Alan Murray comes out in favor of a strict criminal liability standard for corporate executives:
WSJ.com - Political Capital: CEO Responsibility Might Be Right Cure For Corporate World: Ken Lay should go to jail.
That isn't a legal judgment. The legal case against Mr. Lay isn't a slam dunk. Mr. Lay spent more time schmoozing with politicians and picking fabric swatches for his Gulfstream V corporate jet than studying special-purpose enterprises. As a result, his footprints inside the energy company are shallow, and his fingerprints few. Conviction will be difficult. It also isn't a repudiation of the principle, plaintively repeated by Mr. Lay last Thursday, that "everybody should be innocent until proven guilty." In the case of Enron, we already know a giant financial fraud lay at the heart of the enterprise. The convictions of former Chief Financial Officer Andrew Fastow and former Treasurer Ben Glisan established that. At stake in the Lay case isn't whether fraud was committed but whether the chief executive should be held responsible.
For the sake of American capitalism, he should.
The Enron scandal -- and those at WorldCom, Tyco, Adelphia and others -- exposed a glaring flaw in the oversight of America's top executives. At the time, three cures were suggested: the regulatory cure, the corporate-governance cure, and a third tonic, advocated by U.S. Federal Reserve Board Chairman Alan Greenspan and former Treasury Secretary Paul O'Neill, which might be called the "CEO responsibility" cure.
The regulatory cure was the first to be adopted, but is in many ways the least satisfactory. That is because the bad guys will always outrun even the most nimble of regulators, because regulations impose costs on the good guys and because regulations produce unintended consequences. I'm not yet ready to agree with those who grouse that Sarbanes-Oxley went too far. I do agree regulation is a clumsy, though sometimes necessary, solution.
The corporate-governance cure has more appeal, because it is an attempt to fix the system rather than regulate it. In the textbooks, capitalism works because corporate managers are kept in check by shareholders, who operate through directors they elect. The truth, however, is that many American directors are handpicked and handsomely compensated by the very executives they oversee. Giving shareholders more power over boards would seem a reasonable way to improve the system. That was the goal of U.S. Securities and Exchange Commission Chairman William Donaldson when he made a very modest proposal last year. The proposal would have allowed shareholder groups to nominate their own directors, but only if a majority of shareholders had expressed disapproval of the board by withholding votes at the previous annual meeting. The chief executives in the U.S. reacted as if their Gulfstreams had been grounded. Under heavy pressure from the Business Roundtable -- and from a White House eager to maintain good relations with big business during an election year -- Mr. Donaldson backed down.
That leaves the "CEO responsibility" cure. In unusually clear testimony in July 2002, Chairman Greenspan railed against the "infectious greed" that had invaded American business, arguing that the best antidote was strong and ethical CEOs. "It has been my experience on numerous corporate boards that CEOs who insist that their auditors render objective accounts get them," Mr. Greenspan said, "and CEOs who discourage corner-cutting by subordinates are rarely exposed to it. Although we may not be able to change the character of corporate officers," he concluded, "we can change behavior through incentives and penalties." That is what is at stake in the Lay case.
In their book "The Smartest Guys in the Room," Bethany McLean and Peter Elkind tell a wonderful story about Mr. Lay speaking to his employees after the scandal broke. Referring to Mr. Fastow, Mr. Lay said: "I and the board are also sure that Andy has operated in the most ethical and appropriate manner possible." A written query submitted by an employee asked: "I would like to know if you are on crack. If so, that would explain a lot." Mr. Lay on Thursday finally acknowledged that Mr. Fastow had "betrayed" his trust. (Mr. Lay's lawyer was more blunt, calling the former financial officer a "liar and a thief.") Mr. Lay added that "to the extent that I did not know what he was doing ... then indeed, I cannot take responsibility." If he gets away with this defense, plausible deniability will become the strategy in every corporate suite. If he doesn't, CEOs will understand it is their duty to know how the financial whizzes down the hall are turning business failures into earnings gains....
Ken Lay enjoyed the hundreds of millions of dollars he was paid for running Enron; now he should share in the penalties for looting it.
