A Nation of Extremes
We are a nation of extremes. Ask economists about the business cycle, and they will reply with the usual theories: underconsumption, overinvestment, and the like. But they can all be subsumed under the rubric "tendency to extremes."
Can you think of the many ways in which we have cycles of extremes? Such as prison building? Hunting down terrorists? War? Drugs?
On July 30, President Bush signed a bill "to provide an extensive overhaul of corporate fraud, securities and accounting laws. [It] creates a regulatory board with investigative and enforcement powers to oversee the accounting industry and punish corrupt auditors... Executives who deliberately defrauded investors would face long prison terms..." (New York Times, 7/31/02).
This law is both unnecessary and potentially damaging. It is unnecessary because we already have laws against fraud, which (if enforced) should be sufficient to indict the Enron and Worldcom executives. Other than two WorldCom executives ostentatiously led out in handcuffs, these laws have rarely been enforced.
It is dangerous because the government imposes duties on CEOs that do not properly belong to them. CEOs need not be accountants, yet they are now made responsible for the accuracy of accounting statements. And why not, you may ask? "The buck stops here," doesn't it? Should not the CEO be responsible for hiring accountants and auditors that accurately represent the financial condition of the company?
That should be the CEO's endeavor. But companies are now so incredibly complex that various kinds of accounting statements can be equally accurate: covering the mainline activity of the company, covering sideline activities separately, covering domestic operations, covering foreign operations only, covering the operations in a particular country, and so on. Surely CEOs should do their level best to see that all these are accurately presented and described. But CEOs should not spend their precious time assessing the accuracy of these statements. That is the job of the auditor. To sign one's name pledging accuracy, at the risk of a long jail term if a mistake is made, is asking too much. Who would want to accept the job of CEO, with that kind of risk, especially when juries might be swayed, not by the law, but by the rage of an indignant population? Not me!
We are already complaining about excessive emoluments of CEOs. Now we pass a law that loads so much risk on honest CEOs that they will want even higher salaries to compensate for that risk.
Who would want to be an auditor, knowing that an honest error could be interpreted by an indignant jury as a criminal act, putting the "perpetrator" in jail. Not me! (You can have my CPA certificate back again.) Pretty soon CEOs and auditors will follow in the wake of doctors. Too much government oversight has led to a shortage of doctors, and high prices for those who remain.
So, how do we control the CEO, other managers, or auditors? The best way would be the sidewise accountability that I described in TQE #48. Each person or group that would be damaged by corporate fraud should be responsible for protecting itself. This does not mean that every stockholder must understand the accounting procedures of every stock that he or she holds. Rather, those wishing to avoid risk should invest only in mutual funds with reputations for integrity. Any stockholder who buys an individual stock should be ready to accept the extraordinary risk of doing so.
A mutual fund with integrity? Surely you must be joking! I'm not. A reputation for integrity is our nation's greatest loss in the current scandal, and we should do our utmost to restore it. Integrity means that a CPA firm presents an audited financial statement representing the true financial condition of a company, in each of its facets, just as Price Waterhouse did when I worked for them. (Most of you know I am a CPA, who gave up that profession fifty years ago). A mutual fund with integrity will invest only in firms with audited statements certified by a CPA firm with integrity. Fidelity Investments, for example, is already doing that. Banks will insist on corporations with financial statements audited by CPA firms with integrity, or refuse to lend them money. Employee unions will insist on audits with integrity or they will strike. Merrill Lynch will regain the integrity it once honored, or else it will be forced out of business by clients who desert.
The twentieth century ran through a cycle of increased government intervention to "protect" us from all ills. All over the world, the result was corruption (buying of licenses or political privileges for corporations), and state enterprises run by political cronies rather than good business managers. The consequences were unbalanced budgets the world over, inflation, and loss of competitive pricing. All of this caused the erosion of integrity. See TQE #43, #48, and #51. One lesson in TQE #48 was that regulation led to more regulation. Before its demise, the Civil Aeronautics Board was regulating the size of sandwiches in airline lunch boxes.
