The Damage Done

by Russ Roberts on May 26, 2006

in Crime, Regulation

The usually reliable Wall Street Journal gets it wrong (sr) assessing the damage caused by  Lay and Skilling et al  in the Enron debacle:

Meanwhile, the damage done from this fraud was terrible: tens of
billions of dollars in market value, $2.1 billion in pension
obligations, and 5,600 jobs lost in the December 2001 collapse.

That isn’t the damage from their fraud. That’s the damage done when any company is poorly run—lost value and employees having to come to grips with lost pensions and having to look for work.  In the case of Enron, the market value was apparently a phantom—the fraud merely covered it up.

The real damage was the cost to capitalism imposed on all of us whether or not we worked for Enron or held its stock. The real damage was the disillusionment Lay and Skilling caused in the hearts and minds of Americans and the political response to that disillusionment, a new set of regulations that were unnecessary to catch and punish the Lays and Ebbers and others and that instead has made it dramatically more costly for a company to go public rather than remain private.

Lay and Ebbers and the rest of them betrayed their workers and their stockholders.  But most of all they betrayed the ethos of their professions that led to harm to all of us.

In that sense, these dishonest CEOs are most analogous in their impact not to a CEO who runs a company poorly that leads to bankruptcy, but rather to the shoe bomber. The shoe bomber’s evil desire to kill a few hundred innocent people never came to fruition. But the result is that air travel is less convenient for hundreds of millions of people forced to remove their shoes and be inconvenienced with little gain in security.

The crimes of the Enron execs and their ilk are not as heinous as the intended crime of the shoe bomber. But their immorality in violating their fiduciary commitments did far more than harm the people connected to Enron. The regulatory environment that was the result of their misbehavior is the real damage done. And that regulatory envirnment has numerous costs with few if any benefits. Millions of people bear those costs in unseen ways. To paraphrase Neil Young:

I’ve seen the scandal and the damage done
A little part of it hurt everyone
Gone, gone, the damage done.

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ipninja May 26, 2006 at 10:35 am

I really don't think you can blame bad legislation on the criminals that inspired it. Are you really going to let the government in office off that easy?

Second, I really believe that Enron did create some value as a company, just not as much as the company said it did. If Enron had been more honest about it's financial performance, we would not have seen such a doomsday collapse.

Caliban Darklock May 26, 2006 at 11:58 am

I think you *can* blame bad legislation on the criminal who committed the unforeseen crime that inspires a government to make laws intended to prevent it in the future.

Wow, what a sentence.

Basically, the criminal was committing a crime. The legislature is just trying to improve the law. I think the evil intent of the criminal is more blameworthy than the stupidity of the legislature.

save_the_rustbelt May 26, 2006 at 12:05 pm

I presume you are referring to SarbOx.

Lay and Skilling were only a small part of the avalanche that caused SarbOx.

Is it good legislation? Not really. Is it costly? Yes.

I propose the following:

1. repeal SarbOx

2. Have the SEC appoint all directors for public stock companies, phasing in over 4 years.

Board members are still practicing crony capitalism rather than their duties. If you doubt that look at the news reports on the Home Depot annual meeting.

Much cheaper.

Liberteaser May 26, 2006 at 12:27 pm

Two things:

(1) One cannot hold Lay and Skilling responsible for the government's "response" to their behavior and teh subsequent misery it has caused. The government's "response" is an intervening cause that breaks the chain of causation created by Messrs Lay and Skilling (Yes "Messrs"– the journal uses it).

(2) This chain of events is highly analogous to the attack of September 11 and its response. In both cases, our politicians used a negative event, feeding off of the people's passions, to take action that would not prevent the same event and go far beyond what is necessary to prevent the same event (Iraq, NSA, TSA, etc). In the end, the american people, AS A WHOLE, americans are more pained by governmental "responses" to Enron and September 11, than they were by Enron and September 11 themselves.