It's not clear to me that Murray is right. Strict criminal liability is, in some ways, an even blunter instrument than regulation or corporate governance. If I were a CEO, I would much rather have an obnoxious Calpers representative on my board than be criminally liable by frauds committed by subordinates whose financial "wizardry" I don't really understand.
Posted by DeLong at July 13, 2004 08:28 AM | TrackBack | | Other weblogs commenting on this postIn the United States Navy --arguably the most effective naval combat force ever assembled in human history-- the Captain of a vessel is ultimately responsible for *everything* that happens aboard his ship. You figure if a naval captain who gets paid less than 100K a year can be held accountable that way, a CEO who gets compensation one-hundred times that could be held to the same standard as well...
Posted by: Jeff on July 13, 2004 08:41 AMThere is a double standard at play here.
I'm perfectly happy for the Ken Lays of the world to be able to claim "I didn't know what was going on in my company" IF (and only if) they stop insisting on outrageous compensation packages on the grounds that they are the ones responsible for their company's success.
As it is, they want all the credit and none of the blame.
Posted by: Dem on July 13, 2004 08:41 AMIf I were a CEO, I would much rather have an obnoxious Calpers representative on my board than be criminally liable [for] frauds committed by subordinates whose financial "wizardry" I don't really understand.
That suggests to me that strict CEO liability might be a good bargaining chip to get CEOs to let obnoxious Calpers representatives on their boards.
Posted by: Matt Weiner on July 13, 2004 08:48 AMCEOs are supposed to be the ones doing the risk taking, analysis, and thought provoking in a company. They are the stewards of the company. They are liable to the stockholders of the company. They are the ones who represent the company to the public. If they don't accept this reponsibility, then they shouldn't accept the outrageous compensation the company gives them to compensate for them doing all this risk taking, thought provoking and analysis. Tough on them if they were incompetent. Tough on the board of directors. In this case, Greenspan is right. If the least of the employees knew that Fastow was a thug, there is no excuse for Lay to not have known it over a period of years...one financial cycle or two might be understandable, but to have a corporate culture infested with this dishonesty goes beyond the innocent person standing by watching a fiasco. ALthough Lay gets his day in court, it is difficult with the knowledge of the opthers' malfeasance to allow that he was innocent.
Bush-Lay 2004: We're all about values
Posted by: Kosh on July 13, 2004 09:05 AM"If I were a CEO, I would much rather have an obnoxious Calpers representative on my board than be criminally liable by frauds committed by subordinates whose financial "wizardry" I don't really understand."
Under Sarbanes-Oxley, if you don't understand the "wizardry" then you legally cannot certify the financial statements. And besides, if you can't understand what your CFO is doing, then you shouldn't be CEO.
Murray is right about the "giant financial fraud" and about jail time, but he and others are ignorant of the true motive for the fraud. Trading commodities, especially ones like oil and gas which are not discrete like soy beans, takes a lot of capital to cover trades and indemnify traders in trades that were not fulfilled. Enron lacked this capital, but went into the business anyway. When the insurers of such trades discovered this--it didn't take long, they became reluctant to provide insurance. At that point, Enron deliberately began to deceive the players and the markets as to their financial condition. This wasn't Fastow playing "Get Rich Quick," it was Enron playing "Deception of Insurers." It was a game sponsored by the corporation for the deception of others with the purpose of financial gain, a criminal enterprise.
If you don't believe me, ask any insurer of commodity trades on Wall Street and you will hear the same story.
I'm with Kip, if you don't understand it, don't sign off on it. Find someone who does, and put them in charge.
I don't mind the CEO compensation, so long as they justify it in their worth to society.
Posted by: Jason on July 13, 2004 10:25 AMJeff,
A captain in the US Navy is a commissioned officer of military force. He has the authority to exercise exceptional control over the people serving under him, and even if he did not those people are themselves bound by incredibly strict codes of conduct and are punishable under the vastly more rigorous military legal codes. In short, he signs away the normal rights and responsibilities of citizenship in exchange for a level of responsibility and authority over others that we never grant to people in the private sector because it not neccessary to conduct any sort of business except the business of making war.
