Conclusion

Enron’s Legacy: An Opening for Change

CONSIDER THE CHAPTERS you have just completed a time capsule. The closing words of chapter 12 were the closing words of the hardback edition of this book, which was published in November 2001. That was just before the troubles at Enron blew in, the first gusts in what would become corporate ethics’ perfect storm, with turbulence patterns converging from Arthur Andersen, WorldCom, Global Crossing, Tyco, Dynegy, Adelphia, and the rest. The timing was uncanny, for with astonishing speed, what had arisen was the kind of historical moment foreseen in chapter 12. Change, I wrote there, “unfolds into reality through historical moments—through times when the public consciousness cracks open and new ideas can rush in.”

“What will create the opening, we cannot know,” I continued. “But that an opening will come seems probable.” The reason, I wrote in chapter 4, is that when “the system design is unsustainable, crisis becomes likely.” It is crisis that cracks open the collective consciousness, leading the public to demand reforms it might have resisted before. In the system crisis of the Great Depression, for example, President Franklin Roosevelt was able to enact a host of powerful New Deal laws in just one hundred days. “This kind of opening for change,” I wrote, “may come again.”

And so it has. The opening is crater-sized, ripped into the fabric of the public psyche by the multiple crises of fraudulent accounting, document shredding, insider enrichment, tax avoidance, and more. It is as though tectonic plates beneath the economic landscape have shifted, and the upwelling of change is unlike anything observed in decades. The year 2002 saw campaign finance reform, new criminal penalties for CEOs filing false financial statements, a new accounting supervisory board, new stock exchange rules about board independence, and a substantially increased budget for the SEC. In the wake of a felony conviction, the accounting firm Arthur Andersen disintegrated virtually overnight. To avoid similar troubles, other accounting firms spun off their consulting divisions. Energy firms, faced with charges of fraudulent trades, went under or closed their trading divisions. With stock options seen as a key culprit, many companies began expensing them without waiting for a legislative mandate. Countless businesses restated financials as the wave of fear swept through the business community.

This fever-pitch uproar of change has subsided, but public receptivity to change will remain; it may even grow. A rent of this magnitude in the public trust is not easily repaired. For some time to come, we will continue to face an extraordinary atmosphere for reform—the kind of opportunity that may come only once in a lifetime.

Yet despite the tumult of activity, a program for real economic reform—fundamental reform that gets to the heart of the problem—is nowhere to be found. Progressives have been caught flat-footed, with no coherent, coordinated plan. The public consciousness has indeed cracked open, but truly new ideas have yet to rush in. Instead, the cracks are being stuffed with old ideas—most particularly, the old idea of wealth protection.

With the exception of campaign finance reform, the changes thus far have been much ado about a single thing, which is shareholder protection. When the SEC budget was increased and accounting supervision improved, it was to protect shareholder interests. When stock exchanges set out to make boards independent, it was for shareholder protection. When CEOs were made more accountable or Arthur Andersen was indicted, it was to safeguard shareholder interests. Shareholder wealth is still the sun around which the economy is believed to revolve. The divine right of capital remains intact.

ROOT CAUSE OF THE CRISIS: FOCUS ON SHARE PRICE

What’s extraordinary about this is that it was slavish devotion to share price that created the crisis in the first place. As progressives plan how best to use this ripe moment, this point is vital to grasp. The outcry today is for better alignment between CEO and shareholder interests, but that too-close alignment was itself the problem. By pushing too hard on one element of the system—share price—executives destabilized the entire system. It’s like driving the family car solely for maximum speed and shaking it apart in the process, or like taking steroids to pump up muscle mass and destroying the body. A one-dimensional company is not healthy, any more than is a one-dimensional life.

Or a one-dimensional economy. For years, the unexamined belief has been that the health of the stock market is one with the health of the economy. But Enron and Co. give us a chance to see how a stock market on steroids is damaging to the economy, because it leads inexorably to a fantasy world where fraud comes to seem logical. We’re riveted today on the crimes committed by a few. But we must understand how these crimes arose from the system dynamics—and how those dynamics were fueled by our own irresponsible fantasies of wealth.

