The Enron Craze, by Pierre Lemieux

Enron Corp. declared bankruptcy on December 2, 2001, after what appears to have been questionable dealings, and efforts to hide them. Enron's market capitalization amounted to 0.2% of the capitalization of NYSE-listed companies only, and its debt did not reach 0.05% of total credit outstanding in the U.S. The demise of Enron should have made only a small ripple in the economy, and in the judicial system.

Instead of that, present and former Enron executives were subpoenaed before a congressional kangaroo court, and grilled by ignorant, self-righteous politicians. Richard Burr, a Republican congressman from North Carolina, exclaimed, "At the center of this economic melt-down, we find a handful of economic terrorists." When these "economic terrorists" took the fifth, they were crawling with humility: "On the advice of my counsel," they said, "I respectfully decline to answer." At the time of writing, there is a possibility that Arthur Andersen LLP, Enron's former auditor, will be prosecuted for obstruction of justice. On March 7, George Bush claimed that the faith of Americans in financial markets was shaken, and proposed his 10-Point Plan to "get back to basic capitalism." The barbarians are not at the gates, they are manning them.

The Bias for Debt

I am not defending Enron; I just want to put the focus on the statist system of which it was part. Wharton School professor Jeremy J. Siegel asked why 19th-century capitalism — which was much more "basic" than today's — worked, while there were virtually no legislated standards of disclosure. How were investors able to evaluate corporations? The answer is simple: a firm signaled that its earnings were real by paying dividends. This signaling device doesn't work anymore because of tax distortions: dividends being taxed at higher rates than capital gains, shareholders prefer the latter. While the average dividend yield on stocks was 5.8% in the 19th century, it fell below the interest rate on long-term government bonds after 1958, and is now less than 2%. Add the fact that the tax system encourages debt financing as opposed to equity, and you have the recipe for Enron types of debacle.[1]

Moreover, we need to question the simplistic idea that more disclosure of information is always better. George Bush's Plan simply affirms that "we must improve disclosure."[2] In fact, information is a good like any other, and is only worth producing as long as its marginal benefit is higher than its marginal cost. A related problem is that too much information might not be assimilated. General Electric said that it is willing to issue a disclosure statement the size of a phone book[3]; yet, there is no guarantee that investors would read it.

How do we know if enough information is disclosed? There is no way to answer this question a priori, and regulatory agencies like the Securities and Exchange Commission do not have the faintest idea. Each investor decides for himself, and the interaction of all investors with information providers — i.e., the market — will determine the optimal disclosure.

No Optimal Level of Information

There is no reason why there should exist a single optimal level of information. Some corporations might, given their own circumstances, prefer to be more secretive, and compensate investors with higher dividends for the supplementary risk. Some investors might be more risk-seekers, and be willing to trade less information and more risk for higher expected returns. Such diversity would offer more choice to investors, more flexibility to corporations, and more chances of finding the optimal rules. There is no need for standardized norms that stifle diversity, experimentation, and discovery.

Bush's Plan argues that, in effect, the information market would disadvantage investors. "Each investor must have the opportunity to analyze the performance of the company, and the risks associated with an investment," says the document. "Without proper disclosure, it is impossible for investors to make informed investment decisions . . . " Obviously, this is not true of all investors, because they would otherwise have their companies' annual meetings impose new disclosure policies. The controlling shareholders must think that more disclosure would cost them more than they would benefit. Bush is thus taking sides against these investors, and in favor of some other investors he thinks don't get the information they want. This is just one illustration of the non-minimal state necessarily taking sides against some of its subjects.[4]

Presumably, in Bush's mind, the state wants to favor small investors. Indeed, the Plan says, "sometimes it seems that the needs of the average investor are forgotten by some companies." Now, there is no God-given principle that dictates the participation of all potential small investors in financial markets, and if they do participate, it is at their own risk. Indeed, most people participate through intermediaries (mutual funds, pension funds, banks, etc.) whose role is to diversify, and manage, the risk. Paradoxically, by pretending to create a "level playing field," the state has given unrealistic hopes to small investors, hopes that must be constantly shored up by further regulations.

There is a usage in the English language that has made the slope much more slippery: using the expression "public corporation" to mean a private company whose shares are available to the general public on organized exchanges. In French, for example, "public corporation" only refers to a state corporation; a company whose shares are listed on exchanges is simply called a "listed corporation" — "société cotée (en Bourse)." The unfortunate English convention suggests not only that "the public" needs to be protected, but also that officers and directors occupy some kind of public functions. Broad-based ownership, says the government Plan, "imposes a special obligation on the officers and directors of a public corporation. . . . Therefore, the President believes we must improve corporate disclosure, make corporate officers more accountable, and develop a stronger, more independent audit system . . ."

Increased SEC Power

One of the means to "make corporate officers more accountable" is given by Proposal #5:

CEOs or other officers who clearly abuse their poser should lose their right to serve in any corporate leadership positions. This proposal, which would require legislation, would authorize the SEC to ban individuals from serving as officers or directors of publicly-held corporations if they engage in serious misconduct. At present, the SEC needs to seek court approval in certain types of cases.

A course in "basic capitalism" is not necessary to see that the power to forbid somebody from becoming an officer or director of any company that would freely choose him is completely antithetical to the free enterprise system. What is more remarkable is that such state power already exists, albeit in a restricted form. The SEC already imposes lifetime bans. According to a Wall Street Journal report, "[d]uring the fiscal year ended Sept. 30 [2001], the SEC took such action against just 33 officers and directors, though that was up from 14 during the prior fiscal year."[5] The government now wants to impose these lifetime bans of contractual freedom without judicial review.

With the exception of the ban without a court judgment and the confiscation of incentive-based compensation from executive sinners, the Bush proposals do not require new legislation. In matters relating to disclosure, to corporate "accountability," or to accounting and auditing rules, the SEC already has the legal power to act.

As usual in state propaganda, not all goals are achievable. Take Proposal #10: "Firms' accounting systems should be compared with best practices, not simply against minimum standards." How can a standard be anything else than minimum, since anybody is free to do better? If "best practices" become the standards, they are not best practices any more, or else everybody has to be the best.

To sum up, the Enron craze feeds state power, and contributes to making corporations more and more "public," i.e., regulated as state corporations even if they remain nominally private.

[1] Jeremy J. Siegel, "The Dividend Deficit," Wall Street Journal, Feb. 13, 2002.

[2] "The President's 10-Point Plan: Improving Corporate Responsibility And Protecting America's Shareholders," Wall Street Journal, March 6, 2002.

[3] Steve Liesman et al., "Enron Triggers a Slew of Proposals, But Which Reforms Will Truly Stick?" Wall Street Journal, March 7, 2000.

[4] See Anthony de Jasay, The State (Indianapolis: Liberty Fund, 1998).

[5] Jacob M. Schlesinger and Michael Schroeder, "Bush Unveils Plan to Strengthen Accountability for Corporations, Wall Street Journal, March 8, 2002.