This lesson is always forgotten with the next crisis. At one time we are greedy for money, at another for revenge, blaming someone else. Then the people clamor for more government "protection." In the current scandals, the result is redundant laws that do no more than increase the punishment for fraud that is already forbidden by law. The loss lies in personal responsibility, integrity, and trust in the firms that presumably safeguard our financial interests.
That integrity need not be lost is shown in nonfinancial firms in retail businesses. Many in the clothing industry, for example, stand behind their products and make good if any are faulted (and sometimes even if they are not). There is no reason why Merrill Lynch, communications companies, energy suppliers, and mutual funds cannot do as well as L.L. Bean.
But the loss from corruption has been so devastating that even if the biggies start now, a long time will pass before the survivors regain the reputations they once held. They will be regained only if customers, stockholders, bankers, employees, and others demand integrity. But the companies' integrity will be delayed if they spend their vital energy trying to evade government regulations rather than in satisfying the demands of their stakeholders.
Quakers have always stood for integrity, personal responsibility, calmness in the face of public anger, sound business practices, and punishments that fit the crime. We have always stood for moderation in the face of extremes. Where do we stand now?
Sincerely your friend,
I spent 24 years as the CEO of Vermont American Corporation before I lost a takeover battle. I always thought I was attesting to the accuracy of our financial statements. We were highly decentralized. While I had delegated authority, I could not delegate the need to know what was happening. I spent much of my time reviewing internal audits, talking to managers, employees, and customers. I also tried to hire ethical people. It is not the attesting that bothers me; it is the way the new system will encourage huge lawsuit settlements.
Lee B. Thomas, Jr., Friends Meeting of Louisville (KY).
I'm not feeling the sympathy for the CEOs you do. They are already extremely well-compensated in some cases seemingly illegally well-compensated. They are certainly paid enough to take responsibility for what goes on in their companies. I'm no CPA or businesswoman or anything resembling an economic expert but it was my impression that it was the executives (rather than the accountants) of these companies who cooked up the shady deals in the first place. Getting the accountants to go along was just one part of their business strategies. And on your last point, Quakers used to run people out of meeting for bad business dealings an extreme reaction, in my opinion. I would hope that a Quaker business leader wouldn't insist on immense compensation and would insist on an accurate accounting.
Signe Wilkinson, Chestnut Hill (PA) Friends Meeting
A nice story and explanation, but who was responsible? If we take Enron or WorldCom we also find organizations that have incurred un-serviceable debts. Do we blame the shareholders (in whose name the debts were incurred) who lost everything, or the lenders (who provided the money) who look to lose substantially, or management (analogous perhaps to corrupt rulers) who make off with millions? We blame the managers/politicians? But they are the only ones who made anything out of the mess. Surely they are the only ones who acted at all like homo-economicus?
Wilfred Candler, Annapolis (MD) Friends Meeting.
Jack, I enjoyed TQE #52. We had excellent teachers in economics at Harvard, but we got very little of the advocacy of free markets that you and I now see as important. Remember, though, that the depression of 1929 went on through '39, and only ended after preparations for WW-II kicked in. Unemployment was endemic I recall the difficulty of getting any kind of job, at any rate, during the summers of 1938 and '39. The market economy was not working. Keep up the good work we will discuss it in detail at our 65th, God Willing, after I read your book. Regards,
Note: Dick Wolf is a college classmate of mine. We last saw each other at the 60th reunion in 2001. Jack
I'm a recent 'convert' to your column. I'm trained as an economist, but now have a marketing/advertising business. I find your perspective refreshing. Thank you.
Eric Malm, Haverford (PA) Friends Meeting.
What about the ability of victims to sue for fraud based on, or fine-tuning, centuries of precedents? Isn't the goal to have guilty parties compensate those harmed? Won't this be part of a market system in the absence of regulations along with due diligence, insurance, and diversification to protect against swindlers?
Jerry Van Sickle, Boulder, CO.
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