In the 1990s, many of us came to believe that the stock market could forever climb 15 percent a year. But in a world where GDP grows about 3 percent a year, this is a dangerous illusion. One sector of the economy cannot grow that much faster than the whole, unless (1) it systematically takes from other sectors of the economy (holding down wages, evading taxes), or (2) it creates funny money, relying on an unsustainable artificial inflation in value (such as fraudulent accounting or bubbles that will pop and drag down the real economy).

We saw in chapters 2 and 6 how the first option was played out in recent years, with wages flat, benefits declining, layoffs soaring, and the corporate tax burden dropping—as the stock market climbed. That was phase one of the bull-market fantasy. Phase two—creating funny money—was played out initially through soaring price-earnings ratios, in which the same earnings streams were imagined by investors to suddenly be worth far more than before. “Irrational exuberance,” Alan Greenspan called it. When these tricks were exhausted and yet Wall Street’s appetite remained insatiable, companies turned to one final way of keeping the fantasy going: accounting sleight-of-hand. Thus was Enron born.

We miss the point if we see Enron, WorldCom, and the other scandals as merely the handiwork of a few bad-apple CEOs. We should ask ourselves this: if Kenneth Lay, Bernard Ebbers, and the rest had never been born, and others were in their places, would the crisis have been averted? Do we really believe there was some kind of aberrant crop of bad-seed CEOs, bred together in some secret nursery, where the ethical gene was left out? It’s more likely that the nursery was the atmosphere of the 1990s stock market, where outrageous gains were seen as a birthright, and where CEOs were forced to whip their companies into a frenzy to attain them.

Individual culpability cannot be denied. But the fact that so many committed such similar frauds is evidence of systemwide pressures at work. As we saw in chapter 4, these pressures can be traced back to the boardroom coups of the 1980s and early 1990s. Large shareholders reasserted their power over corporations and began using new tools for enforcing CEO focus on shareholder gain. They punished CEOs with the stick of hostile takeovers and firings, and they rewarded them with the carrot of stock options.

There is outrage today about these options packages and how executives used them to cash in and bail out, leaving stockholders holding the bag. But this is a little like dog owners training their dogs to attack, then complaining when they get bitten. CEOs were selected and rewarded for their ruthlessness. That ruthlessness was accepted, even celebrated, as long as shareholders were the ones who benefited—from the bites taken out of employees, through low wages or benefits reductions, or the bites taken out of communities, through tax evasion and corporate welfare. But when the bite was turned on shareholders, suddenly there was a crisis. Heaven and earth had to be moved to call the scoundrels to account.

What was exposed was not only the villainy of a few CEOs, but the narrowness of the financial world’s sense of ethics. Breaches of loyalty were of little concern when it meant laying off devoted employees after twenty years of service, or closing plants and letting company hometowns fall to ruin. That was hard-nosed business. But breaching loyalty to shareholders—that was a crime. Again we see the divine right of capital at work, insisting that wealth holders deserve protections that others must be denied.

That is not to say that taking advantage of shareholders is excusable; it is not. The punishments executives are receiving are necessary, serving as a reminder that in a democracy, even the most powerful of the financial elite are not above the law. To hold individuals accountable is vital to the rule of law. But to understand the causes and conditions that gave rise to their behavior is to begin the process of repairing the system.

MANIA AT WORK: UNDERSTANDING ENRON

What we must acknowledge is our own complicity in the debacle. Some unconscious sense of this may be why the scandals have so riveted the nation, because it is our own fantasies that have been exposed as unreal. Since this is uncomfortable to accept, we would prefer that the dream world be propped up again. Fortune magazine thus spoke for the zeitgeist when it declared in gigantic letters on its July 1, 2002, cover, “System Failure,” and then beneath that, “Seven Ways to Restore Investor Confidence.”¹ The implication was, of course, that what matters is getting the stock market climbing again.

