This article has been chosen as a Making Sense of These Times
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A great history lesson about capitalism and the market – you really get the historical moment we're in, and how it is, that in spite of the outrages making headlines, nothing much figures to change in this stranglehold that our corporate culture has us in. A very informative piece by a listmember, who is long-term pre-eminent voice speaking for how our American culture, as a model, should be. "The needed reforms enumerated by 'Business Week,' suggested by the New York Stock Exchange, Business Roundtable, and various business reformers, are exceedingly modest, and the reformers are perfectly frank that the important thing is 'renewing confidence' rather than doing much of substance."
-Suzanne-

June 29, 2002

The Corporate Abuse-reform Cycle
Edward Herman

We are at the peak of the latest corporate abuse-reform cycle in which business abuses have been so severe, and their effects so conspicuous, that their low-key treatment and normalization by the mainstream media has been unsustainable.

During the past year the media have featured the Enron collapse; the Enron (and many other) management's conflict-of-interest dealings with and looting of their own company; Enron's (and other companies') manipulation of electric power prices and looting of California consumers and taxpayers; the conflict-of-interest and criminal actions of Enron's auditor, Arthur Andersen; the role of the major banks in helping Enron and others engage in various malpractices;

the disclosure that brokers had touted stocks underwritten by their investment banking department, but which they privately derided as "a piece of junk" or "a piece of crap" (in the words of internet stock analysts at Merrill Lynch); managerial overpayment and de facto looting via stock option plans, golden parachutes and other forms of more or less legal theft, all on an obscene scale; and the utter failure of regulation to curb these excesses.

The extensive publicity has sparked anger and distrust of business. Naturally, this distresses the corporate community, and some of its members, along with the media, are in the phase of trying to repair the damage. Business Week's Cover Story of June 24 was "Restoring Trust In Corporate America," with subtitle, "Business Must Lead the Way to Real Reform."

This was the same problem that faced the business community during the Great Depression. Business abuses of majestic proportions in the 1920s had helped inflate the stock market with borrowed money and unload on the public vast quantities of sure-fire dogs issued in the United States and abroad. The Great Depression collapsed these junkpiles and uncovered massive fraud in security markets and banking alike.

Some Wall Street dignitaries actually served prison time (notably, Richard Whitney, former president of the New York Stock Exchange). Business had a huge public relations problem on its hands, which also provided an environment in which REAL reform could take place. In 1934-35 this included creation of the Securities and Exchange Commission (SEC), public disclosure requirements for the sale of securities on the exchanges, the Glass-Steagall Act's enforced separation of commercial and investment banking, and the dismantlement of public utility holding companies.

These real reforms of the 1930s were fought bitterly by the bulk of the business community, although an important segment did support them, considering them needed to make capitalism viable. The reforms were softened and weakened in these struggles, but were unstoppable at that time. It is therefore of great interest that as the business community has gained political and media muscle over the last two decades it has succeeded in steadily eroding those earlier REAL reforms.

Reflecting this transformation, the word "reform" has come to mean deregulation, privatization, and faith and trust in markets. During this period the Glass-Steagall separation of commercial and investment banking and other limits on financial integration were removed, and regulation was weakened by inadequate funding, damaging rule changes, and more frequent and blatant conflict-of-interest appointments of regulators.

For example, George W. Bush's appointee to head the SEC, corporate lawyer Harvey Pitt, had worked for dozens of banks and security firms, the New York Stock Exchange, and all of the Big Five auditing firms, including Arthur Andersen. He had helped the Big Five fend off regulatory constraints on the conflicts of interest that were notable features of the Enron-Arthur Andersen relationship.

His conflicts of interest as a regulator are remarkable, almost co-extensive with the scope of securities regulation. Unsurprisingly, Pitt does not support very strong legal or regulatory changes (Business Week notes that his "proposal to put 'real teeth' into auditor discipline has some big gaps where the gums are showing").

The corporate community's (and Business Week's) call for business to lead the way to "real reform" thus reeks of hypocrisy. Business took advantage of its advancing power to create an environment in which Enron, Global Crossing, Arthur Andersen, Citibank, Tyco International, et al., would thrive and be able to exploit their increasing freedom from the controls of the earlier and effective REAL reforms.

Business was enthused about the Gingrich revolution of 1994 and is extremely pleased with George W. Bush, who has been aggressively pushing the traditional business agenda, supporting consolidation and weakening regulation. Business's successful drive to weaken labor, by diminishing the strength of a major countervailing power, has made it easier to exploit pension fund money as well as elevate profit margins that can be skimmed off by managers practically at will.

