Ready to step up: Robert H. Herz, FASB chairman, 2002-2007. (Domestic).

"I'm ready to step up to the plate," says Robert H. Herz on beginning his five-year term as the newly appointed chairman of the Financial Accounting Standards Board. Formerly PricewaterhouseCoopers LLP's North America Theater Leader of Professional, Technical, Risk & Quality, his 20-plus years of broad experience includes technical, operational and board positions. A stint on the International Accounting Standards Board, and his education in both the U.S. and U.K. -- he holds a CPA and CA -- give him fluency in working with international standards.

Herz is beginning this high-visibility post at a turbulent time for accounting standard setting, and just prior to his July 1 start date, he spoke candidly with Financial Executive's Managing Editor Ellen M. Heffes about accounting standards, the state of financial reporting and his professional and personal goals.

Recent corporate reporting coverage has centered on Enron, Andersen, investor lack of confidence, the dot-com debacle, reliance on short-term earnings and investment bankers' and analysts' conflicts of interests. From the "inside," how bad is it, really?

RH: By and large, companies are trying, and do report properly. But the numbers of instances of accounting abuses and financial reporting scandals, and their effects on the system, have grown. This is causing some fundamental questions to be asked by all of us who are part of this system, [as well as] Congress and the public, and it is having an effect on the confidence in the capital markets. While the markets are fairly resilient, it is serious enough that everybody has to recognize that there are questions, and many of those questions are quite valid.

I'm a "glass-half-full" kind of guy. I think [questions are] healthy and that coming out of this process, we'll hopefully have a system with renewed dedication to everybody playing his or her role and taking responsibility in a highiy ethical and sound way. And, I think some structural fixes will be put in place that could also help.

There were some excesses in the system, and people who were not exactly clear about their roles [or] where the boundaries were. That led to some bad behavior.

That's part of the reason why I am excited about the FASB chairman job, because of the opportunity to contribute to the proper functioning of the capital markets. A key aspect of that is sound corporate information that's relevant, that's reliable and that people can trust.

Another aspect is financial reporting, and a very important facet of that is setting standards relating to accounting and financial reporting.

As for the numerous U.S. standards, often ambiguous and open to interpretation, one argument goes: "With over 15,000 registrants reporting, how many are 'bad apples?"' It seems only only a few, but they are so highly publicized.

RH: True, although the argument has been that, "It was only Cendant, Sunbeam and Waste Management." Then came Enron, and now the list seems to be growing, [with morel problems coming to light. So, while it is still a small percentage, it's larger than people thought before and, in my view, indicative of some broader problems in the system.

Do you think it's more than the individuals involved, but rather the rules themselves?

RH: I think it's less the rules themselves. About two years ago, I co-authored a book, "The Value Reporting Revolution: Moving Beyond the Earnings Game," and believe the reason a lot of people read it was because of our depiction of what we called "the earnings game" that was going on. It is the quarterly earnings forecast game -- the constant pressure from Wall Street on companies to meet or beat the Street's estimates on quarterly earnings -- and it's made some people behave in unfortunate ways.

I think it is still an issue, [and] one that can be fixed. But, it requires people to acknowledge that there has been an issue.

Which leads us into your role at the FASB, beginning July 1. What do you aim to do?

RH: It all starts from my overall goal and passion: I want the FASB to play its role in doing what it can to promote good financial reporting. But, we can only do so much because the standards themselves are only one element. That's got to go with good implementation of the standards, [which involves]: faithful implementation by the companies, strong auditing, sound corporate governance, analysts doing real analysis and proper review and enforcement by the Securities and Exchange Commission.

So we have a role to play at the FASB in trying to improve the system that can start with improved financial reporting standards. But there are many other elements and other players that have to weigh-in and do their part as well.

What specifically are you planning to do to move in that direction?

RH: Some of it comes with what we focus on, the agenda. Is the agenda right? Are we looking at the right things? Are we also trying to think ahead, to get good intelligence as to what is really going on, out in industry, out in the markets? What might the problems be? [I don't mean] crystal-ball gazing 5 or 10 years into the future, but more [in terms of] what issues are coming up, both around our existing rules in terms of new business structures and arrangements, and what kinds of questions do they raise for accounting and accounting standard setting?

Second, we need to look carefully at existing processes to see whether there are ways to improve them -- in terms of both effectiveness and speed, without compromising appropriate input and due process. The existing board has started a project to determine whether standard setting--from getting it on the agenda, to finishing a project -- can be made a little quicker.

Also, from my perspective, the success of any organization is very much dependent on not only the quality of its people, but also on the pride and passion of its people. I certainly feel that the FASB is an extremely important organization within the whole context of financial reporting and the capital markets, and I am sure people there already feel that way. That sense of pride and passion in the mission is important to the success of our efforts.

Would that be a number three item or goal, then, the staff?

RH: I am not listing my goals in any order, but certainly, the pride and passion of the people working at the FASB would be very high on my list.

I also believe strongly in the international movement [towards] convergence. I've long believed in it, and it's at the stage now where things could begin to happen. I have a high regard for the International Accounting Standards Board (IASB), as a member of it -- a post I step down from on July 1 -- and my intent is to have the two groups work very closely together.

