Business Ethics Going Broke?

A Crisis of Confidence in Management Practices

NEW YORK, JULY 6, 2002 ( Business scandals involving dodgy accounting practices or unscrupulous executives have become almost daily fare in the news in recent weeks. The announcement by WorldCom of a $3.8 billion accounting fraud came on top of the collapse of Enron and the related conviction of the accounting and consulting group Arthur Andersen.

Then came Xerox’s announcement that it is going to restate five years of results and reclassify more than $6 billion in revenues, Reuters reported June 28. Xerox said pretax income over a five-year period would now be down by $1.4 billion from previously reported amounts.

Creative accounting practices, designed to make company results look better, are not so uncommon. Each quarter, companies must report their results and if the figures do not meet estimates made by market analysts their stocks might fall by 10% or more in a day, the New York Times said June 29.

To avoid this, some companies start off their accounting with the profit that investors are expecting, and then adjust their sales and expenses in such a way as to ensure the desired result is obtained, on paper at least.

A compounding factor in this process is that during the last decade executive pay became increasingly linked to how share prices were faring. Often the largest portion of a chief executive officer’s salary was in the form of stock options.

This meant senior executives had an interest in propping up share prices, the Financial Times observed July 1. The conflict of interests between the roles of executives and shareholders led to WorldCom lending more than $375 million to Bernie Ebbers, then chief executive, largely so he would not have to sell his 28 million company shares.

Other recent examples include Dennis Kozlowski, who made more than $200 million by selling shares in Tyco in the three years before he resigned as chairman and chief executive. And Jeff Skilling of Enron made $100 million selling his shares in the three years before it collapsed.

“Stock options were supposed to align the interests of shareholders and managers,” concluded the Financial Times. “But these examples show that excessive use of options can lead to misalignment on a grand scale.”

The scandals came at a time when share prices were already depressed, and have intensified the downward trend that in the last week has seen market indexes drop to levels not seen in years. The U.S. dollar has also weakened, declining almost to a level of parity with the euro. All this has led not a few commentators to speak of a crisis in the American model of capitalism.

A commentary by George Trefgarne in the London Telegraph of June 27 supported the market system, but noted the problems due to a lack of personal honesty. The fault lies with the modern-day robber barons, he stated: “The greedy chief executives, bankers and accountants, some of whom have lied and cheated, misled investors and looted companies for their own benefit.”


Another factor leading to the current crisis is merger-mania. Mergers, often fueled by booming share prices, were behind the extraordinary growth of WorldCom, a Washington Post analysis noted June 30.

In 1997 WorldCom bought MCI, the long-distance telephone company, for $37 billion. In fact, MCI was worth three times more than WorldCom, but the purchase was made with fast-rising WorldCom stock.

Another recent failure, Tyco, had acquired 700 companies in the past three years alone, the Wall Street Journal noted June 6. This “frenetic deal making” had made Tyco one of the hottest stocks on Wall Street, with 20% annual growth rates, but its shares started collapsing this year because of accounting worries.

The Journal cited a study the newspaper commissioned with Thomson Financial. The study found stocks of the top 50 acquirers of the late 1990s have fallen three times as much as the Dow Jones Industrial Average.

Other examples mentioned included AT&T, which is now selling off the huge collection of cable companies it had bought for more than $90 billion in the 1990s. And Cisco Systems Inc., one of the leading acquirers in the tech world, has seen its stock fall 80% over the past two years.

Mergers peaked at $1.8 trillion in 2000, more than triple the level in the mid-1990s, according to the Journal. But merger activity this year has fallen to its lowest level in eight years, partly because of the recent collapses.

An earlier study, by Deloitte & Touche, examined the 40 most recent big investigations carried out by its reorganization services practice in the United Kingdom. The study found that 57% of the businesses had a failed merger or acquisition as the chief cause of their problems, the Financial Times reported Feb. 12.

A vivid example of merger problems is the case of AOL Time Warner, the world’s largest media conglomerate, formed as a result of a series of mergers in past years. As of midweek, its shares had plunged 61% this year, the New York Times reported July 3.

On May 2 the Guardian published a report on the company, just after it had announced a $54 billion write-down, “reflecting the crumbling value of its assets since the merger of America Online and Time Warner two years ago.” The paper noted that the share price was no less than 75% below the levels at which the companies were trading before merging.

A return to moral guidelines

In his 1991 encyclical “Centesimus Annus” John Paul II spoke strongly against illicit financial practices. Along with a lack of stability and the problem of corruption, “the spread of improper sources of growing rich and of easy profits deriving from illegal or purely speculative activities, constitutes one of the chief obstacles to development and to the economic order” (No 48).

The Pope spoke appreciatively of private property and the role of markets, but he also observed that ownership of property and the means of producing wealth “becomes illegitimate” when it is the result of speculation, exploitation or breaking solidarity among working people. “Ownership of this kind,” he wrote, “has no justification, and represents an abuse in the sight of God and
man” (No. 43).

John Paul II spoke again about this subject in the World Peace Day message for 2000. In a prescient warning he said: “What seems to be urgently needed is a reconsideration of the concept of ‘prosperity’ itself, to prevent it from being enclosed in a narrow utilitarian perspective which leaves very little space for values such as solidarity and altruism.”

The Pope urged that “economic practices and related political policies have as their aim the good of every person and of the whole person. This is not only a demand of ethics but also of a sound economy.”

The Peace Day message affirmed that: “An economy which takes no account of the ethical dimension and does not seek to serve the good of the person — of every person and the whole person — cannot really call itself an ‘economy,’ understood in the sense of a rational and constructive use of material wealth.” Business leaders and investors are now finding out the high cost of not taking heed of this sound advice.

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