Monday, February 28, 2011

Natural finance comptrollership function - A Private regulation model

A Natural Finance Comptroller (NFC) controls cash, financial accounts, and the issuance of (loan) securities by the enterprise.  He may also restrict cash expenses and cash salaries for reasonableness, and thus manage deferred compensation .  May advise on future project loan structuring.  May manage share issuance and assist board or partnership issues.  The NFC is independent of the company, and his primary role is to ensure that investors, and suppliers/partners/employees are paid when supposed to, according to enterprise's voluntary contractual obligations, thereby enabling management to engage in flexible loans and supply agreements.

Comptrollership under natural finance principles provides different, stronger, and mostly cheaper financial controls over enterprise than does accounting audits.  Auditing still has value, but natural finance comptrollership (NFC) can replace almost all of that value.

Audited financial statements (by CPAs) are proactive regulation designed to protect investors.  The birth of the public accounting industry was the SEC acts of 1933-34 which made auditing mandatory for public corporations.  Against the act, corporations argued that not permitting them to say anything they wanted on financial statements would impede their ability to raise funds.  Today, investors, and even banks, prefer to invest in public companies over private companies largely because of the financial reporting integrity brought through audited financial statements.  The accounting industry would survive even if the legal requirement of audits was removed, because investors appreciate its value.


Potential Investor abuses (legal and illegal) in corporate governance
The following investor abuses are sorted from smaller companies to larger company issues.

Embezzlement, fraudulent liquidation, and fleeing to tropics.  This is one of the larger fears of bankers in giving general operating loans.  NFC prevents embezzlement by controlling bank accounts, pre-approving withdrawals.  Traditional auditing merely confirms what is said to be there is there, and cannot prevent the fraudulent liquidation of the company.

Ponzi/Madoff schemes and  unregistered investments.  NFC registers all investments.  Investors want their investments registered so that NFC can ensure their due payments.  Auditing can mostly prevent long term ponzi schemes (Madoff was never audited), but there are sophisticated arrangements that can fool audits. Investors only know about other investors if they are told about them.

Secret contracts, loan guarantees, and repurchase agreements.  A variation of the above.  First, a contract is a secret agreement (until it is enforced) between 2 parties.   Top US investment banks have been accused of shifting assets and liabilities to a 3rd party just before financial reporting timeframes, only to be reversed days later. Enron used most of these abuses.  Natural finance discourages loan guarantees and repurchase agreements are extremely difficult and also discouraged.  Secret contracts are impossible under NFC as long as one party wants his rights enforced.

Accounting conflicts of interest.  Best exemplified, again, by Enron and Arthur Andersen.  I am not aware of any bribing of individual auditors, but 25m in annual auditing fees and 27m in additional consulting fees influenced the firm's deference to management perspective.  More generally, financial reporting involves management exaggerating its results in the most reasonable manner possible, while the auditor certifies that it is reasonable.  An auditor competes for employment services with other accountants.  NFC retains its authority over the corporation until the corporation ceases to follow Natural Finance principles are repays all NF loans.  NFC focuses on cash flows, and ensuring they properly reflect revenue, expenses, and investments.  NFCs can offer consulting on future project securitization, accounting and mediation services, but cannot perform any other services for the organization.  Any financial reporting opinions (optional) made by NFCs are made from the NFC's perspective reflecting probable investor benefits, and not an endorsement of management opinion.

Friendly loans. accounts payable.  Friendly loans are informal loans made under the impression that borrower will repay when he is able to.  Accounts payable similarly are usually incurred providing the impression that they will be paid in prompt order.  More of an annoyance than an abuse, these types of obligations can often involve repeated requests for payment from the lender.  NF soft loans are very similar to friendly loans.  NFC formalizes friendly loans and ensures that such obligations are paid when due.  Traditional accounting principles enhance perceived cashflow through high accounts payable balances.  Natural Finance makes soft loans more attractive if accounts payable balance is low or zero, because accounts payable can impede the speed of repayment to investors.

Crony-nepotism. overly generous salaries and perks.  Management paying itself and its friends anything it wants is a corporate governance issue.  Not an auditing issue.  Corporate governance makes no consideration for debt holder concerns.  One of the more controversial aspects of NFC (to business owners) is interference in cash salaries and cash expenses.  These restrictions vary based on profitability and debt levels of the organization, and whether the expense is unlikely to contribute positively to the health of the organization.  NFC can never demand cutting of expenses.  NFC is just able to negotiate acceptance of new expenses.  The business owner has several options in dealing with such NFC oversight.  First, all expenses funded through new soft loan issuances are always accepted.  Business owners have complete discretion in allocating deferred compensation prioritized after investor queues (3rd queue).  New ongoing fixed monthly increased expenses can be funded by new soft loans amounting to 6-20 months of such expenses, and whose proceeds are destined to repay existing investors.  And employees/suppliers can also have part of their compensation in the form of main investor queued soft loans.  The aggressiveness of NFC oversight in this area is determined at the time the company adopts natural finance principles.  Startups would tend to accept stricter expense oversight than converted successful public companies.  Strict oversight can be a selling point for investors as it necessarily improves expected repayment cashflows.  Strictness can always be raised with enterprise approval, and strictness can be loosened based on success benchmarks, and so pre-scheduled expense-standard loosenings can be determined and triggered upon success benchmarks.  The greatest limit on corporate debt today is the lack of expense controls protecting debt holders.

