While Enron's (ENRNQ) accounting methods were shady, its goals were the same as those of many other respected companies: amping up quarterly profits and bolstering its stock price, says a George Washington University professor.
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In that sense, the worst-case scenario at Enron highlights a worrisome trend among U.S. corporations, says Lawrence Mitchell, a law professor and author of
Corporate Irresponsibility: America's Newest Export
. The problem, says Mitchell, is that executives are so obsessed about keeping stock prices up, they may end up taking shortcuts that sabotage a company's long-term health.
Mitchell explains how the corporate fixation with quarterly numbers came to be -- and what could be done to improve things.
TSC: How do the revelations about Enron relate to what you've written about corporate irresponsibility?
I think that I'm probably the only person in America who's writing
former CEO Kenneth Lay a thank you note. The theme of my book is stated in the first sentence of the second paragraph of Lay and
former CEO Jeffrey Skilling's letter to shareholders contained in Enron's 2000 annual report. It says, "Enron is laser-focused on earnings per share."
My thesis is that what's gone wrong with corporate America is precisely that. In the past several decades -- and I blame Wall Street, institutional investors, individual investors, everybody for this -- we have developed a mentality about our market that puts enormous pressure on corporate management to maximize short-term stock prices. That focus on the short-term stock price means that lot of things get sacrificed, including the long-term health of business.
In that respect, Enron is no different from any other American public corporation, except that they chose to maximize their stock price by committing fraud.
does the same thing
maximize its stock price, but it does it by laying off tens of thousand of workers.
does the same thing, but it does it by violating antitrust rules. Other corporations do it by cutting R&D or maltreating workers or cutting corners in product quality or dumping into the environment.
We live in an era where if you don't make quarterly numbers -- actually, if you don't make whisper numbers -- you get hammered by the market. So that puts enormous pressure on executives and directors to keep the numbers going up and up and up.
That's another part of it, too -- not to let them off the hook. Over the past decade, the practice of paying executives principally in stock has mushroomed, to the point where executive stock options account for some 13% of the market in terms of outstanding shares. Executives and directors now have a direct incentive themselves to maximize short-term profit, exercise their options, sell and get the hell out of there.
When you combine those things, Enron is no surprise. The scope of the deception may be a surprise, but the kind of behavior that it was engaging in is not a surprise. It's a business that could not possibly have sustained adequate profitability to keep its stock price moving, so they resorted to fraud to keep the stock price up.
And the thing I'm afraid of is that there are a lot more Enrons out there. They're not necessarily as shaky or as massively fraudulent as Enron. But there are corporations that are shortchanging the long run for the short term. And in the long term, that's going to end up hurting them and all of us.
TSC: What are some of the other Enrons -- companies that aren't engaging in fraud, but are maybe taking too many shortcuts?
GE with the layoffs. Evidently
, which just is splitting up now, did a lot of funny accounting. A lot of companies use off-balance-sheet transactions to get debt off their books.
But I mean
there are other Enrons, not just in terms of financial manipulation, but in terms of this whole general sacrifice of long-term well-being to short-term
American R&D has gone down, and is lower than other countries'. R&D is expensive. The wage gap among American workers, between average workers and higher earners, has increased. That suggests we're not supporting our workforce with adequate pay. Median income for a family of four was less than $40,000 last time I looked. And 75% of Americans make less than $50,000 a year.
TSC: How did this tendency to focus on short-term profits come about?
It's a combination of factors:, the realization that people could profit in the short term substantially more than if they held stocks for the long term, or at least a lot faster; there were the takeovers
in the '80s, and the dot-coms. And as the market rose in the '90s, it's become the increasing pressure to see those share prices get higher and higher and higher.
The institutional investing phenomenon, instead of being advantageous as was once hoped, also has created this pressure effect. Fifty-eight percent of American equities are held by institutional investors. The private institutional investors are run by people who get compensated on the basis of their currently quarterly performance. And to get your performance to look better, you get the share value of your portfolio to increase.
I'm not about to let Wall Street analysts off the hook. They're in the business of pushing the stock their firms underwrite or would like to underwrite. As a result of that, they tend to be sloppy and careless. In addition, they jump on the quarterly numbers as if they mattered. Warren Buffett has famously said, nothing of importance happens to a business in a quarter -- Enron perhaps excepted -- and probably not even in a year.
In order to really develop a corporation that is going to be sustainable and produce value, you've got to be patient. It takes time, and we are no longer patient. From 1990 to 1999, the average holding period for equities went from two years to eight months. That's not long-term investing. The average holding period for mutual funds in the same period went from 11 years to four years. The evidence all suggests that turnover is just dramatically greater now, that people aren't willing to wait for their profits.
TSC: What could be done to make investors and companies focus more on the long term?
It sounds counterintuitive, but it seems to me that we should have directors serve for longer terms. We ought to do mandatory financial reporting on an annual basis. If firms want to release quarterly reports, let 'em. But if you live by the quarter, you die by the quarter.
We also ought to look at the way we define long-term and short-term capital gains. With exceptions for sales that are justified, we ought to have much more punitive short-term capital gains taxes for high turnaround. All these are incentives to make people long-term stockholders.
We ought to reward companies that pay workers well and train them well. One way of rewarding them is instead of taking employee salaries as an expense, which hits on the bottom line, we ought to say, this is your industry average wage for this job category. To the extent you pay employees more than this or to the extent you invest more in employee training, you get to capitalize that as an asset and you get to depreciate it. If you lay off employees without good cause, they've got to recapture the depreciation. This is a way of being able to manage employees as the assets they are, which I think would result in better treatment.
TSC: Do you think Enron's collapse could make it easier for companies to shift their focus away from short-term goals?
Nope, not by itself. I think, while this is really big news now and may result in some regulatory tweaking, in six months the lessons will be lost on us. Enron will be seen as an aberration rather than the norm. That's why I want to emphasize that I think Enron is the norm.
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