Published in the Laissez Faire Electronic Times, December 23, 2002
The Anti-Capitalist Witch-Hunt
by
Pierre Lemieux
The 80s saw assaults on insider trading and takeovers. Michael Milken, the inventor of junk bonds, was sent to jail for committing half a dozen regulatory offenses. The flurry of attacks on unethical business behavior followed well into the 90s. "The New Crisis in Business Ethics," the title of an April 20, 1992 Fortune article was only one example among many. "To meet goals in these tough times," explained the subtitle, "more managers are cutting ethical corners." Under titles such as "You Don't Have to Cheat to Win,"[1] management ethics gurus were targeting self-interest, economic freedom, and competition.
What we have seen recently – Enron, WorldCom, the assault on stock market analysts, etc. – is, by and large, only a remake, under different excuses, of the corporate witch-hunt of the 80's. Consider the following hints: the recent so-called scandals were blown out of proportion – assuming that there were scandals in the first place; and the moral condemnation is based on the double assumption that honesty is a clear-cut, transcendent concept, and that the state is more efficient than markets in furthering honesty.
I have argued in another article that the Enron case was a political tempest in a statist teapot.[2] Enron had $21 billion in assets on its balance sheet, plus a couple of billions in off-balance sheet liabilities that were questionable but had been reported in footnotes to the company's financial statements. WorldCom's crime basically lies in erroneous accounting.
Accounting rules are largely arbitrary.[3] I don't remember which economist said that accounting conventions are like religion, that is, meant to give answers when there can be none. At any rate, accounting rules are more efficient for internal control purposes than for conveying information to investors. Indeed, the only proof of realized profits is dividends paid, and the only reliable indicator of future profitability is market evaluation of a company's shares. There is no substitute for actual market processes, subjective evaluation, and entrepreneurship. Let's not delude ourselves into thinking that generally accepted accounting principles (GAAP) can give us the real, complete picture of a company's prospects.
The American state's reaction to the so-called business scandals was to bring business executives before congressional kangaroo courts where self-righteous politicians made them feel guilty of something, and, then, to adopt the Sarbanes-Oxley Act which, as Paul Craig Roberts writes, "criminalizes accounting mistakes."[4] Of course, banana republics all over the world followed suit.
Minimal honesty is required for any economic system to work, but what is honest depends in part on what people generally expect. Consider the case of Philippe Kahn, founder of software maker Borland International in the 80s. Kahn needed an advertisement in Byte magazine to get his products off the ground. Since he needed good credit terms, he fooled the magazine into thinking that his start-up was a well-financed, venture-backed company. The day the Byte sales rep's visit was expected, Kahn hired actor extras to play employees, arranged for the phones to ring non-stop, and even left a fake advertising plan lying around for the sales rep to see. By most definitions of the word, Kahn lied, but his behavior was probably not inconsistent with shared expectations in such circumstances: entrepreneurs are a special brand, and sales reps are not virgins either. When we say that honesty is necessary, we mean – at least in large part –that respecting other people's expectations is required.
There is no reason to believe that the state is better placed than the market and evolved rules to provide standards of honesty. Indeed, states often do much worse than bad capitalists. Consider the federal government of Canada, whose revenues are of the same order of magnitude as Enron's sales before bankruptcy. The government's balance sheet shows a net debt of nearly $600 billion, plus at least $500 billion in off-balance sheet liabilities (figures in Canadian dollars).[5] The Auditor General of Canada recently revealed that the federal government has spent close to one billion dollars on registering guns and gun owners without respecting simple accounting standards, and without obtaining the proper authorization from Parliament.[6] There is no reason to believe that the state can moralize markets. In fact, it is more likely that markets will moralize states by providing individuals with escape routes from control and tyranny.
Competition provides automatic checks against economically or morally questionable dealings, by allowing shareholders to vote with their feet and sell their shares. For more than two years, WorldCom's shares had been doing badly relative to the Standard & Poor and NASDAQ indexes. Of course, the relatively bad performance of WorldCom's shares does not mean that the market had perfectly forecasted the company's problems. It does remain true that markets are more likely to discover problems than state-mandated procedures.
The main problem with Enron, WorldCom, and the "mixed economy" in general, is that much free-market signaling has been short-circuited by state intervention. How did 19th-century capitalism work with virtually no legislated standards of accounting or financial disclosure? As Richard M. Salsman writes, "The first public firm in the U.S. to hire an accountant and issue audited statements was U.S. Steel Corp, in 1903."[7] 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 now works very badly 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 is now less than 2%.[8]
The attacks against "unethical" corporations point mainly not to flaws in capitalism but to state failures and to the continuing anti-capitalist witch-hunt.
The criminalization of insider trading provides a good example of a fabricated crime. Ask George Soros. The anti-capitalist international speculator who argues for politically-correct corporate governance and more regulation of financial markets is actually tasting his own medicine: He is being prosecuted in a French criminal court for insider trading in a 1988 politically dictated raid on Société Générale.
[1] See, for example, Kenneth Blanchard and Norman Vincent, The Power of Ethical Management: You Don't Have to Cheat to Win (New York and London, 1988).
[2] See my "The Enron Craze," Laissez-Faire Electronic Times, Vol. 1, No. 6 (March 25, 2002); available at http://www.pierrelemieux.org/artcraze.html.
[3] See Paul Kedrosky, "The Witch is the Fraud," Financial Post, June 29, 2002, p. 11.
[4] Paul Craig Roberts, "Criminalizing Business," at http://www.townhall.com/columnists/paulcraigroberts/pcr20021026.shtml (visited December 15, 2002).
[5] Pierre Lemieux, "Our Government: The Ultimate Enron," The Financial Post, June 25, 2002; available at http://www.pierrelemieux.org/artenron.html.
[6] Auditor General of Canada, Report 2002, (Ottawa: December 2002), Chap. 10; available at http://www.oag-bvg.gc.ca/domino/reports.nsf/html/02menu_e.html (visited December 15, 2002).
[7] Richard M. Salsman, "Audited by the State," Financial Post, June 29, 2002, p. 11.
[8] Jeremy J. Siegel, "The Dividend Deficit," Wall Street Journal, Feb. 13, 2002.