Paul Volcker's second career is shaping up to be as influential as his first. Until recently, his claim to fame rested primarily on his tenure as Federal Reserve Board chairman from 1979 to 1987, when his tight money policy broke the back of the double-digit inflation that doomed Jimmy Carter's quest for a second term. But although Volcker's performance prepared the way for America's economic turnaround and longest-ever bull market, his star was eventually outshone by that of his successor at the Fed, Alan Greenspan.
Now, as Greenspan's own star has dimmed as the Internet bubble has burst, the 75-year-old Volcker has reemerged this time as a beacon of integrity in the business world. After leaving the Fed, he served as chairman and CEO of investment firm James D. Wolfensohn Inc. from 1988 to 1996, and became a professor (now emeritus) at Princeton University, his alma mater. Then, in 1996, he was chosen to chair the committee overseeing the restitution by Swiss banks to Holocaust victims. The committee's investigation ultimately uncovered thousands of accounts that probably belonged to victims of Nazi Germany.
In 2000 Volcker accepted the invitation of Arthur Levitt, then chairman of the Securities and Exchange Commission, to head the Oversight Board of the International Accounting Standards Committee. The board was charged with bringing IAS rules into greater harmony with U.S. generally accepted accounting principles. Levitt gave Volcker the job despite the latter's blunt comment that it was "arrogant" for the United States to believe that everyone should report in GAAP.
It was in part this reputation for bluntness and independence that landed him his next post. In one of the oddest footnotes to the Enron scandal, Arthur Andersen CEO Joseph Berardino hired Volcker to serve as chairman of a committee to reform Andersen. Such was Volcker's clout that Andersen agreed to adhere to any recommendations he made. Although this extraordinary initiative was abandoned quickly as Andersen fell apart, Volcker survived with his own reputation not just unscathed but even enhanced. So it was no surprise when SEC chief Harvey Pitt, shortly before his own downfall, called on him to head the new Public Company Accounting Oversight Board (PCAOB) mandated for the accounting industry by the Sarbanes-Oxley Act of 2002 (or "the Sarbanes Act," as Volcker called it during a recent Association for Financial Professionals conference, "since Sarbanes did 90 percent of the work"). Volcker declined Pitt's offer, citing concerns about the time demands of the job.
Abe de Ramos, managing editor of CFO Asia, recently sat down with Volcker for a far-reaching conversation about how the demands on his time have been influenced by the events of the past two years — and how those events have changed both the climate for corporate governance and the prospects for international accounting standards.
Now that you've turned down the PCAOB job, we're back to square one. Have your sentiments changed from two months ago?
No. I think it's unfortunate what's happened. [The first announced candidate was vetoed; the second, William Webster, resigned amid controversy. Charles D. Niemeier now serves as acting head.] I thought it was going quite smoothly and then, for whatever reason, it blew up. There are accusations of lobbying and political pressure.
What would make you reconsider the job?
I don't know. I urged them not to make it a full-time position. I thought it would be difficult to get people of the stature they wanted full-time, and that's proven to be the case.
Isn't the SEC in a crisis of its own?
"Crisis" is a strong word, but I think it is in sort of a crisis. Not just because of this. The SEC has been underfunded and understaffed for some time, and it hasn't had the ability to keep up with all that's going on in the market. And it's lost, I think, the confidence just because of a lack of manpower. All the government has lost prestige, but the SEC had a lot of prestige and moral authority and integrity. I still think it's got integrity, but it's lost some of its resources. One of the things that Sarbanes-Oxley did was to authorize a big, big increase in expenditures — small in terms of the total budget, but big for the SEC. That was important, and the Administration has refused to provide the funds that were authorized. [The agency] needs more money; it needs higher salaries.
Why did you decide to take on the job of IASC Oversight Board chairman?
I'm a sucker for punishment! It just came out of the blue. I've had some interest in international accounting standards just in a very general way, and I had no idea that this kind of international group was working on it, including Arthur Levitt, who was then the head of the SEC. He called me up one day and invited me to chair the oversight board. It sounded interesting, so I did it.
What progress have you made so far?
Well, the board has been reorganized. We're now getting to the point where we are issuing standards. The issues will be very controversial. I wish the first points [on financial instruments] didn't have to be so controversial, but that is perhaps inherent in the business.
