December 13, 2005

Excerpts: The Battle For The Soul of Capitalism - Part XVIII

By: 800-CEO-READ @ 7:52 PM – Filed under: Management & Workplace Culture

Bad Apples

Striking as they do at the heart of our capitalistic system, the corporate scandals of the recent era were unpleasant to witness. But even as “it’s an ill wind that blows no good,” when the bright spotlight of public attention shines on major scandals, it also illuminates all the nibbling that has taken place around the edges of proper ethical practice. Were it not for the scandals, untoward practices may have persisted indefinitely. Because they call attention to a corporate barrel that itself is in need of considerable repair, we owe a certain perverse kind of debt to the fallen idols of capitalism, “bad apples” like these:
  • Kenneth Lay, Jeffrey Skilling, and Andrew Fastow presided over the collapse of Enron, revealing a panoply of financial engineering that quickly turned to fraud. Enron’s bankruptcy also turned the spotlight on the profound failings of a blue-chip board, the co-opting of its accounting firm (which also provided Enron with consulting services), and the active participation of its bankers in deals of dubious validity. Market value of Enron at pre-scandal high: $65billion. Final market value: zero.
  • Bernard Ebbers, CEO of the bankrupt WorldCom (later MCI), gained his position in the hall of shame when the firm cooked the books, resulting in an $11 billion accounting scandal. To avoid selling his own shares to meet margin calls, he had borrowed a stunning $40 8million, which WorldCom’s board guaranteed. (The Sarbanes-Oxley Act now bans corporate loans to executives.) Market value of WorldCom at pre-scandal high: $165 billion. Final market value: zero.
  • William Esrey and Ronald LeMay of Sprint gained the spotlight with their receipt of $287million in option compensation, paid to reward them for a merger (with the aforesaid WorldCom, of all choices) that in fact was never consummated. Their subsequent attempt to dodge taxes through an allegedly illegal tax shelter also raised the issue of collusion by the firm’s independent auditor in the setting of executive compensation. Market value of Sprint at pre-scandal high: $58 billion. Market value in early 2005: $32 billion.
  • Dennis Kozlowski, the CEO of Tyco, gained his first unwelcome attention with a clumsy attempt to illegally evade state sales taxes on $13 million of art purchases, quickly followed by disclosure of the $2 million Roman-theme party given in Sardinia for his wife’s birthday. The fete included the now-famous ice statue of Michelangelo’s David exuding, as it were, vodka. But the spotlight on those events quickly illuminated a classic case of a manager’s confusing the shareholders’ money with his own, as he allegedly looted Tyco and its shareholders of $600million. Market value of Tyco at pre-scandal high: $117 billion. Market value in early 2005: $68 billion.
  • Jack Welch of General Electric gained an equally unwelcome spotlight for his extramarital peccadilloes. His divorce proceedings illuminated the “stealth” compensation typically awarded to retired chief executives but rarely disclosed. While his total compensation as GE’s CEO surely approached $1billion, his lavish retirement benefits, valued by one commentator at $2 million per year, included a New York apartment with daily flower deliveries and wine, and unlimited use of a company jet. He also was awarded a generous retirement stipend of $734,000...per month. Nonetheless, he seems to have little to spare, given that his charitable giving came to just $614per month.* Market value of GE at 2000 high, $600 billion. Market value in early 2005: $379 billion.
  • Steve Case of AOL. In an extraordinary example of the delusions of grandeur that characterized the information age, the news of the marriage of the “new economy” AOL and the “old economy” Time Warner as 2000 began sent the price of Time Warner soaring to a then-all-time high of $90per share. But AOL’s revenues began to tumble almost immediately. Barely two years after the merger was announced, the firm reported losses totaling $98billion. In the heady days before the bubble burst, Case, the founder of AOL (and the chairman of the merged company) sold nearly one-half billion dollars worth of his shares, mostly at boom-level prices. The stock value declined to a low of $9.64. Market value of AOL at pre-scandal high: $226 billion. Combined market value of Time Warner and AOL at merger, $240 billion. Market value in early 2005: $82 billion.
  • Richard Grasso, chairman of the New York Stock Exchange, made news with the disclosure in 2004 of the staggeringly large compensation package ($187.5million) bestowed on him by those he regulated. The spotlight also illuminated the salutary (if not explosive) effects of disclosure, the Big Board’s flawed system of governance, and the near-monopoly it maintains for its member firms and specialists, who operate each day with bountiful inside information about the buying power of, and selling pressure from, investors who intend to engage in trades. Value of seat on the New York Stock Exchange at 1999 high, $2.65 million. Value in early 2005, $975,000.

  • There are many other “bad apples” whom I might as easily have mentioned, but these seven examples should be enough to make the point that the scandals ofthe recent era have brought into sharp relief the painfully broad and baneful impact of managers’ capitalism, and the financial shenanigans that it fomented.

    The problem goes far beyond the few renegades I have listed as bad apples. The traditional nature of capitalism has been distorted, and today’s version is riddled with problems reflected in serious manipulation of financial statements. Indeed, since the market crash, some 1,570 publicly owned firms have restated their earlier financial statements, including some of our largest global corporations, such as Royal Dutch/Shell, the giant oil company, Schering-Plough, Qwest, Bristol-Meyers Squibb, Xerox, and Halliburton. (See Box 1.3.)

    *While the Good Book says “judge not, lest ye be judged,” the tight-fisted charitable giving of such fabulously wealthy executives appalls me. Another example is Sam Waksal, imprisoned for his crimes at ImClone. He earned $134 million in 1999–2001 and gave but $157,451 to charity, implicitly telling the world, “1⁄10 of 1 percent for the greater good, 99.9 percent for me.”

    link to book