The definition of mania is detachment from reality, “something close to mass hysteria,” wrote Charles Kindleberger in Manias, Panics, and Crashes.² Irrational obsession is one of its hallmarks. As Kindleberger wrote, “When a man’s vision is fixed on one thing … he might as well be blind.”³

Rather than keeping our vision fixed on the stock market, hoping for the exhausted beast to roar to life again, we might do well to see how thoroughly wealth mania has blinded us, and how widespread and deep was its reach. Enron is the case in point.

Manic wealth fantasies were clearly in evidence when Enron was at its peak, with its stock price climbing at absurd rates—40 percent in 1998, 60 percent the next year, and 90 percent the following year.⁴ Yet during this rise, no one seemed to think anything funny was going on. No one said, “This can’t be real.” What investors said was, “I want a piece of that.”

Mania was again in evidence when Enron was putting together its LJM2 partnership, one of many off-balance-sheet partnerships that allowed it to hide debt and ultimately helped bring the company down. As Enron executive Andrew Fastow was pitching this deal, he dangled before institutional investors the prospect of doubling their money in a matter of months—and they bought it.⁵ When even sophisticated investors swallow promises that only a Ponzi scheme could deliver, mania is far advanced.

What’s most telling about Enron, however, is how utterly non-unique the company’s mindset was. It was most certainly an unbalanced, one-dimensional company, declaring openly in its 2000 annual report that it was “laser-focused on earnings per share,” which is the basis of share price. But virtually all public companies adopted this focus in the 1990s, for it’s what Wall Street demanded. When firms fell short of earnings projections by just pennies, their stock prices were severely punished. Earnings management was the logical response to this pressure, and hence was widely practiced. General Electric—known for its uncannily smooth earnings growth, created through accounting gimmickry—was the most admired corporation in America.

If earnings management was not unique to Enron, neither were its questionable special-purpose entities. After bankers at Citigroup and Credit Suisse First Boston helped Enron create its complex partnerships, they took the idea on the road and sold it to other companies that wanted to improve their financial statements.⁶ Chief financial officers won awards for devising clever ways to remove debt from balance sheets. WorldCom CFO Scott Sullivan—since indicted for orchestrating the company’s $7.2 billion fraud—was celebrated as one of the finest CFOs on Wall Street.⁷

The actions of what today are called villainous firms were a direct result of systemic pressures. What happened was not the work of a few errant bad guys. It was the inevitable outcome of the stock market’s insatiable, unceasing, unreasonable appetite for increasing share prices—in other words, wealth’s desire for more wealth.

THE LEGACY OF DEREGULATION

If systemic pressure for shareholder gain was the root cause, it was aided and abetted by the lack of systemic safeguards, which was the legacy of deregulation. The absence or destruction of laws was what enabled the powerful to make rules to suit themselves—which is, of course, the hidden agenda of laissez-faire theory. In proclaiming that markets (that is, businesses) can regulate themselves, free market or laissez-faire theory permits companies to claim governance rights like those claimed by feudal barons, who—as we saw in chapter 6—asserted a sovereignty independent of the Crown. This is the divine right of capital in governance garb, for it is wealth asserting an exclusive right to govern.

Enron is again the poster child. Seeking to control the regulatory environment in which it operated, Enron made contributions to more than half the members of Congress. CEO Kenneth Lay took regulatory capture to new heights, supplying the White House with his personal list of preferred appointments to the Federal Energy Regulatory Commission, which supposedly oversaw his firm. To win pipeline, power, and water privatization contracts overseas, Enron allegedly bribed foreign officials, in moves that were later investigated by federal prosecutors. As a result of all this, Enron was able to operate aggressively in a lightly regulated environment. It created its own regulatory black hole, inside of which it ultimately burned up.

This lesson is a powerful one, for what it broadcasts to the world at large is the bankruptcy of the laissez-faire model. Since the days of Ronald Reagan, we have been endlessly told that deregulation is always best, that government is inept at intervening in the economy and should keep out. But after Enron, no longer can the barons of big business thumb their noses at democratically made rules. No longer can companies hide behind the laissez-faire-y tale that markets can self-regulate, guided by a magical, invisible hand. In the public imagination, the invisible hand has been replaced by the thieving hand of CEOs like Kenneth Lay.