Where the real progress has been made is in the general environment. All the scandal has been a big help in one sense: it has challenged the traditional American view that if you want international standards, use our standards, because we've got the best and the brightest.
The Americans are now more cooperative — there's more public understanding of the need [for international standards], which has been helpful. There's good cooperation between the Financial Accounting Standards Board and the IASB. The new head of FASB [Robert H. Herz] came from the IASB, so that's a reflection, I think, of some mutual sympathy.
We have a big work program, because European countries and some others want to adopt international standards, by law, in 2005... [and that means] the companies want to know where they stand by 2004. There's a lot of work to be done in the next year or so.
The FASB-IASB agreement makes it appear that the United States is willing to compromise U.S. GAAP. Is that actually the case? Where do you think the resistance will come from?
It's much more the case now than it would have been a year or two ago. I would not have done this if I did not think that the United States was sympathetic to it. Some people in the United States are not, but the SEC at that point said it was. The interesting thing is, I think FASB itself is supportive.
My observation, or my assumption, is that FASB has come to the conclusion that it may be easier to work out some of the problems internationally rather than domestically, because [board members] were being subjected to very heavy political influence, and I don't think they liked it much — understandably.
As the IASB and FASB work together, where will the opposition come from?
Well, that depends on the standard. On the table right now are proposals for handling derivatives. Most countries don't have a standard; the United States does. It's quite evident that the big problem there is not going to come from the United States, it's going to come from Europe and elsewhere, where institutions that have not had a standard like it that way.
The standards on stock options, which everybody expected to be very explosive, are still going to get big opposition, and most of the opposition there will be in the United States — I believe from high-tech industries. But they're much less controversial today than they were a year ago.
Why would accounting for derivatives be controversial?
I'm not supposed to comment on technical things, but I will tell you what the issue is here. In general terms, banks are active users of derivatives, and, although it's more complicated than that, they fear that accounting for the changes in value in derivatives will create a lot of volatility on their earnings. They also argue that it will make it harder to engage in activities that provide a good hedge.
I think [banks] probably also are opposed to fair-value accounting on a wider basis. Again, you have to expect it. Outside the United States, this will be a new standard. People doing business a certain way don't like change.
What about the opposition to stock options?
When I look at stock options, I am more and more convinced that in a basic sense, the trouble is not whether you expense or not — stock options are just a bad instrument. They're so subject to abuse, you want to get rid of them. There ought to be better ways of compensating people. There are better ways. Because the results are so capricious, so fortuitous, depending upon what the overall market is doing.
I want to discourage the use of stock options. Expensing them would somewhat discourage it. If I'm not going to do it by law, then I'm going to do it the way it should be done: What is accepted good practice? What should stockholders insist upon? What should public opinion insist upon? If a company is going to give stock options, [there had better be] some damn good reasons why that company, at that particular time, finds it desirable to use an instrument that is so subject to abuse.
What is the alternative?
Just give executives stock, for one thing. There are so-called restricted stocks — you get stocks over a period of time, then you have to hang on to them, and you're going to be subject to the downs as well as the ups.
Moving on to the subject of corporate governance, what do you think are the weaknesses of the typical board structure in America?
I have a favorite issue that's not popular among American CEOs, to say the least. I think the single most important structural change is to encourage nonexecutive chairmen. The advantage is that you have a better degree of oversight over the CEO.
There's always talk about how the independent directors, when they get together by themselves, are not being directly influenced by the chief executive or the management, so they can have a free discussion. I agree with that; I think that's very important. But I think the best way to get some independent leadership on the board is to have a nonexecutive chairman who can also determine the agenda. That way, the board isn't entirely at the mercy of the priorities and information of the chief executive. In extraordinary times, it becomes really important — for instance, when a company isn't doing well, or when there's some question as to whether you want a new chief executive, or when you have to pick a new chief executive.
I know that when I was a regulator, if something went wrong and you wanted some changes made, who did you talk to? You talked to the chief executive. But what if he's the problem? Who can you talk to then?
Do you think CFOs should report to audit committees?
I think it's a good idea, and one that has to be explored. But where do you find the people to spend all that time and have the experience to do it?
I think on the ordinary board you have competent people who don't have the time, and you have people who have the time but are not competent. My idea is to elect the members of the auditing committees separately, so that you're not just voting for a slate of general-purpose people. You have to have some indication of who's going to be on the audit committee, what his experience is, what his background is.