I sometimes used to feel like Cassandra when I complained about corporate managers and directors during the roaring 1990s, only to be met with patient sighs, explanations of the "new paradigm," and of course, the powerful rebuttal of the bull market. Now I feel like the character Jan Struther once described as having "the triumphant look peculiar to those who, suspected of hyperbole, are found to have been employing meiosis."
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StumbleUponI am not looking triumphant, though. It turns out that saying "I told you so" isn't nearly as much fun as I would have thought. My primary emotions are sadness and anger. And I am also trying to figure out whether I feel outraged.
I have complained in the past about pay packages for CEOs that are all upside and no downside. If I conclude that the corporate meltdowns at Enron, Global Crossing, Adelphia, Tyco, ImClone, and WorldCom are not just unfortunate but unfair, am I asking for the same thing for shareholders? Or have these companies crossed over from the category of poor judgment—meaning that everyone who invested takes a hit and hopes for better next time—to the category of injustice—meaning that we are entitled to penalties for the bad guys and some changes to the rules?
These latest stories have sent me back to revisit some of the great frauds of the past. Who can forget National Student Marketing, whose six-figure scam seems endearingly modest by today's standards? Then there was Equity Funding. The NYSE-listed company wasn't making enough money from its insurance policies, so the executives just made up a bunch more over nine years: 64,000 phony transactions with a face value of $2 billion, $25 million in counterfeit bonds, and $100 million in missing assets.
And there's my favorite, ZZZZ Best, the carpet-cleaning firm run by teen-age tycoon Barry Minkow, who built the company up to $240 million on paper before he was old enough to order a drink. He had the chutzpah not just to borrow money from the mob, but to characterize it as an asset instead of a potentially knee-breaking liability. After serving seven years in prison, Minkow is now a preacher. He also operates a "fraud detective" firm (they perform "fraudits") and has been giving interviews about Enron.
For sheer, out-and-out crooks, it's hard to do better than the savings and loan scandals. And for sheer Schadenfreude, you can't beat the insider traders of the 1980s, and all those guys in expensive suits being led off in handcuffs.
More recently, we saw billions of dollars of fraudulently overstated books at Cendant, Livent, Rite Aid, and Waste Management, but those were trivial distractions in a bull market fueled by dot-com companies. Those days were so heady and optimistic that you didn't need to lie. Why create fake earnings when an honest disclosure that you had no idea when you were going to make a profit wouldn't stop the avalanche of investors ready to give Palm a bigger market cap than Apple on the day of its IPO?
Just as people will always be imaginative and aggressive in creating new ways to make money legally, there will be some who will devote that same talent to doing it illegally, and there will always be people who are naive or avaricious enough to fall for it. Scam artists used to use faxes to entice suckers into Ponzi schemes and Nigerian fortunes. Now, they use e-mail. Or, sometimes, they use audited financial reports.
Are the scandals this year any worse in scope or magnitude than they have ever been before? Most of the focus has been on less than a dozen of the thousands of publicly traded companies, and I think it's fair to say that the overwhelming majority of executives, directors, and auditors are on the level.
If the rising tide of a bull market lifts all the boats, then when the tide goes out some of those boats are going to founder on the rocks. That's just the market doing its inexorable job of sorting. Some companies (and their managers and shareholders) got a free ride for a while due to overall market buoyancy. If the directors and executives were smart, they recognized what was going on and used the access to capital to fund their next steps. If they were not as smart, they thought they deserved their success. If they were really dumb, they thought it would go on forever.
The same goes for shareholders. I don't have a lot of sympathy for anyone who invests in a public company if five out of nine board members are members of the same family (Adelphia) or if the board gives the CEO a signing bonus that includes 2 million options at $10 a share below market (Global Crossing). If, after four years without a contract, the CEO decides he needs one that protects him from termination "for cause" if he commits a felony, unless the felony is directly and materially injurious to the company (Tyco), that should be a sell signal. All of that information was public. There is a reason that the SEC makes them disclose this kind of thing, and investors who ignore it get what they deserve.
But I also think it's fair to say that we can and should do better than we have. If it is possible, even once, for all of the checks and balances to fail at the same time, then we should at least make sure that all of them are able to do what we expect them to do. I'd like to hear what you think led to this year of corporations toppling like dominoes, and which—if any—of the current reform proposals you think are worth pursuing.
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Notes From the Fray Editor:
This is going to be good. The Minow/Jenkins battle is only part of the juiciness here. Minow has actually jumped into the Fray to score a point for tropology! But the Fray editor will remain fair and balanced in his selections if and when someone takes Jenkins's side...
Notes From the Fray:
Am I high, or were Holman Jenkins' arguments as follows:
1) The bubble economy and its burst was caused solely by (ahem) internet entrepreneurs and day-traders, but that the real responsibility lies with "shareholders," who should have known better, and
2) the rash of corporate fraud recently uncovered was also caused solely by shareholders, who should have known better than to tempt executives with huge rewards for fraud?
Perhaps a Genius of Capitalism award is in the offing. You'd think a writer for a paper that spends so much time trumpeting "personal responsibility" for crack mamas, rapists and Palestinians might take the same tack with corporate executives. Pity their halo doesn't extend to cover us all.
-- Captain Ron Voyage
(To reply, click here.)
(7/2)
Notes From the Fray Editor II:
True to my word, here is the closest thing to a pro-Jenkins post I could find.
Notes From the Fray II:
Holman Jenkins says that a proposal to eliminate the double taxation of dividends is the single worthwhile proposal he's heard. Leave it to a WSJ pundit to take any issue and say that the only solution is to lower taxes!
But while I have trouble with his use of "single" in this context, it may well be a good idea, eliminating an important distortion. Even he recognizes that it would be a tough sell politically, so I've got a compromise for him -- and one that really enhances his proposal!
Let's couple this with an elimination of another distortion -- the preferential tax rate for capital gains. Just tax capital gains as regular income. We would eliminate two significant distortions at once, yet balance off liberal and conservative forces?
I've been amazed that no one has commented on the effect of the capital gains rate preference in the whole bubble phenomenon. Shareholders now much prefer to get their return through higher share prices than dividends because of the lower tax rate, so management now has all sorts of perverse incentives. There is now a preference toward debt financing, so much so that there was a net equity loss in the market in the late nineties. This has made many companies a lot more vulnerable in the downturn. Share buybacks artificially raised stock prices, suckering less sophisticated investors into believing real improvements were being made. All sorts of high-priced talent went into financial games to turn ordinary income into capital gains, contributing nothing to the real economy.
Eliminating the preference for capital gains income would make the payout of dividends look even more advantageous to shareholders, enhancing his proposal. So is he really interested in improving corporate incentives, or is he just looking for another excuse to advocate a tax cut?
-- Voice of Reason
(To reply, click here.)
(7/3)