TW May 26, 2006 at 2:33 pm

[2. Have the SEC appoint all directors for public stock companies, phasing in over 4 years.]

Either you really want to destroy every publicly-held company in the country, or you don't realize just how reckless this statement is. It should be clear that the cronies of the leading political party at the time would be placed as directors of companies, irrespective of their abilities to help those particular companies.

The blame for poor Boards of Directors lies with shareholders, who either keep electing them or just don't vote. Those are the owners of the companies, after all, and with that power comes the responsibility to actually vote.

It truly amazes me that the same person who has his entire retirement invested in a few stocks will not vote for the directors of those companies, but will instead go to great lenghts to cast multiple ballots for the likes of "American Idol," which he clearly has no vested interest in!?

Forbes May 26, 2006 at 2:33 pm

Save the Rustbelt (what a telling nom de net) apparently advocates usurping shareholder (the owners of the corporation) rights in favor of the government controlling private capital. (Good god, the Kelo decision was bad enough.)

Where have we heard such philosophy propounded before?

It's truely amazing–as I think Prof. Roberts has pointed out before–that the same people that believe that the government doesn't get anything right (pick an issue), or shouldn't be trusted with certain powers or authorities, would hand over control of the private sector economy to the very same incompetant bureaucrats.

Never again do I need to wonder the effects of suffering schizophrenia.

save_the_rustbelt May 26, 2006 at 4:49 pm


Actually I'm not advocating that at all.

The current crony system for board members has allowed corps to take repeated actions against the interests of the shareholders, not to mention totally abandoned internal controls, therefore we get SarbOx.

Can a corp with millions of shareholders really have any sort of fair election? Look at the results of the baord votes, and the lack of success of opposition proposals.

Currently management picks their own board members, conducts a sham election and then goes into the public markets for capital.

Let's try another option, public stock corporations can either 1) continue with SarbOx or 2) have directors selected by the SEC. I wonder what the selections would be?

We do agree on shareholder voting. Text messaging maybe?

MjrMjr May 26, 2006 at 4:56 pm

Wow. This is one of the best posts I've read on this blog ever. Russell, I agree with everything you said and couldn't have possibly put it better myself.

Are Lay and Skilling personally responsible for SOX? Eh…. Does the gov't get a pass for implementing burdensome regulation that will cause deadweight losses? No, they really shouldn't. Did Lay and Skilling wish to see such regs passed? I highly doubt it. But I don't think it can be disputed that SOX would not have passed if it weren't for the actions of Lay/Skilling/Enron.

Skilling and Lay did ignore their moral and ethical responsibilities to employees and shareholders, and now here we are. SOX probably needs to be reformed-along with lots of other financial regs, I'm sure-but I think *part* of making sure something like this never happens again is a clear condemnation of the actions of Lay and Skilling. I never expected to read it here on CafeHayek, but wow, great post.

John P. May 26, 2006 at 7:14 pm

I think a couple misconceptions underlie save the rustbelt's comments. First, the main way that poorly run public companies are disciplined is by stockholders' selling their stock. Stockholders vote with their feet immensely more often than they vote with ballots. A drop in stock price then makes it harder for a company to raise capital and brings greater scrutiny upon the company's management. This system works well, and there's no need to give stockholders more of a voice in corporate governance.

Second, what Lay and Skilling did that was so harmful was not "cronyism." Cronyism is not a problem in the normal course of things because, if it really affects the company's performance, stockholders will sell and the company is taught a lesson in the same way that the crappy restaurant that nobody goes to is taught a lesson.

Lay and Skilling's sin was fraud — they hid the riskiness and flimsiness of Enron's business from investors. Their misdeeds were basically the same as selling a house while concealing from potential buyers that the foundation has been ruined by termites.

