Corporate Punishment

Greedy leaders are bringing down America’s big business. Will our faith in the system ever be the same?
From the August 2002 Trumpet Print Edition

How would you like to receive $20 million simply for advising someone to buy a company? Does it sound too good to be true? That’s what a former member of Tyco International’s board of directors received in a secret deal with the company’s ceo simply for issuing a piece of advice. The board of directors alleges that because it was done behind their backs, it was illegal and unethical.

One day after the $20 million deal was publicly disclosed, Tyco’s stock value dropped $17 billion. Investor confidence had been shattered.

The ceo, Dennis Kozlowski, has also been charged with evading $1 million of sales tax and is facing charges of tampering with evidence. As if this is not enough, Tyco is suing its former chief corporate counsel for a broad pattern of misconduct for personal gain that includes accepting $35 million in unapproved compensation.

Tyco has now entered the ranks of other massive corporations, including Enron, WorldCom, Xerox and Rite Aid, that are drowning in the depths of corporate scandal. The irresponsibility of these powerful institutions has rocked the very foundations of the economy and sent shock waves through corporate America.

Through the uncovering of flagrant abuses of power, deception and fraud in the corporate world, the U.S. is being forced to face the results of an erosion of its morals. Government, higher education and business leaders are all working to find a solution for the crumbling of ethical standards and to restore confidence in the American economic system. But are they looking to the cause of the problem, or only attempting to contain the effects?

To date this critical dilemma remains unsolved and daily appears to be worsening. What is the solution that will end the economic faith crisis?

Executive Corruption

Many companies aggressively and routinely pursue legal policies that push the limits of Generally Accepted Accounting Principles (gaap), the rules that govern accounting in America. However, the number of companies exposed for ignoring these rules when they prove inconvenient seems to be multiplying every week. In addition to the deceptive accounting practices, more and more instances are coming to light of executives, such as those at Tyco, who are engaging in outright abuses of power for self-gain.

A fundamental part of the issue is that one of the primary compensation incentives for top executives is stock options. Often millions of shares of stock are given to corporate leaders in the hope that they will then make decisions that raise the value of the stock.

The problem with this kind of incentive is that it puts the emphasis on short-term results and serves as a motivator for inflating the numbers. Thus, it has become prevalent to use financial statements and other performance indicators to create a false picture of what is happening.

Another company now exposed as having morally inept corporate leaders is Rite Aid. The Securities and Exchange Commission said in a complaint against the company in June that this “concerns one of the largest financial frauds ever perpetrated on the investing public by senior management of a public company.” Rite Aid was forced to restate its pretax income downward by $2.3 billion.

As with Tyco, the leaders of Rite Aid used their positions of authority for unfair personal gain. They manipulated the financial records and worked schemes that made the company appear far more profitable than it actually was. Thus the company seemed to achieve its financial goals, and senior executives were rewarded with performance-based compensation such as additional stock and cash bonuses.

While some companies have privately pursued strategies that would improve the appearance of their financial statements, many others have sought to push the limit of gaap with the assistance of accounting firms. One of the most publicized instances is the relationship between Enron and Arthur Anderson. Together they set up numerous off-balance-sheet companies, among other schemes, that enriched Enron executives and hid the true state of their financial affairs.

In addition to providing consulting services to Enron, Arthur Anderson also audited the financial records. This required Anderson to verify the validity and accuracy of the numbers in the financial statements by reviewing the financial practices of the company. Obviously, there was a conflict of interest in Arthur Anderson auditing its own work. Yet this is common practice in the accounting field.

Consider also that consulting services are typically far more profitable than audit work, and the individuals who once worked for accounting firms often transfer to former client corporations and fill senior executive positions.

Such interwoven relationships between an accounting firm and company management can make it difficult to issue an objective opinion. This is especially true when the opinion is harmful to the client and conflicts with its own consulting work.

Cost of Corporate Transgressions

The price for making decisions based upon greed is being paid by society as a whole. The self-centered actions of leaders of some of America’s greatest corporate icons are weakening the nation by creating a widespread environment of mistrust. The mistrust has translated into a loss of confidence that is eroding the faith of both the domestic and foreign investor (see p. 7 on how this has affected the value of the U.S. dollar). America’s already sluggish economy, which is just showing signs of coming out of recession, desperately needs investor confidence.

Tens of thousands of ordinary Americans are hurting because of greed at the top. This is the real tragedy of companies such as WorldCom, whose stock price plummeted after announcing its “accounting irregularities”—a politically correct phrase representing a nearly $4 billion fraud. The widely publicized cutting of 17,000 jobs quickly followed this revelation. In this case, 17,000 employees directly paid a large part of the price for the misdealings of a few self-focused individuals.

