Imaginary Fiscal Distress Syndrome or “How Pollyanna looks at Orchestra Management”

Like Disney's Pollyanna, the Chicken Little Think Tank can only see Orchestra Management as doing good!
Like Disney's Pollyanna, the Chicken Little Think Tank can only see Orchestra Management as doing good!

Like Disney’s Pollyanna, the Chicken Little Think Tank can only see Orchestra Management as telling the complete and absolute truth about their organization’s finances!

Some months ago I read Karen Berman, Joe Knight, and John Case’s, Financial Intelligence for Entrepreneurs: What You Really Need to Know About the Numbers, which is a wonderfully concise intro to finance basics that any entrepreneur should know.  The book also gives some insider advice and tips on the art of finance (yes, that’s the art of finance–not the science of finance).  Anyone who has run his or her own business has probably already gleaned some of this insight–especially those have done their own accounting.

Even if you do have an accountant, this book is particularly useful for you to understand the types of assumptions and guesswork that your accountant might be doing by necessity.  In light of the investigation of the Minnesota Orchestra (see also Robert Levine’s piece, Cooking the books, and a series of pieces posted at Song of the Lark) as well as many folks who just make the assumption that the numbers in the books are an accurate reflection of the financial reality of an organization, it might be good to quell the myths or at least give a more realistic image of what is for all intents and purposes a highly developed art form.

Understanding the Art of Finance

In the first chapter of the book on page 6 (under the heading of “Understanding the Art of Finance”) we have this opening paragraph:

A second aspect of financial intelligence is understanding what might be called the art of finance.  In the preface we referred to it as the finance profession’s little secret, but it isn’t really a secret; it’s a widely acknowledged truth that everyone who has studied finance knows.  Trouble is, the rest of us tend to forget it.  We think that if a number shows up on a financial statement or on your accountants’ reports, it must accurately represent reality.

the implication of that last statement being that the number on a financial statement or on an accountants’ report just might not accurately represent reality.  The authors continue with:

Of course, that can’t always be true, if only because bookkeepers and accountants can’t know everything.  They can’t know exactly what everyone in the company does everyday, so they don’t know exactly how to allocate costs.

After giving a couple of concrete examples to illustrate that last statement, they continue:

The art of accounting and finance is the art of using limited data to come as close as possible to an accurate description of how well a company is performing.  Accounting and finance are not reality; they are a reflection of reality, and the accuracy of that reflection depends on the ability of bookkeepers, accountants, and finance professionals to make reasonable assumptions and to calculate reasonable estimates.

What does that mean, anyway?  Bias.  And here bias is simply used in its neutral connotation.  As the authors state:

The result of these assumptions and estimates is, typically, a bias in the numbers…Where financial results are concerned, bias means only that the numbers might be skewed in one direction or another.  It means only that bookkeepers, accountants, and finance professionals have used certain assumptions and estimates rather than others when they put their reports together.  Enabling you to understand this bias, to correct for it where necessary, and even to use it to your company’s advantage is one objective of this book.

The emphasis is mine.

Using bias in numbers to your company’s advantage

Financial Intelligence for Entrepreneurs gives a wonderfully concise overview of finance, and one of the ways it does this is by showing how some publicly traded companies have “Cooked the books” even well beyond what would be considered legal, if not ethical.  But I think it’s the ethical side that Levine is looking at in the piece above, and despite some who feel as if management of classical music institutions always report the financial situation of their organizations accurately, there are others who feel otherwise.

Baumol (yes, the Baumol of the Baumol Cost Disease) and Bowen in the introduction (page 3) to their seminal work on Cultural Economics, Performing Arts, the Economic Dilemma, state in their intro describing the crises that are “apparently a way of life” for Performing Arts organizations that:

Doubtless, some alleged crises represent a tactical stance — cries of woe intended to help in raising funds or in negotiation with unions.

or, in other words, what Drew McManus calls the Imaginary Fiscal Distress Syndrome is simply a normal tactic used in business and seems to be the case with the Minnesota Organization.  Sure, regular independent audits might help to curtail the usage of the tactic, but as the Philadelphia Orchestra has shown, you can always just file for bankruptcy to get out of financial commitments.

The question here though is how easy is it to Cook the books legally to show your organization’s financial situation is precarious thus necessitating a rally call for fundraising or as a call for cuts from the unions?  Well, it’s not particularly difficult–and you don’t even have to Cook the books if you just want to hide behind the rhetoric of refusing an independent audit for the sake of protecting the anonymity of your endowment donors.

