Enron: Shorthand for Scandal, Foil for Polemicists (including me?)
By Steve | May 30, 2006
I tried to restrain myself. What more could be written about Enron and Lay and Skilling in the week of the conviction of the devasted duo? The news dominated most news outlets, although a few were still relentlessly covering the critically important news out of American Idol.
In the end, it was the commentary out of two of my favorite newspapers, The Wall Street Journal and The New York Times, that compelled me to add my few cents. From totally different angles, both used Enron to call into question the efficacy of the Sarbanes-Oxley Act.
To be fair, most of the Wall Street Journal's May 26 editorial, The Enron Verdicts, was pretty darn good. Their concluding paragraph is a classic
"The Enron verdicts are proof, if more were needed, that lying to employees, shareholders and the public about corporate finances is a serious crime that will be punished."
Unfortunately they use the conviction as a foil to revisit one of their favorite issues--how Sarbanes-Oxley is overly burdensome and destroying American competitiveness. So they posit that the conviction of Skilling and Lay "will do more to deter future corporate crime than anything in Sarbanes-Oxley."
Maybe. But Sarbanes-Oxley is demonstrably working now, unless you believe the usually reliable Gretchen Morgenson of the New York Times. I think she was either betrayed by her editors and headline writers, or by her own rhetorical oracle. In a May 28 commentary called "Are Enron's Bustin' Out All Over," Ms. Morgenson states:
"Sorry, pals. Other news from last week showed that the Enron verdicts were, at best, the end of the beginning of this dispiriting corporate crime wave. They were certainly not the beginning of its end."
The "other news" was a recap of the Fannie Mae scandal, courtesy of a 350 page report issued by the Office of Federal Housing Enterprise Oversight. The report is damning. It outlines bad accounting and financial practices, poor controls, a broken culture and a failure of oversight. It contains excellent lessons for all ethics officers. (See Chapter 4, "Corporate Culture and Tone at the Top.") But the report focuses on issues from 1998 to 2003 and into 2004--before Sarbanes-Oxley was fully implemented!
Like most ethics officers, I don't believe Sarbanes-Oxley got everything right. For example, many of the applications of Section 404 have seemed overzealous, and need to be re-calibrated, especially for smaller firms. But contrary to what the Wall Street Journal editors and Ms. Morgenson believe, the combined effect of the corporate governance reform efforts of the past few years is making a difference in corporate practice.
Ms. Morgenson believes that "Unfortunately, questionable corporate practices continue apace." No, at least not apace. Certainly questionable practices continue. But large companies are successfully implementing changes based on Sarbanes-Oxley, the U.S. Sentencing Guidelines, and the NYSE and NASDAQ listing requirements. Controls are more rigorous, auditors are more emboldened, board members more assertive, and ethics programs more robust. These changes are making a difference.
We'll still see scandals. Most involving large companies will be flushing out the last contaminants from the pre-Enron era. Until we forget these lessons, and a new Boesky/Milken/Enron emerges . . . .
Comments
I personally agree with your latest blog entry, and so does the best empirical research that has been done on the subject.
Consider the results from Ashbaugh, Collins and LaFond’s December 2004 article titled “Corporate Governance and the Cost of Equity Capital”. This article found that firms reporting larger abnormal accruals and less transparent earnings have a higher cost of equity, whereas firms with more independent audit committees have a lower cost of equity. In total, these “integrity savings” result in about 14 percent lower equity costs.
Or consider the now famous Gompers, Ishii and Metrick article “Corporate Governance and Equity Prices”. They rated the governance performance of 1500 companies, and created two indices – a “Democracy Index” of the top decile of companies based on strong shareholder rights, and a “Dictatorship Index” of the bottom decile of companies based on weak shareholder rights. They tracked the results from 1990 to 1999 and found that the Democracy Index substantially outperformed the Dictatorship Index.
Even more telling, the advantage of good governance is larger in developing countries, which often lack the kind of regulatory oversight we enjoy in the US. A McKinsey Quarterly study in developing country exchanges found that governance performance alone was responsible for 10 to 12 percent of a firms’ market value.
szr
Posted by: Santiago Reich | May 31, 2006 04:51 PM