Retirement plans have frequently been another casualty. At institutions like Enron, which invested heavily in its own stock, the devaluing of its stock literally wiped out employees’ life savings. Although individual investors owned many of these stocks, a great many others owned them indirectly through their mutual funds, 401(k)s and iras (U.S. investment plans). Remember, these were not obscure stocks of small companies. WorldCom’s stock, when its capitalization peaked in 1999, was the fifth-most widely held stock in the country.

“For baby boomers facing retirement, this is a frightening prospect. Most have bet just about everything on a rising stock market to finance their old age. With their 401(k)s flat for the past two years and going nowhere fast today, fiftysomethings are scared” (Business Week, July 8).

The bondholders of debt from companies like WorldCom are also likely to suffer. Time magazine reported on July 8, “Dozens of mutual funds, banks and financial-services firms are exposed, including Bank of America, Citigroup, Deutsche Bank and G.E. Citigroup holds an estimated $335 million of WorldCom bonds and could face lawsuits as a result of its cozy ties to the telecom. In May 2001 Citigroup co-underwrote, along with J.P. Morgan Chase, an $11.9 billion WorldCom bond issue. Buyers of those bonds may move to sue the banks, claiming they failed to properly inspect WorldCom’s books.”

The timing of this ethical crisis in business could not be worse. As the U.S. economy is struggling to come out of recession, it now appears we might find ourselves sliding into another. Two consecutive recessions would most likely result in economic stagnation that slows growth in the business sector and increases unemployment.

Investors now are wondering whether they can trust any company. Doubt has been cast on the validity of all financial statements! People crave stability, especially when it comes to investing their money. That sense of security—that ability to have faith in the system—has been seriously damaged. For individuals to invest their money with a reasonable measure of confidence, they must be able to rely upon financial statements and other performance indicators. If this fundamental trust is lost, then their faith in the entire system is lost.

Call for Change

The U.S. president responded to the crisis in a July 9 speech on corporate responsibility. He called for “a new ethic of personal responsibility in the business community; an ethic that will increase investor confidence, will make employees proud of their companies and … regain the trust of the American people.”

President Bush stated earlier in his speech, “The misdeeds now being uncovered in some quarters of corporate America are threatening the financial well-being of many workers and many investors. At this moment, America’s greatest economic need is higher ethical standards—standards enforced by strict laws and upheld by responsible business leaders. … The American economy—our economy—is built on confidence.

Many ideas to re-instill that confidence and solve the ethics problem are being put forth. They include the idea of returning to how things used to be. An International Herald Tribune article proclaimed, “The alternative is yesterday, when American business practiced a responsible capitalism that considered itself responsible to employees, to the public interest and to stockholders” (June 29).

Then there is the increasing cry for more government regulation of business practices. Presumably the goal would be to make businesses more transparent—to help ensure adequate segregation of duties and re-establish arms-length relationships between the company and the firms that perform its consulting and audit work. Proponents of this idea further believe that additional government oversight could help ensure that executive compensation packages are in line with the desires of shareholders.

Everyone seems to have a solution, whether it is accountability in terms of increasing penalties for offenders of corporate fraud or calls for a public accountability board, like the Securities and Exchange Commission has made. These are all, however, attempts to put compensating controls in the place of having ethically sound employees. They do not address the cause of corruption.

A Certainty

The democratic capitalist economic system has proven to be the best that man has achieved to date. Yet it is still fundamentally flawed. Greed, whether we want to admit it or not, is the real driving force behind the economy. Human nature is at the heart and core of the matter.

In corporate America, business leaders are following their own rules. President Bush warned against this in his speech, stating that “schools of business must be principled teachers of right and wrong, and not surrender to moral confusion and relativism.

Relativism is doing what you think is right based upon your personal outlook. Essentially, relativism teaches that everyone is responsible for establishing his own standard of right and wrong. It is a process that is the direct opposite to the biblical injunction, “Trust in the Lord with all thine heart; and lean not unto thine own understanding” (Prov. 3:5).

There is only one standard of right and wrong: Almighty God! His perfect nature, which establishes absolute right and wrong, is revealed in the Ten Commandments, which are taught throughout both the Old and New Testament of the Holy Bible. “For this is the love of God, that we keep his commandments: and his commandments are not grievous” (i John 5:3). That law is still in effect today.

The Ten Commandments are not outdated. They are simply immutable: “For I am the Lord, Ichange not …” (Mal. 3:6). When applied with their spiritual intent, the Ten Commandments provide a framework for dealing with every situation! The first four speak of our relationship with God; the last six tell us how to get along with our fellowman. These are standards that must be adopted if we are to truly solve the ethics crisis.

No amount of reform or government regulation will resolve this underlying spiritual issue. Teaching ethics that are not based on God’s law will not accomplish it. Spiritual problems can only be solved through spiritual means. The crisis of confidence will only be resolved when individuals begin obeying the Ten Commandments. Ethics based on these commandments are the only ones that will make a real difference.

Although we cannot have true faith in any company or investment opportunity, we can have absolute faith that keeping the Ten Commandments will provide more happiness and security than we ever thought possible!