• by Tig Tillinghast , March 6, 2002

Our nation’s system of earnings reporting and accounting is about as broken as our campaign finance system. It’s been corrupted for so long that the “tricks” companies employ to even out their reported earnings have become standard business practices, and companies that don’t employ these sleazy methods are seen as cheating their shareholders. This comes to haunt agencies and media companies because one of the most prevalent methods to hide money is to stick it in the marketing budget.

Marketers as Honeypots

Agencies get a ring-side seat for these shenanigans. A company may have a great quarter, doubling earnings. But when a firm knows that increased earnings come from one-time market conditions, it wants to minimize the amount of earnings it has to report for that quarter, pushing the rest of the profits out into subsequent quarters. That gives the stock market the (false) impression of steady, predictable growth: which is great bait for investors.

An obvious way to hide the cash is to take paper “charges,” like prospective legal charges, inventory and goodwill write-downs, downsizing charges and other types of arbitrarily-set debits to the company’s balance sheet.

But the most artful way is to plow the extra money into advertising. Presuming that the advertising is actually effective, it will set in motion a process that will result in honest-to-goodness earnings coming back to roost in a quarter or two in the future.

In fact, it sounds a whole lot like an upstanding business practice. The difference, however, can be seen in both the intent and result of the advertising. Companies trying to hide cash will spend money on advertising that clearly won’t return the whole investment. A branding campaign designed to launch an existing brand into a new category may be money well spent. But a branding campaign designed merely to serve as company chest-pounding will likely return only a portion of the original investment. And if the true objective of that campaign is to hide money, a 60 percent ROI can be a beaming success.

Many a branding campaign was started because $10 MM had to go down the drain somewhere. Why not kill two birds with one stone, and throw that money at a feel-good campaign aimed at investors?

Who Gets Hurt?

Investors get hurt. They have clouded data with which to make investment decisions. Worse, the economy gets hurt. While one company may not experience much of an advantage over another company engaged in the same cash hiding practices, the entire industry will experience slowed growth from the wastefulness of the process.

In a perfect world, investors would be able to see highly-volatile earnings growth rates as a realistic condition, and the sum of all those growth rates would be higher than we see today.

And, thinking more selfishly, the marketing companies, like ad agencies get hurt. Agencies get jerked around by clients hiding cash. Initial budgets look very large, requiring new staff and lots of overhead planning costs. But the budgets then get cut when subsequent quarterly performance doesn’t measure up to the initial, one-time circumstances. The agency’s revenue plummets disastrously, while the companies earnings look like they increase gradually, all due to a combination of killed media budgets and revenues created by the previous quarter’s advertising.

Potential Fixes

The real fix will come when someone running the Securities and Exchange Commission starts to care more about these practices. That probably means it won’t start to happen in the current administration, unless the Enron stuff continues to gain even more attention.

Another possible means of reform may come in the form of shareholder lawsuits that examine this behavior. The threat of these lawsuits, already a scourge among publicly traded companies, could well keep companies on their very best behavior.

For the short term, however, agencies can limit their liability by negotiating client contracts that force advertising companies to compensate the marketers for staffing and planning expenses, regardless of how much money gets spent.