Guess Your Liability

In these days of corporate scandal, who can argue against full disclosure on financial statements? But now comes one cockeyed movement that pushes the concept to extremes. It would require executives to guess potential liabilities from environmental and social problems that just might affect their companies, and list them on balance sheets.

I can envision, for instance, that an oil company axe Royal Dutch/Shell, as supplier of fuels that supposedly contribute to global warming, would have to report the potential environmental liabilities. How much? A ready estimate can be derived from the movie The Day After Tomorrow. As the film ends, half the U.S. population lies frozen beneath a gigantic ice sheet. So let’s say $100 billion. Or maybe $10 trillion is a better number.

See how ludicrous this gets? Remarkably, this movement is drawing support from Wall Street. In June Goldman Sachs and Morgan Stanley endorsed a report of the United Nations

Global Compact that calls uponregulators to “require a minimum degree of disclosure and accountability on environmental, social and governance issues from companies, as this will support financial analysis.”

The Rockefeller Family Fund, the Turner Foundation and the United Steelworkers have also signed on to the balance-sheet responsibility movement. California Treasurer Phil Angelides wants his state’s public pension funds to push for “accurate corporate environmental accounting.” The Rose Foundation for Communities & the Environment, in Oakland, Calif., has already asked the SEC to mandate disclosure of “financially significant environmental liabilities.” These activists aren’t trying to improve the reliability of Moody’s bond ratings. They are out to influence corporate behavior.

Yes, environmental and social liabilities can be huge—witness Superfund, asbestos and breast-implant costs. In today’s world of strict, joint and several liability, where almost anyone can be assigned fiscal responsibility for almost anything, conservative accounting would seem to require the disclosure of all the future damage that could be done by tort lawyers. The problem is coming up with a number.

A federal judge in California just gave a green light to a class action on behalf of 1.6 million women who worked at Wal-Mart anytime since December 1998. The plaintiffs accuse the retailer of denying women equal pay and opportunities for promotion.

Should Wal-Mart have anticipated this suit? Should its 2004 balance sheet have included a liability of, say, $104 million (the amount Home Depot paid in 1997 to settle similar suits) or maybe $176 million (what Texaco agreed to pay out in 1996 to settle a race-discrimination class action)? Wal-Mart’s bigger, though. How about a few billion dollars?

Note that American and United Airlines, Boeing and the owners of the World Trade Center are all being sued (by families who opted out of the

September 11th Victim Compensation Fund) for failing to take measures to prevent the attacks. Maybe juries will size up damages in the billions. Should AMR, UAL and Boeing be listing massive conditional liabilities on their quarterly reports?

There are an infinite number of possible futures and thus an infinite number of possible asset/liability estimates. Which of the myriad low-probability (but possibly high-cost) risks should be incorporated on companies’ balance sheets? At what point does the noise introduced by adding more and more low-accuracy valuations destroy the informational value of accounting itself? In mandating the disclosure of information about less-likely risks, don’t we run the risk of omitting information about more-likely risks?

Assets and liabilities that can’t be connected to historical transactions or tradable contracts have no assignable market value. Goodwill is like that If it isn’t from an arm’s-length acquisition, the number you might put on this asset is entirely arbitrary. So investors are better off if the asset is not counted_ So, too, for liabilities that are to be plucked from the air. Accounting is not a field in which we want to encourage fanciful thinking.