O2: oxygen of publicity: the accountancy profession has been the subject of especially intense public scrutiny over the past 12 months—for all the wrong reasons. Ruth Prickett delivers her financial review of the year and asks the experts what the prospects are for global economic thaw in 2003

Financial Management (UK), Dec, 2002 by Ruth Prickett

It's hard to think of any industry which could argue convincingly that the past year has been the best of times--in fact, many could complain that it's been the worst of times. One thing that 2002 has not been, however, is dull.

On the world scene, honours for the most exciting stories must go to the dramatic collapses of Enron (January), followed by WorldCom (June). That these companies should announce huge losses was startling enough, but the fact that they had been concealing them through fraudulent accounting caused an international outcry. Next to lose its head in the furore was Andersen, a break-up almost more shocking for many accountants than the fraud revelations themselves.

The WorldCom saga rumbles on. In November the US Securities and Exchange Commission announced that the telecoms firm had admitted concealing $9 billion in expenses--more than double the original sum revealed in the summer--and converting them into false profits. Soon after that revelation, Harvey Pitt, the commission's chairman, resigned amid criticism over his management of the crisis.

These scandals triggered debates worldwide on corporate governance and transparency, strengthened calls for the adoption of international accounting standards and weakened faith in US Gaap. While government committees and business leaders discuss the possibility of tighter regulation, firms are facing demands from fund managers, investors, employees and campaigning bodies for more reliable data. Some doubt whether it will be possible to provide genuinely transparent information, but most accept that they must be seen to be doing what they can to reassure key stakeholders.

The collapses have increased public concern about the role of directors and how they axe rewarded. The accountability, independence and qualifications of non-execs have also come under the spotlight. These issues, of course, have gone hand in hand with falling share prices and perennial complaints that directors receive disproportionately large sums while staff are laid off and investor returns decline.

While Enron and WorldCom did not cause the general decrease in share prices, they certainly worsened the existing downward trend. Many people blame the terrorist attacks of 11 September 200l and uncertainty about a future war with Iraq, but others insist that the current depression is a normal cyclical correction of overpriced stocks and overcapacity in the markets.

"Enron had a depressing effect on shares, especially in the US, but it probably means that they are now down to a realistic level, having been overpriced for years," says John Holdsworth, head of macroeconomics at PwC. "Even at the start of the year we thought prices were still too high, so the events at WorldCom probably knocked them down to fair values faster than we expected.

"Contrary to some predictions, 11 September didn't push the US into recession. It actually helped the recovery to go faster in the short term because the government cut interest rates and raised spending, so consumers went back to the shops quickly--although this petered out after six months."

While he agrees that uncertainty about war in Iraq may be depressing some sectors, Holdsworth thinks that a quick, successful war for the US could actually improve its economy. A longer conflict would have more varied effects, especially if it spread to other parts of the Middle East and affected oil prices. "Generally, wars are not bad for economies. They have a sectoral effect, so they are bad for airlines, but good for the defence industry," he says. "A prolonged war, however, would affect the US debt and the economy."

Bruce Russell, head of fund management and research for Barclays Private Clients, believes that the downturn is a direct consequence of economic trends stemming back to the mid 1990s. He argues that large US companies were advised by their banks and consultants to increase their gearing and buy back shares, thus paying bigger dividends to managers who owned stock options.

"It was sold as a way to improve business performance and translated into a stronger share price. This is fine until the music stops-when the debt starts to be felt," Russell says. "In 1999-2000 share prices became very overvalued and raising finance was cheap, so businesses could invest far more."

This, he adds, is why there is now massive overcapacity in most markets. In the 1990s firms maintained prices but increased volumes. Now that demand has fallen, firms have to boost volumes in order to survive. "It's a vicious circle," he says. Car manufacturers, for example, need to boost sales volumes, yet have reached a point in the US where there are 1.05 cars per driver and 2.01 per household.

Current figures suggest that the economy has passed its lowest point, but Russell warns that the recovery is likely to be slow. The first half of 2002 saw a general improvement and raised hopes, but this stalled in the summer. The sharp decline in share prices and activity has been matched by an increase in financing costs since companies were hit by falling bond yields and spread assets.