When Lay was indicted, his lawyer was giving a sob story about how he'd suffered enough because Enron was like a child to him, so he was like a parent who'd lost a child.
Guess what? Even if he wasn't actively involved, we lock people up for fatal child neglect, too!
I'm guessing he didn't intend the analogy to be taken that far...
Posted by: Redshift on July 13, 2004 10:54 AMTHE DISAPPEARANCE OF RESPONSIBILITY
Limited Liability limits the risk of investors. The risk is transferred to 2nd parties by an implied contract and to 3rd parties by explicit government coercion.
"Corporate Responsibility" is an oxymoron.
The Principle-Agent problem becomes gigantic in a corporation the size of Enron ---- the CEO and thousands of investors have different interests. And a Board is as likely to throw in with the CEO as to look out for investor interest.
If CEOs are not responsibile for actions within the corporation, what are they responsible for, who is responsible? The question should be more about severity of the punishment.
Posted by: pedro on July 13, 2004 10:55 AMStrict Liability is normally imposed on extremely risky endeavors that are nonetheless necessary. Building demolition in a populated area is the most common example. Strict Liability maximizes accident avoidance efforts while allowing the activity to continue. The down-side is that the money and effort spent on avoidance is usually beyond the Rational level.
The effect here may be to require CEO's to spend an unprofitable ammount of time on internal financial issues to the detriment of other aspects of the CEO role. Is that a good use of the CEO's time? Or should more of the burden be shifted to the board?
Perhaps a better approach would be to increase the transparency of a company's accounts so that such "financial wizardy" cannot occur in the first place. How many investors would have pulled their money out of Enron if all those Star Wars-themed shell companies appeared on regular filings with the SEC?
Posted by: kevin white on July 13, 2004 10:56 AMI hear comments like Jeff's frequently. This is, as a friend of mine recently put it, the Darth Vader approach to accountability. When something happens, you may take other steps, but you must always execute the guy at the top.
It is the same when we hear commentary to the effect that, all after the fact considerations aside, SOMEONE should have been fired as a result of 9/11 occurring in the first place. I am a big fan of accountability, but I suspect that while periodic decapitations may make some feel better, the horrifically complicated nature of large organizations precludes anyone from ACTUALLY being in the know to the level implied.
A good chief is not necessarily one who knows every detail of organizational activity five rungs down. I would argue nearly the opposite. If we insist on public executions for every problem, we are selecting for leaders who are micromanagers, and that is not an improvement in my book.
Posted by: Jason Ligon on July 13, 2004 11:02 AMKevin,
Why are precautions beyond the "Rational level". Aren't they just doing a risk-reward computaion that has been changed because of the Strict Liability (full responsibility)?
Why transfer the responsibility to government (making government create transparency regulations and enforce them for a private contracts between investors and CEOs)? Why not enforce responsibility and make investors, boards, and CEOs police themselves. You may think that it is not "efficient", if so "efficient" to what end? maximizing freedom, maximizing utility, or maximizing the production of goods and services?
I don't mind maximizing goods and services as long as there is some justice done with respect to distribution. (I'm not trying to say that you don't think this as well -- i'm just ranting a bit )
Posted by: feeble rantings on July 13, 2004 11:38 AMOye, it's been a while since my Economics & Law classes. Let's see if I can get this right without looking like a complete ass...
Normally, the cost of avoidance is calculated by dividing the cost of the event by the probability of it's occurance. Strict Liability upset's that calculation by effectively eliminating the probability calculation. Under Strict Liability, the defending party is responsible for 100% of the cost of the accident. Therefore the avoidance cost is also 100%. No probability calculation.
Let's use my building demolition example. A company is contracted to knock down a house between a hospital and a zoo. The company is strictly liable for any damage to the surounding properties as a result of the demolition. That means if a patient with an alergy to old house dust has a window open during the demolition and dies, the demolition company pays 100% of the damages. If shockwaves from the demolition opens some cages and a tiger eats the last breeding pair of rare elk, the demolition company pays 100%.
No discounting for likelyhood. No discounting for contributory factors or other actors. The hospital could have checked patient records and rooms. The zoo could have bought better locks. None of that matters. The demolition company pays 100%.
