RUSS ROBERTS

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Curing What Ails Corporate America

From the St. Louis Post Dispatch

(The title has been changed to protect the author.)

When the prizes get bigger, people run a little faster, jump a little higher, try a little harder, rest a little less often and do all the things competitors do to get an edge.

They also cheat.

Over the past 25 years, interest in sports has grown dramatically. As a result, salaries, television rights and championship money are all much, much higher than they once were.

So athletes train longer and harder. Coaches get paid more and stay up later analyzing film. Universities compete for television contracts and post-season pay-outs by devoting more resources to athletic facilities.

Look at highlights from men’s college basketball from the 1970s. Today’s players are men; yesterday’s look like boys. That’s not evolution. It comes from hitting the weight room and maybe stopping by your favorite street-corner for pharmaceutical assistance.

Because when the prizes get bigger, some people cheat. They break the law. They violate the implicit and explicit codes of conduct. Baseball players take steroids. College football coaches recruit more violent players who act less and less like students. A 1997 survey of the NFL found that over 20 percent of the players had a criminal record.

Most if not all of those rapists and felons went to college. Why would universities allow such people to represent them? When winning gets more profitable, people do things they wouldn’t think of doing when there’s less money on the table.

Which brings us to the current state of corporate America. Alan Greenspan recently blamed “infectious greed” for the increase in corporate crime. But were people really immune from greed in more placid times? No. What changed in the business world was the same thing that changed in the sports world. The prizes got bigger.

Through most of the 20th century, a dollar of earnings added roughly $15 to the value of a company’s stock. But in the past five years of the century, the multiple went past 20 and then into the previously uncharted territory past 30. So the return to earnings went up. And because of the widespread use of stock options, executives and employees had an even bigger stake in the market than before.

So there was a huge increase in the ever-present incentive to increase earnings. One way to increase earnings is to create new products that people value. A second way is to make a pre-existing product better or cheaper. Many corporations and CEOs followed these paths, prospered and benefited others. But there is a third way: Cheating and lying to inflate accounting profits artificially. That path rewards the cheater at the expense of others.

So what’s to be done?

Put the cheaters in jail. Use existing laws to take away ill-gotten gains and return that money to defrauded investors. Expand the staff at the SEC to uncover existing and future wrong-doing.

Let corporations compete to convince skeptical investors that their books aren’t cooked. Coca-Cola recently announced it will put stock options on the books as expenses. Here in St. Louis, Emerson and Charter Communications have announced that they will join that movement. Good idea? Let investors decide, not Congress. If investors value the expensing of options, then these companies’ stocks will rise and other companies will follow their example.

Let the private sector impose its own punishment. Let Enron and WorldCom go bankrupt. Watch as the reputations of former geniuses are left in tatters. Jail and shame will encourage a return to integrity.

Not surprisingly, Congress is taking a more expansive approach. Some of the provisions of the recent reform bill signed by President George W. Bush are a step in the right direction, such as increased penalties for fraud and document shredding. But the bill also creates a private oversight board for the accounting profession and new responsibilities for all CEOs. The costs of these provision will fall on all businesses, even those that are run honestly.

Ultimately, business will pass these costs on to stakeholders. Investors will earn lower returns, consumers will pay higher prices and workers will earn lower wages.

I hope the government continues to focus its efforts on the guilty.

When a 78-year-old man like John Rigas of Adelphia is dragged away in handcuffs, it gives all executives pause. And that’s the way it should be. Even when there are big prizes, jail and humiliation will keep a lot of people from temptation.

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