The idea behind SOX was to make this kind of fraud harder to commit, though as others have pointed out the cure has been more costly than the problem. There will always be fraudsters, and there will always be investors who refuse to believe that something really can be too good to be true. The proper response is civil and criminal action through the courts, and taking the lesson of caveat emptor to heart, not additional regulatory burdens that make it even harder for companies to break even.

johngaltline May 27, 2006 at 8:51 am

I think it's easier than all that.

Skilling and Lay are going to jail, and ultimately somebody's going to jail for all of the accounting scandals that came to light around the time of Enron.

Sarbanes Oxley would only be necessary if these people were all getting off, which does not appear to be the case.

What's called for is stiffer penalties and better enforcement of existing laws. Sarbanes Oxley is a huge, unnecessary regulatory tax on business that spoils the whole barrel for the sake of a few bad apples.

Zephyr May 27, 2006 at 3:26 pm

Sarbane Oxley is driving capital out of the US. Companies will increasingly use foreign domiciles for their IPOs to avoid the increasingly burdensome regs in the US and pay lower taxes to boot.

We are killing the goose.

John Powers May 28, 2006 at 7:50 pm

I always thought Enron was a smoke and mirrors operation, and I read their balance sheet very carefully, which indicated

1) Accurate, but not very healthy cash flows
2) A bunch of off-shore investments
3) A lot of PR that would be very difficult to back up.

So I did not invest in the company. Am I guilty of insider trading for being a cautious investor rather than beleiving something too good to be true?


LowcountryJoe May 28, 2006 at 10:42 pm

I guess that I'm just an emotionally bankrupt individual but the words 'caveat emptor' and 'caveat venditor' enter my mind and mean something to me.

When the advisory 'caveat erus' starts having to be given before (and especially after) transactions are made, then I'll be emotional…I'll be down right angry at how soft we've become and just what we think we're entitled to. This is why it's wise to diversify one's holding and to be proactive in one's ownership in order to minimze risks. Asking for the nanny state to handle those affairs might seem wise, initially, but do you really think that the nanny state wont bring about its own heavier risks?

Luke Fitzhugh May 30, 2006 at 2:51 pm

Lay and Skilling and probably others have committed a serious crime and deserve harsh punishment. I do not propose any new legislation. I propose that the laws protecting private property be enforced more vigorously and that such individuals be made paupers and prisoners, in addition to seizing all of their assets.

My problem with anarchy is the issue of private enforcement of property rights. I subscribe to min-archy, where the only role of government is to lead the apprehension, conviction, and punishment of criminals, i.e., violators of private property rights (life, physical property, liberty).

Bill Waddell June 1, 2006 at 12:55 am

The Enron boys are certainly criminal, and no one can disagree with Mr. Roberts that the real impact was the further undermining of all business in the popular culture (as if it did not already have a bad enough name), which can only lead to more government intervention.

The government, however, is fully responsible for SOX. SOX is just the next step in a long line of regulations aimed at relieving investors and the entire investment community from having to do any due diligence.

No thinking person would want the SEC or any other government or quasi-government agency appointing directors to any company. They can't even appoint capable people to fill most local dog catcher's jobs. Perhaps adding something to the criminal code for gross negligence would be more appropriate. The Enron boys had bosses, didn't they? The board members who did their job in such an aloof manner that billions could be vaporized under their noses ought to be in the same cell block as Skilling and Ley.

A study conducted by the Center for Automotive Research a few years ago to pin down who the investors in GM were is revealing. Almost 80% of the stockholders did not plan to hold their stock for more than 9 months. Investors today don't buy ownership in companies – they merely rent the company for a few months – and throw temper tantrums if management does not pull a stock increasing rabbit out of their hat by the end of the next quarter.

The investment community complains about cronyism and the old boy networks that control the boards? To them an 'old boy' is anyone who has been affiliated with the company for an entire year.

Half of the fund managers and day traders holding Enron stock when the music stopped probably couldn't tell you what business Enron was in. No crocodile tears from me for the poor folks on Wall Street who view capitalism as a casino game.

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