I'd like to see that happen both on new projects on particular topics and also to see if -- by identifying within the inventory of existing standards the major areas that cause differences -- we can come to some agreement and narrow the range of differences.

There are a couple of quite contentious issues.

RH: Yes. The IASB has 14 board members, and we [the FASB] have seven. On the technical issues, people don't always see eye-to-eye. For real international convergence to happen, it is important that the standard setters of the world's largest capital market, the U.S., be actively engaged in that process.

A number of projects are already on the agenda, and one recent addition is on revenue recognition, which I strongly support. The current rules are all over the place, and are not conceptually consistent. Revenue is a pervasive issue, something that virtually every company has, and one that continues to be a problem -- as evidenced by the many reported financial reporting busts relating to revenue recognition. Having a comprehensive conceptually consistent set of standards on revenue recognition would be a major step forward.

Are you suggesting revenue recognition be taken on by both the IASB as well as the FASB?

RH: I believe that that has to be a project that gets worked on, not just by the FASB, but with international coordination as well. As we [at the FASB] address it, I would like to see that what we come up with is something that can be used internationally.

Will you comment on the stock options (or share-based payments) issue, already under consideration by the IASB?

RH: The IASB has been looking at that since last August, is part way through the project and beginning to look at the measurement issues. About everyone on the IASB believes that conceptually stock options are compensation. The key issue then, becomes measurement. There are some thorny issues.

Its intent is to issue an exposure draft by November. I have a lot of faith in the FASB's process, and believe it will be rigorous. No doubt, it will get lots of comments. Then, we'll see what that tells us.

What about the U.S. view -- where many differ with the IASB?

RH: It is controversial; and people feel strongly one way or the other. In the end, we have to see not only what the IASB comes up with and its process, but what the users want. This is all about capital allocation -- its faith in corporate financial information and about a lower cost of capital, about making our capital markets work as best as possible so that our economy can grow and prosper. [As such] it's important that people on either side bear that in mind. Sometimes those on one side of the debate can be influenced because they receive stock options, and there is a potential conflict of interest, even though I know that their views are heartfelt.

Also, this is an issue of corporate governance. My personal view is that we'd be better off if more plans were performance-based or indexed options, so that there is better alignment between the interests of shareholders and most of the employees and management receiving the options.

I believe in pay for performance. Right now, steered by current accounting rules, most companies issue what are called "Fixed Plan Options." They're just time vesting, with no performance criteria. That is not necessarily in the best interest of the system. But, that's another debate, and not an FASB issue.

What are your perspectives about the FASB's role with the user public and the preparers of financial statements?

RH: Since my appointment, I've been invited to attend many meetings and dinners: a group of CFOs and a group of institutional investors, among others. I've said, "What I'd like is to have dinners where there are people from different groups."

One of the key roles that we can play is to bring the parties together and [encourage] people to try to understand the different perspectives and objectives on accounting and the financial reporting system, because there are different perspective, wants, needs and sensitivities.

The way my thought process goes: First, you've got to understand what people want. Then, you've got to see whether it makes sense, both in terms of the underlying economic and business reality and vis-a-vis our conceptual framework. Next, you've got to ask, "Can it actually be done, and how much would it cost?"

Looking at the FASB structurally, what might you like to change?

RH: Some important changes have recently been put in place. One is the voting procedure -- it is now four to three [for approvals], versus [the former requirement] five to two. That, hopefully, will help expedite things.

The other change is that Timothy Lucas, the Director of Research and Technical Activities for many years, just retired, prompting a look at that role. Determining it was too much for one person, a decision was made to try a "tripartite" structure. This involves one person at the top of the major projects; a second person to lead the EITF (Emerging Issues Task Force) and other implementation activities; and a third person to deal with the internal processes.

I wasn't part of formulating that, but it makes sense. I think it will provide not only more time for people, but it will provide more focus. I have always found that success comes to those who focus.

Your emphasis on "focus" sounds like a good recipe for getting the job done.

RH: I try to live my professional life that way. And [on getting the job done], while there are good people at the board, I would love to get more people -- some from industry, from your readership group -- to work with us for a year or two, to mesh the skills and knowledge they've gained in the business world with what we are doing at the FASB.

Call it an "industry fellowship." Again, we need good people, with up-to-date relevant knowledge and skills. I think that the FASB is such an important organization -- not only in terms of accounting standard setting, but also in terms of the financial reporting system, and more broadly, in terms of the capital markets, that, like, "Uncle Sam needs you," well, here, it's, "Uncle Bob and the Board needs you!"

Realistically, in your five years you won't get everything you want done. So, what's one thing you absolutely have to get done?

RH: The biggest measure of success would be that, in five years, people -- our constituents, the SEC. Congress, the markets -- would think accounting standard setting in this country is in good shape.

On a personal level, I think a measure of success would be that people say, "We really want Bob to serve another term."

Read the complete interview online: www.fei.org/magazine/exclusives.

RELATED ARTICLE: Robert H. Herz's Four Goals (not in order)

1. Focus on FASB agenda

2. Improve processes

3. Ensure staff pride and passion

4. International convergence