Debt and equity dilution. stock options.  These are legal abuses.  The core natural finance principle is that dilution should never occur.  A billion dollar company with no debt can borrow $1 at the lowest possible rate only if there is some guarantee that another billion dollars in debt won't be borrowed at the same credit priority.  Under natural finance the 1st dollar borrowed can be at much lower rate than the billionth dollar borrowed.  The first has top payment priority, and billionth last priority.  Under traditional finance, shareholders are abused through management coopting of board of directors, paying themselves generous stock options, issuing no or low dividends, and making poor acquisitions and investments.  Stock options specifically misalign management interests with long term shareholder interests by promoting bubbles which the options can be flipped.   NFC doesn't insist to involve itself in shareholder protections, but natural finance recommends communal equity principles which does eliminate possible shareholder dilution.  NFC can enforce communal equity principles.  Employee and management bonuses can be freely distributed as interest bearing deferred compensation.


NFC cost analysis

The most important benefit of natural finance is lower financing costs, and allowing management to borrow more, and retain greater or total control of the company's purpose and shares.  NFC provides stronger financial controls than mere auditing, but these can also be more minimalistic.

Cash account control and verification of investment and income flows.  This is the core NFC function.  It is the only essential information needed to control and verify the health of a company. It can be performed off-site, with one comptroller overseeing several enterprises.  Account control can be a banking service.  Investor repayments are straightforwardly automated.  A relatively low skill level is needed to approve what is authorized, or match contractual obligations between enterprise and its counterparties.

Accounts payable.  Enterprise may agree to have procedural accounts payable, and have automated NFC management of them.  Saving enterprise from devoting resources to accounts payable management.

Auditor functions.  While not absolutely necessary to the health monitoring of enterprise, management would like to be able to boast about future revenues and cashflow by highlighting accounts receivable, inventory, and order backlogs.  If management can prove the existence of those items to the NFC, then NFC can certify that they are accurate.  Essentially almost the same service as CPA audits, but incremental to core NFC purpose, and easier given existing relationship.  From managements perspective, these additional audit services may not be necessary.  The decision is based on whether they will bring down financing costs more than the fees.  Since, inventory, AR, orders will eventually turn into cash, apparent success will become eventual success, and lower financing costs eventually as well, all without these additional audting services.

Cash handling security.  If the business involves cash transactions and employees, there's already likely to be cash management security processes.  Having NFC involved in cash comptrolling, either through certifying processes and/or point of sale systems adds additional helpful security.  It becomes essential security if there are no employees, and/or management is doing the cash transaction handling.  Though this is an additional expense, for a business that does substantial cash transactions, cash controls can make the difference between being investable or not, since otherwise, investors cannot be assured that financial reporting  is accurate (that cash is not disappearing).

Investment packaging consulting.  Natural finance encourages funding new projects with new loans.  A secured tranche/queue exists for funding hard assets.  A minor goal for enterprises using natural finance principles is to keep all of its secured loan queues at equal risk and interest rates so that investors need not be overly concerned over which assets to accept as security, or risk one asset being unfunded while other assets are too popular.  NFC can assist in setting the percentage of loan to value that both minimizes the expected interest costs and vouches for the appropriate comparable (to other secured assets of enterprise) risk level of the asset.  For the unsecured queue, repayment policies may be modified without violating the no-dilution principle of natural finance:  Many investors have an aversion to being repaid too quickly.  So an enterprise with fairly low outstanding loans can adopt a policy that targets organic (from profits) loan repayments to 3 years or 5 years effective for future loans.  NFC can help maximize investor participation and minimize enterprise interest costs by recommending loan conditions (enforceable by NFC) to the enterprise.  Conditions are voluntary, but acceptance carries stronger recommendation by NFC to investors.  Both the entire enterprise and individual future projects are an investment packaging under natural finance principles.  The NFC recommends controls, and enforces those accepted controls.  The basis for management acceptance of controls is ample financing and cheaper financing costs.

Conclusion
Natural finance comptrollership provides simpler controls than auditing.  These controls are more effective though, since they prevent embezzlement and fraud instead of uncovering past crime.  It enforces the impossibility of investor dilution compared to auditing's after-the fact (and weak in the case of employee stock options) reporting of dilution.  NFC has independent authority compared to auditor's employment services contract and so is less likely to have integrity compromised.  Through NFC, natural finance can enable funding of private, even small, business, and significantly reduce the cost of capital of large public companies.

Private regulation model
NFC is an example and model for private voluntary regulation.  Natural finance can benefit from a granted government monopoly that would make it mandatory, but it can also prosper under the voluntary model through its natural obviousness.  Verified trust in an enterprise's promises makes the promises meaningful, and thus enhance their value, enhancing the price/benefits that can be charged for them.

Environmental and social responsibility claims by enterprise could also benefit from a verified trust regulator, which can be private rather than public-legislative-based.  Government regulators always have plausible deniability when they express shock at disasters and abuse.  Regulatory legislation tends to be too vague, and lags behind industry development, not to mention being industry wide rather than company or project specific.  When BP proposes a deep-water drilling plan seeking social funding or permits, verified trust in its drilling and safety procedures should carry significantly more weight for approval than would advertisements featuring puppies.  If BP were unwilling to adopt comptrolling of its practices (as it ideally should be allowed), then any competitors willing to submit to verified safety practices would have a significant competitive advantage in obtaining permits/social funding.

An odd example of government regulation "weirdness":  In the beef industry, at times of mad cow scares, individual beef producers were prevented by regulator from certifying their meat as mad-cow-disease-free under the reasoning that it might force the rest of the industry to adopt costly safety measures.  Certified corporate responsibility should be an obvious right of enterprise, and many consumers would pay the price premium caused by certification.

1 comment:

  1. Great Post! this is very helpful in my research since I'm attending Financial Planner Classes very interesting blog you made thanks!

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