Posted by: kevin white on July 13, 2004 12:13 PMkevin white: "The effect here may be to require CEO's to spend an unprofitable ammount of time on internal financial issues to the detriment of other aspects of the CEO role. Is that a good use of the CEO's time? Or should more of the burden be shifted to the board?"
Best of luck in getting such a shift to occur, since it would require giving up the current cronyism arrangement. How many board members of giant American corporations are not members of other boards or officers of other corporations? I have always been "puzzled" by such arrangements, since it implies that both the officer position as well as the board position can be handled on a part-time basis.
I find it appalling to think that the interests of the shareholders in General Electric (to choose an example), a company worth >$300B according to the market, with revenues of >$135B per year, can be overseen by a group of part-time people. I'm very much afraid that today's board structures merely reflect another facet of the fact that a relatively small group of people have discovered that they can acquire great personal wealth by legally "stealing" from the shareholders.
Posted by: Michael Cain on July 13, 2004 12:42 PMI am outraged that Ken Lay's lawyer would call Andy Fastow a "liar and a thief." Fastow may have dishonestly perpetrated fraud that cost millions of innocent people collectively billions of dollars, but the lawyer has really stepped beyond the bounds of human civilization with such abusive and divisive language.
Posted by: Nick Kristoff on July 13, 2004 12:57 PM"The effect here may be to require CEO's to spend an unprofitable ammount of time on internal financial issues to the detriment of other aspects of the CEO role"
How much time is unprofitable in ensuring that your company is not in the position that it cannot account for a BILLION DOLLARS?
Remind me again what a CEO does? Make strategic decisions, and supervise the executive directors? If the CFO (a board level post) is engaging in illegal, or potentially company damaging behaviour, who is responsible for overseeing that executive director? The buck stops at the top.
And if the behavior is fortune 500 company bankrupting, is the CEO, responsible for oversight of that board member, criminally negligent in his fiduciary responsibility to the shareholders?
Posted by: royalblue_tom on July 13, 2004 01:05 PMNick Kristoff made me laugh.
Posted by: KevinNYC on July 13, 2004 01:10 PMThe entire Enron debacle is a good argument for more shareholder rights.
Shareholders should be able to nominate board members, if they can get morn than XX% to sign off.
Shareholders should have to approve senior compensation deals.
Shareholders should be able to fire board members and senior management.
Why should they have these rights, because they OWN the company.
Right now, most corporate boards are with self perpetuating crony oligarchies with phony elections.
It sounds like Stalin's Russia.
Let the owners have a say in how THEIR firm is run.
Posted by: Matthew Saroff on July 13, 2004 01:31 PMKevin,
First, I misunderstood Strict Liability (I thought it meant: NOT limited liability -- that investors could be liable.)
However, I'm still not sure what you see the role of government to be(beyond M.Friedman's 4 roles: Defense, Internal securuty, Public Goods, and caring for the incomptent) Is it to maximize investor wealth?
(This is a core question. I believe much of the fuss in politics is because people either don't understand the view of the person they are talking to on this issue, or becuase they change their answer, depending on personal expediency.)
FB
Posted by: feeble rantings on July 13, 2004 01:36 PMkevin white wrote:
"Normally, the cost of avoidance is calculated by dividing [multiplying?] the cost of the event by the probability of it's occurance. Strict Liability upsets that calculation by effectively eliminating the probability calculation. Under Strict Liability, the defending party is responsible for 100% of the cost of the accident. Therefore the avoidance cost is also 100%. No probability calculation."
two issues:
1) accepting your terms, the defending party is responsible for 100% of the costs, but only when the event happens; so defendant takes the probability of occuring into account when she makes her choices. I disagree that there is 'no probability calculation.'
2) i don't know the technical def'n of Strict Liability, but I think there must be a middle ground: a CEO is held responsible for the actions his company takes. Perhaps not solely responsible, or completely, but not allowing for the "I didn't know" defense. The other day I hit a man on the street with my car; although I was driving, and he had the right-of-way, I was able to show evidence that I was looking elsewhere at the time and therefore didn't know I was about to hit him. That's unacceptable. It is my responsibility to keep my eyes open. However, I was charged with manslaughter instead of murder. That's appropriate. So should it be with Lay. Suppose he can demonstrate he didn't know: then he should be considered criminally negligent with regard to the legal responsiblity of the stewardship of the company.