If free market orthodoxy was once considered the divine law of economics, post-Enron it has been disowned (at least rhetorically) even by George W. Bush. In a mid-2002 speech on Wall Street, he declared that “self-regulation is important, but it’s not enough.” He went on to deliver a “tongue-lashing of big business” that the The New York Times said marked a pendulum swing away from “a quarter-century of bipartisan deference to capitalists.”⁸

The tide of public opinion has turned in favor of regulation, as was revealed by a recent Wall Street Journal–NBC poll. Respondents were asked whether they thought most government regulations were necessary or whether most were “unnecessary and harm the economy.” When this query was made in 1995, as Newt Gingrich was vaulting into the Speakership of the House of Representatives, 47 percent found regulations unnecessary. But in July 2002 that number had plummeted to 30 percent.⁹

STRUCTURAL REFORM FOR A NEW ERA

From many sides today we can read the signs of an age drawing to a close. What has run its course is the conservative ascendancy, which succeeded in fully achieving what it sought: the rebirth of laissez-faire theory, a deregulated business environment, a laser-like focus on share price, and a soaring stock market. The very success of this worldview proved to be its undoing. It was fundamentally unsustainable because it was based on fantasies of wealth that were detached from reality—fantasies that echo the ancient, aristocratic pursuit of prosperity for the very few. As long as most of us were deluded into believing we could be part of the “few,” we embraced this pursuit. But when the few turned out to be a handful of CEOs pocketing hundreds of millions while the rest of us were left with little, the moral bankruptcy of the quest stood revealed.

We can’t all get rich from the stock market, nor should we, because equally deluded is our belief that stock gains are bloodless, entail no negative consequences, and represent free money fallen from the sky for those smart enough to be good at picking stocks. The truth is, when a company like Enron pursues shareholder gain with a laser-like focus, someone pays the cost. So that Enron’s share price might climb 40, 60, 90 percent, the company bought our government, dismantled our regulatory infrastructure, destroyed overseas villages to build power plants, evaded taxes, and manipulated California energy prices. The gains came, temporarily, but in the end they destroyed even the company itself. Making fantasy real is a deadly game.

It is a game unworthy of being the central purpose of a democratic economy. It is time we redefined economic success as something more than a rising stock market, for, as The Nation magazine editorialized, “People do not live and work in order to buy stocks.” The purpose of our economy is to “support the material conditions for human existence, not to undermine and destabilize them.”¹⁰ We need a new vision of a healthy economy, rooted not in unsustainable wealth for a few but in enduring prosperity for the many.

Such a shift is so simple yet so radical that it will take time before the whole of a new vision comes into view. But the broadest outline can be sketched.

In the simplest terms, we must change our economic structures to more closely align with our fundamental democratic ideal, that all persons are created equal. As we saw in chapter 7, this means recognizing that the economic rights of employees and the community are as vital as the rights of stockholders. In terms of system dynamics, the existence of such rights would diffuse the laser focus on share price, keeping corporate behavior more in tune with the real economy—and less likely to fly off on destructive flights of fantasy.

Getting there means democratizing corporations in structural ways, focusing not on outcomes but on underlying forces. It means giving parties other than shareholders a chance to have their interests represented and served. This begins with changing corporate purpose, which resides now in the state law of directors’ duties. These laws could be changed state by state or in a single piece of federal corporate chartering legislation. The aim is to shift directors’ duties from their existing duty of loyalty to stockholders alone to a broader loyalty that includes employees and the community—or at the least, a duty not to harm employees or the community. These new rights should be enforced with the right to sue, perhaps buttressed by individual director liability. If directors knew that their personal wealth would be at stake if corporations evaded taxes or laid off tens of thousands, business behavior would change quite quickly. In Minnesota, a model law of this sort—the Code for Corporate Responsibility—has been proposed and is being promoted by a grassroots citizens’ group.¹¹

As purpose shifts, so too must the measurement of success. As we saw in chapter 7, this means creating supplemental financial statements that measure corporate impact on employees, the community, and the environment. Work on such statements by the Global Reporting Initiative is already far advanced, as discussed in chapter 7.