Although by now the media have given considerable attention to Enron and to managerial abuses across the board, they have stopped short of examining in detail and exploring the political meaning of the links between Enron et al. and George W. Bush and leading Democrats.

If all politically viable politicians are on the corporate take, this helps explain why the Enron phenomenon could happen, and why Glass-Steagall could be eliminated and SEC regulation weakened. But this would make it crystal clear that the developments leading to disaster were just what business wanted, and that the call for "real reforms" by those who engineered these results, and their media front persons, must be treated with the utmost skepticism.

The needed reforms enumerated by Business Week, suggested by the New York Stock Exchange, Business Roundtable, and various business reformers, are exceedingly modest, and the reformers are perfectly frank that the important thing is "renewing confidence" rather than doing much of substance. For many businesspeople the abuses have been minor excesses, the worst of them by "bad apples." And there remains great faith that "the market" can still be relied on to straighten things out in the long run.

For Business Week and the new business reformers, what is needed first and foremost are improved standards of corporate governance – most notably a board dominated by independent directors. They are also pushing for constraints on stock option plans (like requiring that they be approved by vote of stockholders), and improved accounting practices, perhaps helped along by audit company reform and separation of auditing and consulting.

In the more radical proposals, very unlikely to be implemented, it is urged that stock option costs be "expensed," meaning charged off at time of installation so that their costs to stockholders would be put on the table when granted.

These proposals are remarkably thin and would have minimal effect on corporate behavior even if adopted, which is far from certain.

It is hard to define "independent" directors in such a way as to assure the selection of directors who are not dominated by the managements, as the top executives must choose or approve the directors, they frequently have personal or business relations with the "independents," and the managers control the flow of information to the directors.

In each abuse-reform cycle there is a call for more independent and active directors, and more firms than ever have a majority of independent directors, but this only works when the management want it to work, which is where it isn't much needed. When the managers want to dominate, they find this easy, unless the company is in serious difficulties. In the boom phase of cycles, moreover, when things are going well and stock prices are soaring, managers easily dominate and abuses can become egregious and extensive. (These issues are discussed in detail in Herman, Corporate Control, Corporate Power, chaps. 2 and 7.)

Trying to constrain stock option plans by requiring a stockholder vote suffers from the fact that the management usually gets a very large majority of the votes automatically in the proxy collection process, so that its proposals are rarely shot down – corporate democracy is a mirage. It is argued, however, that forcing the vote will still impose a publicity constraint on the abuse of stock options, and there is some small element of truth in this.

But corporate proposals at stockholder meetings normally don't generate much publicity, and the options usually only get out of hand in times of prosperity and euphoria when they are hidden beneath the trappings of success. Furthermore, managements have shown great ingenuity in finding new modes of self-aggrandizement when old ones suffer from adverse publicity.

The usual accounting reform proposals suffer from the fact that accounting firms are in a basic conflict-of interest position: they are hired and paid by the managements whose business operations they are supposed to audit independently. There are no "practical" proposals for reform on the table today for addressing this problem (e.g., hiring auditors for only one year, or having them assigned by an outside body like the SEC). Company accounting practices that mislead are currently under fire and may be repaired, but there is little reason to believe that similar abuses won't crop up in the future under corporate pressure to show good results.

Even a modest "real reform" today would call for a return to Glass Steagall and more, the selection of at least a number of independent directors by major corporate constituencies like labor and local citizens groups, a requirement that there be really independent auditors, and a renewed and strengthened SEC. These are real (if modest) reforms.

More basic would be decentralization of the overconcentrated corporate system, including the media conglomerates, and a strengthening of the labor movement, which would tip the scales toward a more democratic capitalism and away from "corporate democracy" and plutocratic capitalism.

But at present even modest real reforms are unlikely. Capital was discredited and in disarray in the 1930s, with the system in obvious crisis and the need for real reform undeniable. Ironically, one reason why the crisis today is not as severe as in the 1930s is that the government sector is relatively as well as absolutely much larger, helping reduce the impact of private instability, a benefit of Big Government that neoliberals are doing their best to rectify.

So, with the help of Big Government, capital remains in complete command and still rides high, despite Enron, the looting, and the New Economy collapse. The media and major political parties are its agents, allies or hostages; market ideology reigns supreme despite the growing evidence of deregulation's failures; and the corporate community is well on its way to riding out this new crisis with the most nominal reforms, if any at all.

http://www.zmag.org/sustainers/content/2002-06/29herman.cfm

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