QUERETARO, Mexico, Feb. 9 (UPI) -- One (big) company fails. "Oh dear. Never mind. Doesn't matter," as the unsympathetic sergeant major used to say in a British television comedy. Company failure is part of capitalism. Propping up companies would be more dangerous. And yet Enron's failure is troubling in many different respects.
In the first place there is the question of criminality, in Enron, Andersen, and elsewhere. Are the shredders now whirring in numerous companies across the United States? How illegal is big business?
What Enron brings us back to is what a British prime minister, Ted Heath, in 1973, called once the "unpleasant and unacceptable face of capitalism."
Heath was referring to an individual, to Tiny Roland, the head of Lonrho, a mining and food corporation that Roland had built up into a major corporation -- not least in Africa where he won the friendship of the new post-colonial leaders by bribing them. But the phrase upon which Heath lighted has come to be used for abuses of a system that is often abused.
Heath's condemnation of Roland had followed an unsuccessful attempt by eight directors of Lonrho to remove him. In Enron, it appears there had been no attempt by directors within the company to curb its activities. They went along with them or, incredibly, were unaware of them. It is only now that Kenneth Lay, the former Chairman and Chief Executive, is under fire--after the ship has sunk. How much is being hidden in corporate boardrooms across the United States?
But there is another side to the problem, not criminal, but also troubling: complexity.
Enron's stock thrived in the 1990s while the company took growing risks, most of which were legal. Financial transactions have become more and more technical and sophisticated. Derivatives are complex. Managers sometimes do not understand the risks their own traders are running on the trading floor.
Few government regulations intervene. Enron entered the market for credit derivatives; and now Standard & Poor's, the ratings agency, judges that about $3 billion dollars of those derivatives have no backing. The firm did not know what it was doing.
But complexity can also be a screen deliberately erected. Move money offshore; create affiliates; fool the government's tax inspectors. There are too many loopholes, too many ways of playing the financial game.
Lobbying of government to permit the existence of those loopholes may be another part of the problem. The campaign donation provides an opening from which a corporation and its executives may prosper. But the best game has straightforward rules.
Corporate America is always calling for a level playing field. Let it clean itself up. Simplify, clarify, end the twists and turns that are intended to leave the tax man confused and behind.
But the willingness to clean up is challenged by two things: the thirst for success; and sheer greed.
The pressure on firms' executives is enormous. Wall Street scrutinizes them constantly. A weak quarter may cause the share price to be punished; and perhaps within the firm, heads will roll.
Hardly surprising then that the firm always wants to present its best face. A little makeup here and there, a little accountant's foundation and some rouge, may make everything look more attractive, even if the beauty is false.
Yet the accounting problem goes beyond that. Some accounting practices that have become prevalent in the United Stares are dubious in the extreme. Chief among them is payment by stock option. In theory payments from stock options are a bonus that is merited by good performance. A company's executives work hard. The company fares well. Its share price rises. The stock options soar. The executives are rewarded.
But there are problems. The cost of stock options is not properly accounted for as a salary cost. And the stock option reward system only works correctly if the share price is itself an honest reflection of the company's performance. It may not be. It can be manipulated.
For another practice that has become prevalent in the United States are equity buy-backs, in which firms buy back their own stock "in order to enhance shareholder value." Fine. But, of course, if the executives are themselves share and stock option holders, the incentive for them to buy back the shares is very high. They are the immediate monetary beneficiaries of the corporate decision. And their judgment on the wisdom or otherwise of effecting a stock buy-back may of course be influenced by their proprietary position. Perhaps the buy-back is not in the firm's long-term interest but is to the immense short-term advantage of the executives.
Compensation brings us to another part of this problem. Now the pensions of Enron's staff are unfunded. For many this will mean hardship late in life. But Enron's executives made huge sums in the 1990s. Between 1991 and 2000, as he piloted Enron towards collapse, Kenneth Lay was paid $37 million in salary and bonuses, almost $4mn per year: not bad.
But that compensation was more than doubled by his stock options. Here it is more difficult to know his annual return, but in the three years from 1999 to 2001 he sold Enron shares worth $82 million.
And that raises another question: why was he selling the shares? He had the most inside of inside information. He presumably knew something other investors did not know: that he was running the company into the ground. As The Street.com has reported, while Lay was selling shares, he was telling the market that Enron stock was probably under-valued. Why, then, did he not hold on to the shares himself?
The stock buy-back phenomenon has another angle that makes it still worse. Many firms have bought back stock in recent years and have issued bonds. In other words, increased debt has replaced equity and provided stock option bonanzas for executives. Is this a practice in firms' interests, or in the long-term interests of their shareholders?
Did Lay deserve to be paid so generously? Apparently not, given the results of his tenure. So why was he paid so much? And will he give the money back?
The compensation of senior executives is usually a generous statement of appreciation of themselves by themselves. The rewards at the top in U.S. corporate life are absurd and greedy. We could find thousands of examples. Take one, from another troubled company. Dennis Kozlowski, the Chairman, CEO and President of troubled Tyco, earned $40.5 million in the 2000 fiscal year. Should not shareholders be asking why? It is, after all, their money that he is taking.
Investors need to put more pressure on the little emperors of individual companies who are paying themselves fortunes whether the company fares well or not.
Enron's collapse can be seen as another marker of the end of the 1990s' boom. Let us call them the naughty '90s. While the U.S. economy boomed and the U.S. stock market soared -- inflated perhaps by self-interested calls by Wall Street analysts --many companies thrived even when their business and their accounting left much to be desired. Now that the boom has ended and the economy is weak, more Enrons are going to come to light. The U.S. stockmarket has been right to be nervous in recent weeks.
In Enron abuse of capitalism was rife at a time that proved ideal for abuse of the system. Its executives shared in a bonanza that rained money upon the top half of the U.S. population that owns shares but most especially holders of stock options, while those in the bottom half of the population fed on the crumbs from the semi-corrupt boardroom table, doing better largely because there were more jobs. Yet at Enron and elsewhere it is the broad mass of the population that will suffer in the bust. Those at the top have already made their fortunes.
Yet Enron's egregious failure may do more harm outside the United States than within it. In many parts of the developing world resistance to capitalist development is still strong. Keep energy in the state sector, they may argue in Mexico or India, rather than let the greedy and corrupt capitalist pirates in. And yet in both countries capital and capitalism are needed to fund development and provide the investment that is needed.
Capitalism, with all its abuses, is the most successful economic system we know. The abusers damage, too, those who have not benefited from capitalist development by strengthening the anti-globalization protesters in the developed world and, in developing countries, those who try to preserve state ownership -- often because that, too, is a system which offers illicit opportunities for enrichment at the highest level.
Enron's failure does matter. It has sounded a loud and ominous warning. Keeping big business clean will always be difficult. It is always essential to try.
(Global View is a weekly column appearing on Fridays in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected].)