Likewise in need of change are corporate governance structures. As we saw in chapter 10, today only stockholders are represented on boards, which supposedly oversee the chief executives. But since CEOs today pick their own boards—or have cronies on the board pick them—it’s absurd to imagine that those boards are very effective. The favored fix is to increase the number of independent directors, but this is like counting angels on the heads of pins. When directors have no personal knowledge of a company, are selected by insiders, are ratified in uncontested elections, and fly into town once a month to view high-level reports, it is fantasy to imagine that they can control CEOs.

Far better would be to follow Europeans in creating a system of nonmanagerial worker representatives on corporate boards, as suggested by John Logue of the Ohio Employee Ownership Center. Employees are people who know what’s happening in companies, as Sherron Watkins knew what was happening in Enron, as she demonstrated in her famous memo to Ken Lay warning of accounting troubles. If employee board members had the resources to hire financial consultants from company funds, as they do in Europe, worker directors could provide a “significant counterweight to managerial abuse of power,” Logue writes. He emphasizes that here in the United States, employee-owned companies with worker directors have been shown to outperform those without.¹²

For other structural changes, we need a broad principle that corporations must not harm the public good, returning us to the founding ideals of America, when corporations were chartered to serve the public good, as we saw in chapter 9. This might be enforced with a sliding scale of penalties against corporate lawbreakers—from withholding government contracts or levying higher taxes to pulling the corporate license to exist.

Those are a few of the most immediately compelling, most basic structural reforms that would democratize the corporate system. We will need others. We need recognition of a living wage as a fundamental human right, as vital to our economy as property rights. To protect this right, we will need revitalized unions or other ways to empower employees collectively—perhaps starting with an employee voice in managing pension funds. We must recognize the right to the fruits of one’s own labor, through profit sharing or employee ownership. And we will need broad civil liberties protections inside corporations.

As for public rights, we need recognition that property rights are subordinate to the public good. We need restored antitrust law, because no corporation can be effectively controlled when it becomes too large. We also need a revitalized right to cast a vote that counts, which is to say, we must get money out of politics.

We must recognize that the manic pursuit of wealth for everyone in the stock market was a delusion, and a dangerous one, for it was precisely the pursuit of share price gains that destabilized our economy. Living in the delusion that we all could win at the stock market game, we all became losers. The real way for everyone to win is to redefine business success to encompass genuine, long-term enduring gains for real people—through measures like a living wage, corporate investment in communities, and protection of our clean air and water. These are forms of success that will not evaporate overnight. And they are forms of success that touch human lives in real ways, not the delusory way of a stock market bubble.

FINISHING THE AMERICAN REVOLUTION

We can make our economy one that serves all people. We can do it first by making corporations genuinely accountable, as they are not today, and second, by making them accountable to someone besides shareholders. The aim is to bring democratic principles into and around corporations, so that companies are imbued with a democratic ethos, naturally working with the democratic polity rather than against it.

We are experiencing today a unique convergence of forces—not only the forces of scandal, but the forces of change. We can use this moment to take corporate social responsibility to the next level—the level of economic democracy. We can become a new founding generation, completing the design in the economic realm that our forefathers began in the political realm. Instead of chasing one form of corporate wrongdoing at a time, we can put in place enduring structures of justice, effective structures of checks and balances. For it is only in this way that we can truly safeguard the common good—not only for today, but for generation after generation to come.

The aim in this volume has been to suggest the kinds of fundamental, structural changes that must be brought to the table of reform. If the proposals presented here seem unlikely or far-fetched, we must recall how unlikely and far-fetched the conservative agenda appeared before it gained ascendancy. And we might recall how that agenda was advanced by a radical fringe, which was sustained by its conviction that its ideas would ultimately prevail. In part because of that conviction, those individuals were proved right.

There was a similar depth of conviction—and a similar air of the unlikely—about the concept of democracy itself back in 1776, when America’s first band of revolutionaries took their stand against the divine right of kings. Our task today is to take a similar stand against the divine right of capital. If we dare to think in radical yet practical ways, if we can present our ideas in simple terms that the public can understand, and if we act always out of concern for the public good, then make no mistake about it: we too shall prevail.