The Fallacy of Giants | Part Two

Essay by J. Richard Finlay

The blind eye which shareholders and analysts too long cast upon the abuse of excessive CEO pay is now being turned to the recent trend of monetizing ethical abuse. Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium. 

Continuing from Part I

One of the defining features of today’s world of big business is that, too often, shareholders have been willing to turn a blind eye to any amount of pay to a CEO, no matter how disproportionate, as long as they were getting impressive returns each quarter.  Never mind how many times poorly crafted compensation devices gave incentives to CEOs to artificially push up the stock when such growth could never be sustained in the long run.  As I suggested to the U.S. Senate Banking Committee long before the financial meltdown that traced its roots in part to unsound compensation schemes:

The most corrosive force in modern business today is excessive CEO compensation. Such lofty sums tempt CEOs to take actions that artificially push up the price of the stock in ways that cannot be sustained, and to cash out before the inevitable fall.

Our comments on these pages and elsewhere over the years have also attempted to rebut the most common justifications frequently advanced by boards as to why CEO pay needs to be at the level to which it has skyrocketed.

But the inescapable lesson of history appears to be that no boardroom scandal or financial meltdown is so great, no gap in wealth or income is so wide, that it will deter CEO pay from its self-appointed destiny of creating the wealthiest professional class in the history of the world.

Now a view is emerging in many boardrooms and on Wall Street that appears to regard ethical and legal transgressions, even the kind that result in multi-billion dollar fines, penalties and settlements, as mere transactions.  This is the case with JPMorgan Chase, whose profitability is so vast its shareholders are prepared to accept a record settlement with the U.S. justice department for $13 billion (among other penalties) as just another cost of doing business. The stock has risen 28 percent in the past 12 months.  Other examples abound, including Bank of America’s $9.5 billion to settle government actions involving federally insured mortgages, $1.2 billion paid out by Toyota and $7 billion in penalties by drug makers GlaxoSmithKline, Pfizer and Abbot.

It is not as if the ethical and legal dimension of business has suddenly dropped onto the corporate landscape unexpectedly. There are more compliance officers and university think tanks on ethics than at any time in the history of business.  Every publicly traded corporation has a code of ethical conduct. Company websites all make reference to being committed to the highest standards of ethics and honesty.  Most CEOs will give an annual keynote speech somewhere showcasing the social responsibilities of their business.  I’ve written many of them over the years myself.   Enron had a stellar reputation for commitment to high ethical standards.  Its CEO, Ken Lay, liked to be known as “Mr. Business Ethics.” But between the words and the actions of too many companies there falls an ethical shadow.   It is much easier to simply assume a standard of ethical performance than it is to subject it to the scrutiny and testing it actually requires.

History is littered with the bleached remains of fallen giants, even of the corporate species. Nortel and BlackBerry not long ago led their industries. Today, one has vanished and the other is quickly disappearing.  Some years ago another Canadian institution, Royal Trust, collapsed under the slumbering eyes of inattentive directors and stunned regulators.  Livent was North America’s largest publicly traded theatrical entertainment company. But its most artistic accomplishment came in the form of the highly creative, but decidedly unlawful, accounting engaged in by its Toronto-based founders Garth Drabinsky and Myron Gottlieb, who both swapped the company’s swank Manhattan condo for sentences in a Canadian prison.

General Motors had a hammerlock on the North American auto market that was thought to be unbreakable, until it limped pathetically to the wicket of government assistance and declared bankruptcy.  The “new” GM is today being rocked by the lingering effects of a culture that dismissed the risk of customer deaths from defective ignition switches as an acceptable business cost. Microsoft, once the dominant force in consumer software to the point where it actually fixed prices, has been reduced to selling software for competing Apple iPads on the rival iTunes store as consumers abandon its signature Windows software in droves.  And to the pantheon of vanished business icons, Bear Stearns and Lehman Brothers are now fully inducted, as are their former leaders, Jimmy Cayne and Dick Fuld.

Like many other companies, they were lost to the all-too-common, but entirely avoidable, affliction of hyper-ego and deficient common sense.  Before the crisis that claimed them, we often asked here if some of these companies actually had a real board of directors, since it seemed there was little evidence of them when they were most needed.

In situations like these, and in many others, when disaster strikes the board of directors typically professes surprise and claims to have no idea what could have caused it.  Memo to board secretaries everywhere: Have a full-length mirror installed in the boardroom.

The idea that there are few outcomes that are not insurmountable when a company skates over ethical and legal boundaries, that a board can throw money at any type of egregious conduct to get past it, is fundamentally subversive to the well-being of both capitalism and society. It feeds the delusion, commonly held by many who enjoy great wealth and power, that certain companies are endowed with a financial shield so impenetrable it makes them invincible to the consequences of their actions.  This same view creates a culture of moral hazard where the scale of the transgressions, and the costs necessary to remedy them, inevitably keep getting bigger and bigger until the unthinkable calamity occurs.  As the lessons of the great financial crisis of recent years demonstrate, when the unthinkable does happen, the CEOs whose misjudgments caused it have long fled with their trove of stock options profitably cashed out, while ordinary shareholders, and occasionally taxpayers, are left to pick up the pieces.

Far more important than the loss of any one giant, however, is the integrity of the system of capitalism itself.  Capitalism cannot survive if its leaders, guardians and gatekeepers remain willing to tolerate such costly misbehavior.  Nor will society, whose support it requires, endlessly abide a system that does not convincingly demonstrate that it recognizes a sacred obligation to the public for upholding a standard of ethical conduct that goes well beyond what has been evidenced by many firms in recent years.  Lest there be any doubt, twice in the past 100 years, capitalism has effectively turned to government for its very survival in what amounted to a public bailout from the epidemic of excess and misjudgments that led to massive job losses and social dislocation.

It would be the height of folly for the titans of Wall Street and elsewhere to conclude, as a result of these recent multi-billion dollar settlements, that they can simply write a cheque and continue on with business as usual whenever moral impediments stand in the way of increased profitability and outsized compensation.

Business has misjudged the reaction of society to a number of major issues over the years, from the dangers to food safety and the exploitation of child labor to threats to the environment and the need for safer cars.  The results were not particularly welcomed by business nor were they predicted by it.  And the business world did not exactly distinguish itself by the silence of its leaders in the early phases of the subprime meltdown or for presiding over an inadequately governed system that let America down to the point where corporate welfare through the generosity of government became capitalism’s only hope.  When high profile tycoons like former GE CEO Jack Welsh and Home Depot’s billionaire co-founder Ken Langone bemoan the expressions of antipathy toward Wall Street and big business, voicing puzzlement over its cause, as they regularly do on CNBC, for instance, they betray a larger disengagement from the forces that shape the social and political dimensions of modern capitalism.

Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium.  A firestorm of outrage may be in the waiting.

In that context, it is not unreasonable, and certainly not imprudent, to suggest that if a more fair and honest culture consistent with the core values with which America has always approached its concentrations of power, is not soon embraced, if the idea that ethical abuse can be monetized is not quickly dispelled starting with capitalism’s most valued icons, the costs to investors and to society will be measured in more than the Sagan-like billions and billions tallied thus far.