Restoring Trust in Corporate America

This past week, the President and the Congress have been consumed by the challenge of trying to restore trust in corporate America. Prominent financial and accounting scandals at Enron, Global Crossing, Adelphia, Tyco, World Com and others have shaken the confidence of investors and the public alike in the stability of our corporations and economy.

President Bush is concerned that corporate fraud is weakening an already fragile economy and giving his political opponents new attack points on his administration. In a speech on Wall Street, he pledged stronger enforcement and new criminal penalties against corporate executives who hide vital information from their investors.

The Chairman of the Security and Exchange Commission, Harvey Pitt, is under political siege from both parties. Recently, he quoted a line from the movie “Network”: “I’m mad as hell, and I’m not going to take it anymore.” He pledged that corporate crooks and charlatans would be doing jail time.

The Congress has also sprung into action. Bipartisan consensus is gathering for passage of a tough accounting reform bill and increased penalties for corporate fraud.

The New York Stock Exchange has proposed a strong set of new listing requirements for the corporations that trade on the Exchange. The proposed rules expand the role and authority of independent directors, increase the power of shareholders, and implement new control and enforcement mechanisms.

While the nation cannot legislate honesty and competence, neither can it ignore dishonesty and incompetence. New laws, tough enforcement and increased regulatory checks and balances are an important first step. But the cause of these scandals goes deeper.

There is a culture that has developed in the business world during the last ten years that has encouraged the kind of behavior that breeds financial scandals. It is that culture that must change if real trust and confidence is to be restored.

At the turn of the century, President Teddy Roosevelt confronted a similar time. “Corporate cunning has developed faster than the laws of nation and state,” he remarked to a reporter in 1904, “… So when the weather is good for crops, it is also good for weeds.”

What has developed today is the result of “corporate cunning” and reflects a set of distorted values or “weeds” in corporate America that have inspired the kind of fraud and deceit that have stunned the marketplace:

Earnings over Profits

In recent years, Wall Street has become increasingly obsessed with earnings projections. Whether a corporation meets the quarterly or annual earnings targets set by analysts has become the test of success or failure, regardless of long-term profits. The total incentive for chief executive and chief financial officers is to “manage” earnings in order to meet these arbitrary projections.

The problem is that earnings are inevitably subjective and can be readily influenced by management and accountants. For example, estimating the number of years over which to depreciate assets is a judgment call. These accounting manipulations are exactly what led to World Com’s $3.8 billion expensing error.

The key is for the business community itself to return to a more legitimate standard that looks at the overall performance of a company over a period of time and rewards honesty and integrity in management. This is not simply a matter of laws. It is a matter of values.

Style over Substance

Chief executive officers have become a cult all to themselves. A lifestyle has developed around many prominent CEOs characterized by multi-million dollar salaries, corporate personal loans and lines of credit, huge homes in Florida, California and Long Island, private jets, fancy cars and limousines, and generous retirement and stock option plans. The level of corporate opulence in some cases has been nothing short of obscene. The former head of Tyco International – L. Dennis Kozlowski – was not only earning a salary of more than $100 million a year, he also had the gall to take director’s fees on top of that. He has now been indicted for evading more than $1 million of sales taxes on the purchase of six paintings, including a Monet and a Renoir.

No one questions providing a capable chief executive with adequate compensation. But too often the level of compensation far exceeds the return to the corporation. Boards of directors and compensation committees have become rubber stamps for the excesses of their executives. These jobs are not about style or panache, they are about the substance of effectively managing and strengthening a company through hard work and integrity. Those values cannot be legislated.

Complacency over Accountability

In a recent report by the Senate Permanent Subcommittee on Investigations, it is alleged that the members of Enron’s board of directors contributed to the firm’s collapse. A pattern of corporate governance behavior has developed over the years where boards fail to ask the tough questions for fear of questioning the judgment of management. Too often, the message to corporate boards is “don’t make waves.” Acquiescence in the decisions of the CEO and other corporate officers is viewed as the safest path to director’s fees, stock options and re-election to the board. But the responsibility of a director is to exercise independent judgment in overseeing the management of the company on behalf of the shareholders. They have a duty to ask tough questions regardless of who may be upset. It is for this reason that the New York Stock Exchange is recommending that a majority of a company’s board should be independent directors and that only independent members should sit on the audit, nominating and compensation committees.

These steps will help, but only if corporate boards encourage greater vigilance by their directors.

Bigger over Better

As a young boy working in my family’s restaurant, my father always proclaimed that the key to his success was hard work and a good plate of spaghetti. Both of my parents worked hard in their business and provided their customers with good service and good product at a reasonable price. That formula has been a key to success for a long time whether the business was Ford Motor Co., General Electric Corp. or Carmelo’s Café.

In recent years, the measure of success has become big over better. Chief executive officers and their companies no sooner establish the fundamentals of their operations than they begin looking for merger opportunities. Telecommunications, entertainment, airlines, and energy industries are among the most striking examples of merger mania. And interestingly enough, many of these mega-corporations are facing serious financial or legal trouble. Consolidation is a fact of life and will continue. But wouldn’t it be nice to again measure success in business not by size but by the basics of good service and a good product? Changing that culture is perhaps the biggest challenge of all.

Our free market system is the strongest in the world and its fundamental strengths rest on the imagination, creativity and leadership of America’s business leaders. But just as in our democracy, our economy is also dependent on the trust of the people.

That trust has been badly damaged. It cannot be legislated. Yes the nation should toughen criminal laws, prosecute corporate criminals and send them to jail, and improve the regulation of corporations and markets. But fundamental change depends on whether the current culture of business is willing to adopt a new set of values and business practices. That will not happen by changing laws. It will only happen by the example of corporate leaders and investors who truly believe that accountability, transparency and integrity are essential to doing business in our free enterprise system. Only then will trust be restored to corporate America.

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LEON PANETTA, is a former congressman and White House Chief of Staff whose column appears regularly in Commentary. Readers may write to him at the Panetta Institute, 100 Campus Center, Building 86E, CSU Monterey Bay, Seaside, CA 93955.
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