Two, Three, Many?
The New York Times
February 1, 2002
By PAUL KRUGMAN
Here's a scary question: How
many more Enrons are out
there?
Even now the conventional
wisdom is that Enron was
uniquely crooked. O.K., other
companies have engaged in
"aggressive accounting," the art form formerly known as
fraud. But how likely is it that other major companies will
turn out, behind their imposing facades, to be little more
than pyramid schemes?
Alas, it's all too likely. I can't tell you which corporate
icons will turn out to be made of papier-mâché, but I'd be
very surprised if we don't have two, three, even many
Enrons in our future.
Why do I say this? Like any crime, a pyramid scheme
requires means, motive and opportunity. Lately all three
have been there in abundance.
Means: We now know how easily a company that earns a
modest profit, or even loses money, can dress itself up to
create the appearance of high profitability. Just the
simple trick of paying employees not with straight salary,
which counts as an expense, but with stock options,
which don't, can have a startling effect on a company's
reported profits. According to the British economist
Andrew Smithers, in 1998 Cisco reported a profit of $1.35
billion; if it had counted the market value of the stock
options it issued as an expense, it would have reported a
loss of $4.9 billion. And stock options are only one of a
panoply of techniques available to make the bottom line
look artificially good.
Motive: The purpose of inflating earnings is, of course, to
drive up the price of the stock. But why do companies
want to do that?
One answer is that a high stock price helps a company
grow; it makes it easier to raise money, to acquire other
companies, to attract employees and so on. And no doubt
most managers have puffed up their stock out of a
genuine desire to make their companies grow. But as we
watch top executives walk away rich while the companies
they ran collapse (there are cases worse than Enron; the
founder of Global Crossing has apparently walked away
from bankruptcy with $750 million), it's clear that we
should also think about the incentives of the managers
themselves. Ask not what a high stock price can do for
your company; ask what it can do for your personal
bottom line.
Not incidentally, a high stock price facilitates the very
accounting tricks that companies use to create phantom
profits, further driving up the stock price. It's Ponzi time!
But what about opportunity? A confluence of three factors
in the late 1990's opened the door for financial scams on
a scale unseen for generations.
First was the rise of the "new economy." New technologies
have, without question, created new opportunities and
shaken up the industrial order. But that creates the kind
of confusion in which scams flourish. How do you know
whether a company has really found a highly profitable
new-economy niche or is just faking it?
Second was the stock market bubble. As Robert Shiller
pointed out in his book "Irrational Exuberance," a rising
market is like a natural Ponzi scheme, in which each
successive wave of investors generates gains for the last
wave, making everything look great until you run out of
suckers. What he didn't point out, but now seems obvious,
is that in such an environment it's also easy to run
deliberate pyramid schemes. When the public believes in
magic, it's springtime for charlatans.
And finally, there was (and is) a permissive legal
environment. Once upon a time, the threat of lawsuits
hung over companies and auditors that engaged in sharp
accounting practices. But in 1995 Congress, overriding a
veto by Bill Clinton, passed the Private Securities
Litigation Reform Act, which made such suits far more
difficult. Soon accounting firms, the companies they
audited and the investment banks that sold their stock
got very cozy indeed.
And here too one must look not only at the motives of
corporations, but at the personal motives of executives. We
now know that Enron managers gave their investment
bankers - not their investment banks but the individual
bankers - an opportunity to invest in the shell
companies they used to hide debt and siphon off money.
Wanna bet that similar deals didn't take place at many
other firms?
I hope that Enron turns out to be unique. But I'll be very
surprised.
nytimes.com |