And as Drew McManus pointed out in a piece by Woods Bowman in the Nonprofit Quarterly, Nonprofits seem to have shifted from performance or artistic excellence driven missions to “strategic commitments (and even some formal mission statements)” that “have moved more toward including language highlighting fiscal responsibility.”  Bowman opens his piece with even uglier behavior which has made some headlines recently:

An article earlier this year and many newswires published by the Nonprofit Quarterly have reported stakeholder rebellions in response to nonprofits ignoring their responsibility to stakeholders. Does Susan G. Komen for the Cure sound familiar? These responsibilities extend well beyond checks and balances in the financial system or misreporting performance statistics—they extend to governance. Do nonprofits listen to stakeholders? Are they in the habit of taking money from them—and in their name—and then ignoring them until they shout?

I don’t think the question is “does this happen?” but rather, “how often does this happen?” and “what are the conditions under which this happens?”

Of course, the biggest irony is that for all the complaints by the Chicken Little Think Tank against those who see no problems with the Classical Music Industry they sure do have a Pollyannistic picture of management and caretakers of the organizations that are purportedly in crisis! This is not to say that there aren’t managers and/or boards that don’t overemphasize financial crises–but as I’ve mentioned in my piece about biases such mundane claims just don’t make good copy and neither do they do much to help raise funds or cut salaries.

Couple that with the art of finance and you have all the flexibility you need to make a claim that, at best, isn’t exactly a lie and, at worst, is at least legal.  It’s in the gray area between where we find what’s ethical.

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15 thoughts on “Imaginary Fiscal Distress Syndrome or “How Pollyanna looks at Orchestra Management”

  1. Quickie comments before I finally get the hell out of my apartment and go get some form of lunch before I eat my own elbows:

    1) The book-cooking to show that they’re losing money is a standard thing in moviemaking. Even enormously successfully blockbusters often cook their books in such a way as to show that they lost money to avoid paying all the tax they should. It’s not so outlandish a suggestion as to speculate that mmmmaaaaaaybe another entertainment realm is doing the same thing.

    2) Studying the books also only tells you the results of decisions made, but not WHY they were made. An organization’s financial records are like the airliner’s black box. They record the results of the pilot’s decisions, but not WHY the pilot made them. They will tell you that the landing gears weren’t in their proper down position, but NOT that the pilot forgot to put them down because he was drunk at the time … which is the real cause of the accident. Books are like dropping a flashlight into a toilet; they tell you where you’ve been but not why you got there.

  2. BTW, regarding the first comment, I’m not saying that they’re cooking their books to avoid taxes. Tax rules for non-profits and for-profits are not the same. But at least in both cases, there are pressing reasons for the organizations to manipulate the numbers and make it seem that they are worse shape than they actually are.

    • I talked a little bit about how Hollywood “Cooks the Books” in a previous post

      4. Studios have reduced production costs by paying stars only a fraction of their official “quote” or asking fee. In exchange for having them sign a “side letter” in which they agree to the cut, studios allow them to claim they got their full fee in the contract. For example, a big name star may have a quote of $10 million, which is inserted in the contract, but he or she will be paid only $2 million. The $8 million vanished through a side letter which the star simultaneously signed relinquishing part of the sum in the contract. Since side letters are kept secret by studios, the star can pretend to receive far more than he does. Stars accept these drastic cuts because they (and their agents and business managers) would rather make a fraction of their quote than no money at all, as long as the world does not find out. For studios, these side letters substantially decrease the cost of making movies.

      There are so many ways to cut costs I think most of us just can’t even imagine the possibilities.

      The Block Box analogy is nice–and I think pretty much what I’m getting at here though there are even more legal ways to easily cook books. For example, if an orchestra were to purchase a concert hall (very few do this, but that’s besides the point), how would that asset be recorded? If you record the total purchase price in the year of purchase your records will show a huge deficit in that year of purchase. Or the orchestra could depreciate it over however many years it wants or needs to. Depreciation and amortization can profoundly affect annual reports in future years while at the same time the actual cash flow was only profoundly affected in the year of purchase. And how something like that gets depreciated depends on how the accountant or financial officer decides it needs to depreciate.

      So yeah, the reasons behind pilot’s decisions (how an organization depreciates a tangible asset or amortizes an intangible asset) has nothing to do with the actual record of the pilot’s decision (the actual immediate purchase of the concert hall or intangible asset). The difference here is that the depreciation or amortization can be adjusted in subsequent years if needed!

