Our suggestions about sharing financial information reflect our interest in a philosophy known as open-book management (OBM). Many entrepreneurial companies—including Setpoint, Joe’s company—are devotees of this approach. For example, several surveys have found that a significant fraction of Inc. magazine’s annual list of the five hundred fastest-growing private companies practice some form of OBM.
OBM involves sharing the financials with your employees and, of course, helping them learn what the numbers mean. But it isn’t just “open the books”; it’s also managing with open books. As everyone learns the numbers, people begin to take responsibility for making the numbers move in the right direction, in accordance with monthly or quarterly goals that they help set. ECCO, a safety-equipment manufacturer, began practicing OBM in 1993. The first task, according to CEO Ed Zimmer, was to develop regular weekly “flash” income statements that were accurate. The company then began sponsoring weekly meetings attended by a wide variety of employees, including production employees. Individuals had their initials on line items of the income statement and were held accountable by their peers for the results on that line.
OBM at its best creates an environment where employees feel that they are part of the success—and are at risk for the failure—of the business. This is particularly true when OBM is combined with an employee stock ownership plan or some other form of equity participation. But in some cases a profit-sharing program works as well. At Setpoint, for instance, Joe has seen employees with no stock in the company behave like owners because they know the numbers and have a chance to share in the profits through a bonus. Joe likes to call this psychic ownership.
The classic texts in OBM are The Great Game of Business by Jack Stack with Bo Burlingham (Doubleday Currency, 1994), and Open-Book Management by John Case (HarperCollins, 1996). You can find more up-todate information simply by googling the phrase open-book management.
If you are reading this book, your company probably isn’t publicly traded. So right now, at least, you probably don’t have to deal with the law known as Sarbanes-Oxley. But in all likelihood you have read about it in the papers or heard about it from your accountant. And although you don’t need to follow the law’s rules, you should have a general sense of what it entails. As you grow, you’ll want to be sure that what you are doing doesn’t veer too far from Sarbanes-Oxley’s rules. In many cases, too, your investors, bankers, and even customers and employees will want to know that your financial reporting is valid by the law’s standards. And, as we said earlier, if you are thinking that at some point you might want to go public, then you certainly should be paying close attention to the law’s requirements.
Sarbanes-Oxley—also known as Sarbox or just Sox—was enacted by the U.S. Congress in July 2002 in response to the continuing revelations of financial fraud at the time. It maybe the most significant legislation affecting corporate governance, financial disclosure, and public accounting since the original U.S. securities laws were enacted in the 1930s. It is designed to improve the public’s confidence in the financial markets by strengthening financial reporting controls and the penalties for noncompliance.
Sarbanes-Oxley’s provisions affect nearly everyone involved with finance. It creates the Public Company Accounting Oversight Board. It bans accounting firms from selling both audit and nonaudit services to clients. It requires corporate boards of directors to include at least one director who is a financial expert, and it requires board audit committees to establish procedures whereby employees can confidentially tip off directors to fraudulent accounting. Under Sarbanes-Oxley, a company cannot fire, demote, or harass employees who attempt to report suspected financial fraud.
CEOs and CFOs are greatly affected by this law. These officers must certify their company’s quarterly and annual financial statements, attest that they are responsible for disclosure and control procedures, and affirm that the financial statements don’t contain misrepresentations. Executives guilty of intentional misrepresentation may face fines and jail time. Also, the law forbids companies from granting or guaranteeing personal loans to executives and directors. (A study by the nonprofit Corporate Library Research Group found that companies lent executives more than $4.5 billion in 2001, often at no or low interest.) And it requires CEOs or CFOs to give back certain bonuses and stock-option profits if their company is forced to restate financial results because of misconduct.
Sarbanes-Oxley requires companies to strengthen their internal controls. They must include an “internal controls report” in their annual report to shareholders, addressing management’s responsibility in maintaining adequate controls over financial reporting and stating a conclusion about the effectiveness of the controls. In addition, management must disclose information on material changes in the financial condition or operations of the company on a rapid and current basis.
Sarbanes-Oxley forces public companies to take more responsibility for their financial statements and may lessen the probability of undetected fraud. However, it is very expensive to implement. The average cost for companies is $5 million; for large companies such as General Electric, it maybe as much as $30 million.
If your company is private, you may feel insulated from the effects of Sarbanes-Oxley. But this legislation has an impact on any growing business in the United States. For instance, the accounting profession as a whole has become more conservative in its audits because of the law. As you grow and need financing, most banks and other financing sources will require an audit of your books—and some small private companies have seen the cost of their audits triple because of Sarbanes-Oxley.