February, 2002

Fruits of Thought

After Enron

What is the core problem that the collapse of Enron reveals? It is the commonplace assumption that it is the responsibility of company executives to get their company’s stock to sell at the highest price.

This belief is a recipe for disaster because corporate executives who are honestly doing their job have only limited influence over the price of a publicly traded stock. Sure they can guide their company well but, often, the prime determinant of a stock price is general market conditions. Things like interest rates, macroeconomic expectations and what comparable companies sell for have substantial effects on the market price of a stock – all completely beyond the influence of an executive.

The boom in compensation paid in the form of stock options has been an attempt, at its most benign, to tie company executives to the interests of shareholders. But the whole process begs the question: Which shareholders? Those who are looking to bail out rich, or trade quickly, or the long-term holders of a company stock who are concerned principally with building long-term value?

Leaving aside allegations of fraud and theft, Enron’s failure came about because executives, anxious to boost share prices, engaged in all kinds of complicated shenanigans to make the books look good. It is important to note that these machinations – often in the form of off-balance-sheet partnerships to borrow money, guaranteed by Enron, and then buying some long term revenue stream from Enron at high prices which allowed Enron to show large profits today with a disguised liability for tomorrow – took a lot of work, a lot of expense, and couldn’t possibly increase long term profitability.

There was simply no reason to engage in these activities except to boost the share price. And so the core question is why executives at Enron were so concerned with boosting the share price and not with, say, the value of the company 30 years out? The answer is part cultural – that is what executives are supposed to do now – and part incentive system – they were paid with stock options that they were unlikely to still hold 30 years from now.

Enron is the biggest but it certainly isn’t the first to do this type of thing. In the food industry, Boston Chicken did almost exactly the same thing. The company sold large area franchises to outside corporations. The franchisees paid large franchise fees to Boston Chicken, thus allowing Boston Chicken to show profits. The only thing was the franchisees had no money – and so Boston Chicken either lent them the money to pay the franchise fees (as well as the money to build the restaurants) or guaranteed the loans and leases that the franchisees took out.

In any case, it was all camouflage. In the end the money had to come from profitable operations. When the profits didn’t materialize and Boston Chicken couldn’t get new investors, the whole scheme collapsed into Chapter 11. Just like Enron.

It is best to look at Enron as the entrails of the dot-com decade in which fortunes were made instantaneously and the expectations of people began to change regarding work and prosperity. All of the sudden, the guy who worked 40 years to build a good business seemed like a sap. The smart ones could make billions in a fortnight.

Yet it is not quite right to see the problem as an outgrowth of the Nineties. For decades our country has been gradually undermining the attitudes and beliefs that make capitalism work. Think about the growth in legal gambling. Typically the issue is framed between those who want legal gambling because of the money it can provide for schools or other functions and those who oppose it because of fear of organized crime or even the problem of poor people gambling away their wages.

In its policies, government both reflects the society it governs and helps shape that society. So legal gambling, with its accompanying “You’ve Got to Be In It To Win” type of sloganeering, encourages an attitude toward money – principally dispensed as a matter of chance – that is inimical to the kind of deferred gratification necessary to successful capitalism.

One has to feel sorry for Enron employees who had million-dollar 401K’s and suddenly find themselves with nothing. But it is important to remember that these people had the million dollars because they concentrated in Enron stock. In fact, all the attention paid to possible legal reforms regarding 401K’s misses the point: whatever the restrictions imposed on the Enron stockholders, at least some stock could have been sold, but the stockholders chose not to.

The Enron employees didn’t sell because they were motivated not by ignorance but by greed. It is an animal spirit and has its place. But when Joe Paycheck sees Mr. Executive getting rich on stock, it should be expected that he’ll want a piece for himself.

The produce industry has been relatively free of this cultural contagion. In its farming roots, the industry is defined by stubborn schedules dictated by powers greater than ourselves. And big public companies that have entered the trade have rarely succeeded beyond bananas.

The single greatest achievement of the produce community is the institutionalization of Moral Responsibility Ratings as intricate parts of credit reports. The notion that a man cannot be judged solely on his bank statement but must also be judged on his character is a restraining and ennobling regulation. It washes out a lot of bad people and sustains a remarkable comity among the trade.

Our nation must wrestle with its collective conscience to find a government that encourages the kinds of dispositions that make democracy and capitalism work. Perhaps our little industry has a bit of an example to offer.  pb