 t
is becoming increasingly clear that many of the activities that got
Enron in trouble are pervasive throughout corporate America. Consequently,
some of the blame for its behavior must go to the business schools,
management gurus, money managers, and financial analysts. They not
only turned a blind eye to unsound management practices, but implicitly
encouraged them. In short, to prevent future Enrons will take more
than
making examples out of Ken Lay and other Enron executives.
Twenty-two
years ago, two Harvard Business School professors, Robert Hayes
and William Abernathy, wrote a highly influential article for the
Harvard Business Review entitled, "Managing Our Way
to Economic Decline." The gist of the article was that widely
practiced management techniques were in part responsible for the
decline of American industry.
In particular,
Hayes and Abernathy criticized managers for having too short-term
a focus. Companies were avoiding investments that might take years
to pay off, in favor of those with a fast return. Moreover, there
was an increasing emphasis on cash flow as the measure of success.
These and other elements of managerial style at many large corporations
were making them risk-averse, conservative, and myopic.
Said Hayes
and Abernathy, "We believe that during the past two decades
American managers have increasingly relied on principles which prize
analytical detachment and methodological elegance over insight,
based on experience, into subtleties and complexities of strategic
decisions. As a result, maximum short-term financial returns have
become the overriding criteria for many companies."
The Hayes and
Abernathy critique was sometimes converted into a criticism of the
trend toward services and away from manufacturing in the U.S. economy.
The problem, many said, was that the U.S. was no longer producing
"things." This was not correct. First, Hayes and Abernathy
never criticized the service sector or treated manufacturing as
paramount; their criticism applied to all businesses. Second, although
manufacturing
employment had fallen, real output in the manufacturing sector as
a share of the real economy was about the same in 1980 as in 1950.
A more valid
criticism of Hayes and Abernathy was that they understated the way
government policies helped bring about the bad behavior they observed.
High inflation and tax rates, combined with growing federal regulation
of business, encouraged companies to manage for the short-term.
If they took risks and achieved "windfall" profits, they
were denounced as greedy and their profits were taxed away. Under
the circumstances, any manager who did not behave as Hayes and Abernathy
described would have been foolish.
Thankfully,
the election of Ronald Reagan changed the economic climate and the
corporate culture in the U.S. Tax rates were cut, inflation was
sharply reduced, and risk-taking and entrepreneurship were celebrated.
Within a short time, investors
and managers discovered new and better ways of responding to market
demands. Whole industries — like the auto industry — completely
reinvented themselves, returning again to the top ranks of world
businesses.
At the same
time, innovations in finance, especially invention of the "junk"
bond, made corporate takeovers easier. Although loudly denounced,
so-called corporate "raiders" like T. Boone Pickens put
the fear of God into complacent managers, forcing them to shape-up
or ship-out. Suddenly, for the first time, shareholders had a way
of disciplining corporate managers who failed to deliver profits.
I believe that this was a major reason for the turnaround in American
industry in the 1980s that established the foundation for growth
in the 1990s.
Unfortunately,
a backlash against corporate raiders set in. Michael Milken, inventor
of the junk bond, was jailed for nothing more than making too much
money too fast. As a result, hostile takeovers have largely become
a thing of the past. Without the threat of a takeover, managers
have been able to go back to ignoring shareholders, treating them
like a nuisance, and giving themselves bloated salaries and perks,
with little oversight from corporate boards.
Now insulated
from shareholders once again, managers could engage in unsound practices
with little fear of punishment for failure. Where Enron was exceptional
was in suborning its own accountants in order to keep financial
analysts and money managers in the dark about what it was doing.
Consequently, I believe that Arthur Andersen is, if anything, even
more culpable than Enron. It failed its responsibility to protect
Enron's
owners and employees by keeping management honest.
It seems that
we have come full circle, back again to the excessively short-term
focus that Hayes and Abernathy decried 22 years ago. Clearly, Enron's
obsessiveness with producing quarterly profits contributed to the
unsound financial practices that got it in trouble. It remains to
be seen whether financial markets will once again rise to the challenge
and discover new methods of disciplining corporate managers the
way hostile takeovers did in the 1980s.
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