      • Haha–yeah, well, that example still wasn’t quite what you were getting at, i think–I’d really be interested in specific book-cooking in for profit entertainment industries. Heck–revenue sharing in Sports is an interesting exercise in actual asset redistribution which leads to an inaccurate picture of how a sports team is actually doing (except that we do know that revenue sharing happens and pretty much how the redistribution happens).

      • Full disclosure: I’ve been working in finance and accounting for over 10 years. The last 6 have been in the nonprofit world, and the bulk of the 6 years were at a major symphony orchestra, where we didn’t claim the sky was falling, but we definitely were trying to be careful about financial stability while developing the mission in new ways.

        Now to my comment. Your real estate example is extreme to the point of being useless. First, there are separate cash flow and operating statements (P&L) and balance sheets. You have to look at all of these AND the footnotes in the financial statements, to understand what’s going on. Nothing is being hidden or cooked when an asset is depreciated. Second, if an organization were to try NOT to depreciate the purchase of a new facility, they’d have a very interesting conversation with their financial auditors (and any nonprofit big enough to purchase any real estate has to get an annual financial audit).

        Yes, there is some room for judgment, but there has to be a good reason to do anything other than follow standard GAAP (generally accepted accounting principles). External financial auditors exist to make sure if anything unusual is done, this is disclosed. I admit that external financial auditors are not “independent” in the categorical, absolute sense. After all, they are paid by their clients, who they are auditing. But any auditors worth anything whatsoever don’t let organizations just treat accounting like the wild-west.

      • Thanks for the insight, Aaron! I think it’s important for folks to realize that in the end, the balance sheets, operating statements, and any cash flow reports all ideally match up in the end. But I think most stakeholders (mainly, I’m thinking the public or audience–if, indeed, we can consider the audience to be stakeholders) might not understand that. When all they see (from the outside) are the news reports or press releases from Orchestra Associations or Musicians Associations–and without some understanding of basic accounting principles (or basic financial intelligence, as the authors of the book I quoted from call it) just hearing that an orchestra is in the red or black doesn’t really give them much to understand the complete picture.

        Sure, that wasn’t a particularly good example, but I thought it was something that could be more easily grasped since a facility like a concert hall is such a prominent symbol of (at least) Orchestras. And i think most folks don’t realize that, in theory, how a facility is depreciated is a relatively flexible affair (unless there is some industry standard for that depreciation of facilities–I’m not an insider so don’t know)–which, obviously, the footnotes should explain if I’m not mistaken?

        I think the main point I was trying to make with the example is that the initial purchase of the facility would only seriously affect cash flow in the year of purchase, while the amount that is included in subsequent annual reports as depreciation has much less to do with the annual cash flow since the purchase amount was a one time deal–and in the end, it’s all this complicated sticky business that finance and accounting professionals like yourself get paid to do.

        A question I would have, regarding auditing–are there really any (in that categorical, absolute sense) financial auditors that could be considered “independent?”

        Again, thanks so much for your time and comments. I know I appreciate your explanations and clarifications!

      • Jon, we’ve reached the limit of reply nesting, this is in reply to your comment on this comment…

        I don’t know if any auditors could be absolutely independent. Official government officials like Inspectors General and Attorneys General, who often investigate organizations, frequently have political agendas. Even if, for example, the State of Minnesota were to engage third-party auditors to go over the MOA’s financials, it would be hard to be 100% certain those auditors didn’t have an agenda, because we can’t really see how much the investigating officials hiring the auditors would pressure them behind closed doors. Though, that would be about as reliable as you could get.

        I suppose that if the state were to hire auditors, and those auditors wrote a “clean” opinion that the financials are materially correct, just like the organization’s auditors, you could be very confident that the accounting was done according to GAAP. But you’re right to say that doesn’t mean that the public at large understands the financials at all. It’s been clear to me that sometimes even musicians’ members committees, who are full of very sharp people who work very hard to track it all, have uneven understanding. And sometimes even if they are very informed, they don’t always pass that information onto membership at large. You can imagine that the public, which has less incentive than staff and musicians to understand an orchestra’s financials, aren’t going to be putting in the time.

        Also, a clean financial audit from a CPA firm just means that the books were kept properly. It doesn’t mean that financial decisions were good and in the best interests of all involved…

      • I should add one clarification. It is most likely that the MOA’s financial audits are reliable. I haven’t looked at them at all, and we know that accounting firm shenanigans have happened in the past (see Enron & Arthur Andersen–no relation to yours truly). But to be blunt, even the largest symphony orchestras don’t offer enough revenue for their auditors to risk their reputation by not doing their job properly. I see that the MOA uses CliftonLarsonAllen, which is a national firm that claims to have over $550M in revenue each year. It is difficult for me to imagine a situation where they would let slip a material financial misstatement.

