cost, workplace violence imposes an immense financial burden on U.S. businesses — an estimated $36 billion annually, including costs for medical bills, legal liabilities, lost revenues due to business interruption, and property damage, among others. "When you combine all of the costs, it's exorbitant," says Paul Viollis, managing director of Citigate Global Intelligence & Security LLC, a firm that specializes in preventing and responding to incidents of workplace violence.

Insurance is now available to address the problem. A number of insurers, including AIG Inc., The Chubb Corp., and The ACE Group, offer workplace-violence coverage. One such policy is AIG's Workplace Assurance product, which covers business interruption, consulting fees, death and dismemberment, and a variety of related expenses, such as temporary security measures, says Jim Dwane, senior vice president of AIG WorldSource. It also covers mandatory training on how to prevent workplace violence, and a 24-hour crisis hotline.

Are such policies really necessary? After all, many of these expenses are already covered by a firm's existing patchwork of policies, including general liability, property and casualty, and workers' comp. The problem, says Dwane, is that existing coverage has major gaps; companies are usually not insured for business interruption or the expenses associated with responding to an incident. (The new policies have some gaps of their own: AIG's, for example, has a terrorism exclusion.)

Best of all, a policy may help prevent a violent event in the first place. According to Steve NyBlom, an assistant director for Aon Risk Services Inc., most acts of workplace violence are avoidable, but few companies take the necessary steps. —Don Durfee

The Added Cost of Corruption

Increased political instability around the globe has made doing business overseas a thorny proposition. Yet it's another threat that could be more destructive to international commerce: bribery.

A recent survey conducted by Control Risks Group, an international business risk consultancy, found that 40 percent of companies think they have lost business because a competitor paid a bribe. A similar percentage chose not to make an attractive investment because of concerns about corruption.

"Corruption is like a tax," says John Bray, director of analysis in Control Risks's Tokyo office. "If good companies want to do business in places where there are high rates of corruption, they need to spend more management time to solve the problems." Indeed, the survey found that a third of executives believe corruption raises the cost of transactions by more than 10 percent.

U.S. executives, who are required by the Foreign Corrupt Practices Act (FCPA) to maintain clean business practices, aren't above the fray. In fact, there is a perception that the FCPA has done little to curb under-the-table payments — 70 percent of respondents think U.S. companies use middlemen to skirt the regulation, although it's forbidden by the FCPA.

What can companies do about the problem? According to Fred Miller, a partner at PricewaterhouseCoopers's Investigations and Forensic Services practice, they should conduct random reviews of foreign operations. "Don't tell them you're coming," he says. The review team should include someone who understands the local language and customs, he adds. After all, bribery can be hard to detect; payments may be disguised as marketing expenses, consulting fees, or commissions.

Companies might also learn from the oil industry. Royal Dutch/Shell Group, for example, publishes an annual report on its performance in the area of "social responsibility," which includes corruption. The report, which is certified by an outside auditor, is refreshingly candid. It even lists the number of employees fired during the previous year for engaging in corruption (three in 2001). —D.D.

The Kickback Premium
How much does corruption add to the cost of international projects?
Source: Control Risks Group

  • 0­5%: 22.4%
  • 6­10: 22.0%
  • 11­25: 7.2%
  • 26­50: 13.2%
  • Over 50: 15.6%
  • Don't know: 19.6%

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