01:54 PM

Huge egos and lies: The software industry’s dirty secrets from Story of Informix author Steve Martin

By Steve W. Martin, author of The Real Story of Informix Software and Phil White: Lessons in Business and Leadership for the Executive Team (www.storyofinformix.com)

Q. What do Microsoft, Oracle, Computer Associates, Veritas, Sybase, Symantec, I2, Red Hat, Macromedia, Microstrategy, BMC, and Informix Software all have in common?

A. They have all made financial restatements because of accounting irregularities that skewed previously released financial results.

According to a recent report from the Huron Consulting Group there were 203 financial restatements in the software industry between 2000 and 2004.

Approximately half of these restatements were made because of revenue recognition issues. As is usually the case, almost all of these revenue restatements were lower than the originally reported numbers.

Revenue restatements are more than just accounting reversals. Their impact affects a company in every possible way. Customers are hesitant to purchase products, investors watch stock prices free-fall, employee morale is ruined (along with the value of employees’ stock options), and flurries of class-action lawsuits are filed by lawyers eager to capitalize on misfortune.

It’s a devastating experience that almost always results in a management change and sometimes in bankruptcy. As I2’s CEO and chairman said about their company’s restatement, “Surely, the audit was no fun for us or our customers, and our customers were asked a lot of questions internally by their own people.”

If these restatements are “no fun,” then why are they commonplace today?

John Coffee Jr., professor of law at Columbia University, offers the following reasons: “First, there is intensifying or weakening of a particular company’s stock, which usually occurs during a stock market bubble. Second, there is an overall decline in business morality and in the words of Federal Reserve Chairman an atmosphere of ‘infectious greed.’ Third, the company has a weak board of directors who are not independent from senior management.

Finally and most importantly, it’s gatekeeper failure--the failure of the auditors, securities analysts, and securities attorneys, who prepare, review or analyze disclosure documents.”

While Professor Coffee would rightly argue these restatements are the result of greed, cronyism among the board of directors, and a gatekeeper that wasn’t independent, I would like to suggest four additional reasons for revenue restatements that are specific to the software industry.

Pride. The high-tech industry is filled with leaders who have a fundamental desire to become rich and, equally important, famous. Since one of their most important possessions is their pride, they will go to any length to prove they are right and to avoid embarrassment, even if they have to cheat.

I would argue that the CEOs’ desire to protect their egos is just as powerful a motivator as greed.

Pressure. The pressure starts at the local sales office, where proving oneself is a matter of survival. Pressure is exerted on the finance department to keep the numbers up. Pressure is on the gatekeeper to keep the client happy, and an incredible amount of pressure is placed on the CEO from investors, analysts, and the press alike. Pressure at all these points encourages revenue fraud.

Politics. When the management regime changes at a troubled technology company, it is in the best interest of the new leaders to restate earnings and make the largest restatement possible. By doing so, they reset expectations extremely low and improve their likelihood of turnaround success.

In other words, they debook as much revenue as possible, regardless of necessity, so that it can be recounted later and improve the financial numbers under their watch.

Past history. History naturally repeats itself. The Huron Consulting Group report also revealed that fifteen percent of all restatements filed in 2004 were by "repeat filers." These companies had encountered financial trouble in the past and reported erroneous financial information on more than one occasion since 1997.

The difference between greatness and infamy has never been smaller for today’s business leaders. Under the business climate of Sarbanes-Oxley, officers risk losing not only their careers but also their freedom, every time they sign off on their company’s numbers.

However, the real story behind the software industry’s restatements is about the humanness of its leaders and a value system based upon net-worth instead of self-worth. And unfortunately, there most assuredly will be more revenue restatements in the future because history has a way of repeating itself.

In the words of Machiavelli, “Whoever wishes to foresee the future must consult the past; for human events ever resemble those of preceding times. This arises from the fact that they are produced by men who ever have been, and ever shall be, animated by the same passions, and thus they necessarily have the same results.”

By Steve W. Martin, author of The Real Story of Informix Software and Phil White: Lessons in Business and Leadership for the Executive Team www.storyofinformix.com