      • Thanks Aaron,

        Yeah, I limited the comment nesting when I switched to this template as you can imagine after this level most of the text would show up in an almost vertical format.

        Ok, so there is no real ideal absolutely independent auditor or evaluation process though there’s the possibility of getting closer to a relatively unbiased report financials. This sounds very similar to what we’re starting to see in the scientific field (in particular the medical and clinical research segments) in that we have formal and neutral principles for organizing information (GAAP and the Scientific Method) but the reality of actual reporting results can be a messier ordeal simply because of various human biases. Whether it’s some political agenda, or behind doors pressure for the former, or publication bias, sample bias for the latter. Just the simple fact of the matter that we’re dealing with measuring human behavior and are limited by the information we’re presented. We’re doing the best we can with what we have.

        Then we’re stuck with how both fields are reported to the public or stakeholders. News media can never get into the meat of the analyses form unrealistic images of how the industries work. I know when my family had to deal with an end of life situation we were just not as informed as Doctors are in likely outcomes and might have made different choices if we were which would have made a significant difference in the costs. The media tends to focus on the “outstanding” (and thus newsworthy) examples–it makes better copy–and those get ingrained in public consciousness more than the day to day operations. Orchestras failing, or the patient who “wakes up” after being in a com for several years are just more memorable events than the more more frequent Orchestras with balanced budgets or coma patients who remain in comas.

        I was wondering about musicians–especially those who do serve on boards–and whether their general level of financial intelligence is sufficient to understand the complexities and whether they did, or could, report to their membership an accurate picture of finances. I know it’s difficult to stay level headed when your livelihood is threatened.

        Thanks again for all your comments, Aaron! You should really blog more about these kinds of issues–I think it would be such a helpful corrective to the news bites (or spin) most of us normally hear about the industry!

  3. If Minnesota manipulated the finances in the way that is being described (is “alleged” too strong a word at this point?), it’s not really a case of cooking the books. It’s a case of taking a larger amount of actual cash out of the endowment than usual when they didn’t want to publicly acknowledge a deficit, and then reversing this policy (which can’t work forever) when they did want a deficit. Indeed, taking too much earlier to “support bonding aspirations” may have made the financial difficulties they now present a real thing.

    The decisions everybody is worried about are not whether the MSO’s Controller inflated the pension liability, or over-accrued expenses, or booked operating contributions to the property fund absent clear documentation, which is the kind of thing your art of finance chapter is talking about. Everything you wrote about biases and estimates is completely true. And accountants that care about excellence in their chosen profession, and who care about looking their auditors directly in the eye, work hard to fully explain their estimates and the reasons for them. Good accountants place a high value on transparency (at least, transparent to others who speak the language of finance and accounting). Not all accountants are good, and even good ones will have difficulty sometimes when they disagree with the picture that the executive leadership wants to paint.

    My point is that the issues at MSO are not about how the books are kept, at least that’s not what’s being publicly discussed. The issue is whether they inappropriately raided the endowment to balance the budget for a few years when they wanted to look financially strong, and then suddenly reversed their approach and became very conservative when they wanted to look financially weak.

    • Your last sentence nails it. All of a sudden, after claiming to be financially stable (including testifying to that fact at the MN State Legislature to obtain $14 million in taxpayer funding), it was “fiscal cliff” time — “the endowment is shrinking! the endowment is shrinking!” — and time to cut musicians’ salaries 30-50%. But the public is on to them, because they had just raised and spent $50 million for a new lobby at Orchestra Hall. If the endowment will be gone within five years, well, that gives them five years to raise the needed funds, correct? They just successfully raised $100 million for other purposes. How dire can it really be? Anyway, we are waiting patiently (with popcorn at the ready) for the Legislative hearings to begin on January 23rd. Hopefully, a few answers will be forthcoming.

    • Thanks for your comment, Aaron–I only mentioned the Minnesota example as it’s the most recent example of what McManus calls the “Imaginary Fiscal Distress Syndrome”–obviously why the MOA is now showing a deficit during negotiations as opposed to in what they were showing when they needed funding for the Hall lies behind one of many reasons organizations would feel the need to create the financial picture it needed for whatever purposes. In the end, why the books were balanced at one point but not at another depends on plenty of factors (such as the example of depreciation and amortization I mentioned in response to fireandair above) including how the data is reported as well as how assets and liabilities are shifted around when it is strategically desirable to do so (as it seems to be the case with the MOA).

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