Posted by: mr. obvious on July 13, 2004 02:05 PMmr. obvious,
I am with you.
SQtP
Somewhere George Stigler is smiling:
A Sketch of the History of Truth in Teaching
--------quote-----------
But the arrows of reform pass through--if they hit at all-the targets at which they are aimed, and in 1973 they hit a professor. Evil day!
In that year a young man named Dascomb Henderson, a graduate of Harvard Business School (1969) and recently discharged as assistant treasurer of a
respectable-sized corporation, sued his alma mater for imparting instruction since demonstrated to be false. This instruction...concerned the proper
investment of working capital. One of Henderson's teachers at Harvard, a Professor Plessek, had thoroughly sold his students on a sure-fire method of predicting short-term interest rate movements, based upon a predictive
equation incorporating recent movements of the difference between high- and low-quality bond prices, the stock of money (Plessek had a Chicago Ph.D.), the number of "everything is under control" speeches given by governors of
the Federal Reserve Board in the previous quarter, and the full-employment deficit.....Assistant treasurer Henderson...played the long-term bond market
with his corporation's cash, and in the process the cash lost its surplus character. He was promptly discharged...and sued.
....Henderson's attorney deliberately pursued several lines of attack....
1 ....
2 Professor Plessek did not display proper scientific caution. Henderson's class notes recorded the sentence: "I'll stake my reputation as an econometrician that this model will not [engage in intercourse with] a portfolio manager". This was corroborated, with a different verb, by a classmate's notes.
3 ....
4. Harvard University was grossly negligent in retaining (and hence certifying the professional competence of) an assistant professor whose work
had received humiliating professional criticism (Journal of Business, April 1972). Instead, he had been promoted to associate professor in 1972.
....
Harvard...asked for a dismissal...claiming that it was frivolous and unfounded. Universities and teachers could not be held responsible for
honest errors, or all instruction would be brought to a stop. .... Judge Howlson (Yale, LL.B. 1940) remanded the case for trial on the merits, and...remarked: "It seems paradoxical beyond endurance to rule that a manufacturer of shampoos may not endanger a student's scalp but that a premier educational institition is free to stuff his skull with nonsense."
...Harvard and Professor Plessek won the case...but by a thin and foreboding
margin. Only the facts that (1) the Plessek equation, as of 1969, looked about as good as most such equations, and, (2) the plaintiff could not reasonably be expected to be informed of the failure of the equation as soon as two years after it was discovered--the lag in publication alone is this long--excused the errant professor. ....
The university world received the decision with what an elderly Englishman would call concern and I would call pandemonium. ...Within a breathless
three weeks, a professor at Cornell's medical school had sent an explicit retraction of his treatment of Parkinson's disease to the last decade's graduates of the school. This proved to be only the first of a torrent of such actions; but well before that torrent had climaxed at least ninety-five suits against universities and teachers had been filed.
[much more snipped]
-------endquote-------
If you're searching for rational discouragement, this is surely a joke.
Lay has made over $50 million out of Enron's activities. If they really throw the book at him hard he might be fined a million or two and he might end up spending as much as 2 years in jail.
This is supposed to encourage CEOs to stop???
Think what you'd do with $5,000,000.
Okay, now think what you'd with with _another_ $5,000,000.
Now think what you'd do with a third $5,000,000.
Now imagine ten times $5,000,000.
The penalties are puny compared with that sort of payoff.
meno
Meno took this thread in a direction that I was thinking. Compare the penalty for a purse snatcher who ruins one person's day with the penalty for executives who ruin many people's lives. What's wrong with this picture?
Posted by: Dubblblind on July 14, 2004 07:20 AM"Compare the penalty for a purse snatcher who ruins one person's day with the penalty for executives who ruin many people's lives. What's wrong with this picture?"
That purse snatching is not a legitimate occupation. 100% of the time it is going to harm a victim, and enrich ONLY the criminal.
Bill Gates has enriched tens of millions of people besides himself.
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