Company Luxuries: Their Impact On Small Cap Company Risk When Times Are Hard

One of the nice things about being an executive in a small cap company doing well is that there are luxuries that you can use that you don't have to pay for. Hunting lodges, beach resort condos, and airplanes are the most frequently encountered. They abound in many large cap companies too, but the attendant risks may be different.

For tax purposes, customers and others we deal with are included in the use of these "toys." They also serve to impress those we deal with that we are doing well and that we know how to smell the roses. They serve us well.

No one complains when life is profitable. Well-served shareholders are grateful and don't read the fine print in the annual reports and proxy statements.

When life is less profitable, and especially if the industry or company is in a period of decline, disgruntled shareholders talk to lawyers, and parsing corporate reports becomes quite detailed.

The goal of the inquiries is to find "handles" that can be used to produce threat risks for the company and its executive management. The goals of the shareholders involved in this are obvious. They want money/buyouts.

Disgruntled employees talk. What they say, especially about the use of company "toys," often becomes a beacon for the unhappy shareholders as well as for prosecutors and grand juries. What is said is that the lodge and beach condo are rarely used for company purposes, and are treated as the private vacation spots of the executives. They also say that the company plane is frequently used for executives and their families and friends to attend golf outings and for other non-business purposes; that the business purposes put on the expense accounts for such trips are phony. For example, that $50,000 trip to Hawaii "to see whether our products are stocked in the local supermarkets" or some other such questionable justification are magnets for shareholder lawsuit investigators. Flight logs and executive expense accounts must be maintained by law, and shareholders can obtain court mandated access to them. These documents are also sought in other kinds of litigation/investigations, and are frequently evidence of things that create substantial risk, not always from shareholders.

Improper use claims raise their ugly heads. These can be used not only to create fear of an IRS audit disallowing a great deal of claimed expenses, plus interest and penalties, but also to question the propriety and truthfulness of important statements made in company proxy statements, suggesting violation of the Proxy Rules.

The crisis management counselor has to address these issues. You can't help find gaps in the company's defenses if you don't "examine" the company.

There is usually reluctance to put the company toys on the block when things aren't going well. There is reluctance to curb their use to strictly justifiable business purposes, giving up privileges that are near and dear.

How these issues are raised with management has to be carefully managed. Shareholders aren't the only people who may become interested in recovering ill-spent company resources. If the company is at or approaching insolvency, management duties owed can frequently shift to include company creditors as well as shareholders.

This is but one more scenario to indicate how much better it is to plan what might be done to mitigate risks far ahead of crisis events.