Send to a Friend <% dim printurl printurl = Request.ServerVariables("URL")%> Version

July 11, 2002, 8:45 a.m. The Regulators Gather On the corporate scandals. By NR Editors, from the July 29, 2002, issue of National Review

atching the liberal mind go to work on the recent corporate scandals has been instructive. It turns out that accounting frauds and irregularities are a reason for new regulations when it comes to the private sector; for new subsidies, when it comes to Amtrak. Pension funds that deprive workers of choice, put all of their retirement assets in one basket, and withhold useful information from them are a monstrous crime in the private sector; but Social Security is a sacred trust. When the Bush administration helps companies, whether through action or inaction, it is typical Republican sympathy for fatcats; when they let companies go bankrupt, they are displaying typical Republican callousness toward workers and small investors. After years of neglect, liberals are suddenly interested in the new investor class — now that the goal of restoring its confidence in the markets is the hot justification for regulation.

The ideological malarkey that the corporate scandals have called forth from the dirigiste party in American life is at least sincere. The same cannot be said for the partisan opportunism to which they have also given rise. Al Gore says that Enron, WorldCom, and the rest show us what happens when Republicans are in charge rather than unnamed solons who would side with "the people, not the powerful." Tom Daschle says that anti-regulatory zeal, impliedly Republican, led to corporate malfeasance.

A little perspective, please. The corporate behavior now under the microscope occurred mainly during the later Clinton years. It is the subject of political controversy now only because first the market and then federal prosecutors began to uncover and to punish it during the Bush administration. Nobody has even suggested an alternative course of action that Bush or his men could have taken since January 2001 that would have mitigated the harm done by this behavior. Harvey Pitt, the head of the Securities and Exchange Commission, has been under heavy fire from Democrats and John McCain for his ties to the accounting industry. But these critics do not criticize any specific decisions he has made as SEC chairman. (His ties to the industry were well known in 2001, by the way, when the Senate voted to confirm him in a voice vote, reflecting the lack of opposition to him.) And opposition in the 1990s to regulation of the accounting industry — much of that opposition justified — was a bipartisan affair.

Some Republicans, in response to these potshots, have taken to saying that the scandals are a result of the lax ethical tone and spotty law enforcement of the Clinton administration. That, too, is a stretch. Lenders and investors get careless in the late phases of booms, especially booms as spectacular as the last one; some of them are bound to give money to the wrong people, get burned, and grow more cautious. Some law-breaking will always occur, under any legal regime.

The policy changes being discussed in Congress are more mischievous than useful. Some "reforms" would muck about with an American success story: the work-based pension programs that have enabled scores of millions of people to invest in the markets. People continue to appreciate the opportunity to invest: For all the talk about investors' lack of "confidence," the flow of funds into the markets remains positive. Another congressional target is stock options. Stock options were designed to increase executives' incentive to get companies' stock to appreciate. But in some cases, poor design led to bad incentives: CEOs could create momentary blips in their stock price and cash out — a clear abuse that companies should curb. A battle royal is being fought in Washington over just how stock options should be disclosed, which we will stay out of since the stakes seem rather small. But the proposal by Sens. Carl Levin and, yes, John McCain to raise taxes on options would be a real blow to start-up companies, which cannot afford to pay high salaries today and therefore must use options to promise rewards tomorrow.

Sen. Paul Sarbanes's bill to regulate the accounting industry should also be defeated. It creates multiple, overlapping bureaucracies to combat fraud — the exact reverse of the organizational reform that everyone rightly agrees makes sense when it comes to homeland security. The new bureaucracies would have substantial power but little accountability. The bill also minutely regulates what accountants can do rather than letting an independent board make those decisions. It's a bad idea to put such policies in law in the heat of the moment, because if they turn out to be counterproductive it can take a very long time to change them. As Sen. Phil Gramm points out in opposition to the bill, it took Congress more than six decades to undo the banking regulations Congress passed during the Depression even though they were clearly antiquated by the 1970s. Other provisions of the bill seem designed to create opportunities for trial lawyers rather than protections for investors.

We do not deny that there are policy reforms that could improve corporate governance. Of these, the most important is to end the tax code's deep bias against the payment of dividends — which are a signal to investors that there is something real to corporate earnings. Since 1993, the tax code has also skewed decisions about executive compensation: Salaries above $1 million are not deductible, but stock options are. Both the federal government and many state governments have made hostile takeovers more difficult. Yet the prospect of a takeover is a powerful incentive for management to hew more closely to stockholders' interests (to avoid wildly inflated executive salaries, for example). A loosening of restrictions on insider trading and short selling, finally, would make capital markets more efficient processors of information. Stock prices would be grounded more in information, both positive and negative, and less in hype.

None of these policies stands a prayer of being adopted. They would be easy for liberals to caricature if the Bush administration even proposed them. Bush is already defensive about the corporate scandals (more defensive than he would be, it's worth noting, if he had mounted a serious assault on corporate welfare before now). His response to the political pressure has emphasized the need for tougher penalties for law-breaking: a reasonable focus, given that all of the corporate scandals in the news appear to have involved criminal activity. He would close loopholes so that executives would not be able to keep any proceeds from fraud, and would be unable to transfer money from their firms to themselves while under investigation. Executives found to have committed abuses would be barred from ever serving as officers or directors of publicly traded companies again. Bush also called on companies to provide shareholders with clear-English explanations of executive compensation packages, and to let them vote on stock options for execs. He would increase spending for the SEC.

The details of Bush's plan can be quibbled with, but it is superior to the congressional Democrats' regulatory agenda and anti-corporate rhetoric. The real work of corporate reform, however, will take place elsewhere. Investor confidence will not return to its 1990s levels, nor should it, until investors and lenders — especially the largest players — make corporate America work better. Since their money is at stake, they have both the incentive and the ability to do so. Washington has neither.