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| Corporate
Catharsis |
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Another
day, another Wall Street scandal. The regularity and
frequency with which "bad news" is coming
out of the corporate world in the US, involving some
of the giants of international business, is almost laughable.
Each week, at least one major company is being forced
to reveal that it has been involved in financial irregularities,
often of breathtaking extent.
Some companies "forget" to record their losses,
or record them as loans to specially created subsidiaries.
Other companies "just happen" to slip in normal
expenses as "capital expenses", thereby removing
them from the profit-and-loss account. In some instances,
important flows of finance are simply not recorded at
all, and just disappear from the balance sheets. Other
accounting discrepancies include understatement of interest
payments, fictitious investments, and simply taking
cash out of employees' pensions and social security
funds.
In most of these cases, the numbers involved are not
small, usually amounting to several billion dollars.
And the indications are that these malpractices are
not just once-off mistakes, but have been going for
some years – suggesting that auditors have been
negligent or even complicit. Quite often, there is even
no mention of these practices in the companies' books,
making it difficult to trace what exactly has been going
on.
The biggest and most public scam of recent times was
that concerning the energy trading multinational giant
Enron, which was earlier seen as the most effective
symbol of the swashbuckling new globalised capitalism
of the 1990s. But now it turns out that the case of
Enron – huge and dramatic as it was – is
just the tip of the iceberg in terms of shady and ultimately
unsustainable business practices in the international
corporate world.
Consider just some of the scams that are now plaguing
the already overworked Securities and Exchange Commission
(SEC), the US government agency that is supposed to
regulate all this. The company Adelphia is facing an
SEC probe into $3.1bn in off-balance sheet loans, some
of which were used to cover the assets of the founder
of the company and his family. Global Crossing is under
investigation for its accounting treatment of long-term
wholesale capacity contracts, which artificially inflated
profits. Lucent Technologies and Peregrine Systems have
been found to be "adjusting" fiscal revenues
and are being forced to restate incomes and profits
for the past few years. The largest retailing company
in the US, K-Mart, has had to lower its recorded profits
after admitting to incorrect accounting methods.
Enron, as is well known, admitted to improperly inflating
earnings and hiding debt through a complex web of off-balance
sheet business partnerships. The company's subsequent
bankruptcy created a ripple effect across the corporate
and financial world even in developing countries. Other
energy trading companies are not pristine either. Duke
Energy has admitted to "round-trip" or "wash"
trades, in which two or more traders buy and sell energy
among themselves for the same price and at the same
time, which added at least $1 billion to its revenues
over three years. Dynegy, the company that earlier offered
to rescue Enron just before its collapse, is being investigated
for using partnerships in deals to inflate its cash
flow.
And then there is the insider trading, along with instances
of top management seeking to save the value of their
own assets of reward themselves before the imminent
collapse of the company. The founder and other top managers
of Computer Associates awarded themselves more than
a billion dollars in shares (which they then sold) only
days before issuing a profit warning which sent the
share price down. The founder and CEO of Imclone Systems
was found to be selling large numbers of shares held
by his family and friends just before the cancer drug
which was its sole product was denied approval by the
US FDA. The chairman and other executives of Tyco International
spent vast amounts on luxury housing for themselves
and other perks, just before declaring losses.
The list goes on and on. The most recent examples are
of the telecom giant WorldCom and the multinational
Xerox, both of which represent in some ways the essence
of current global capitalism.
WorldCom, like Enron, was a potent symbol of aggressive
capitalism in the past decade. Like Enron, it is a company
of recent origin, founded by the flamboyant entrepreneur
Bernie Ebbers, who was perhaps the most aggressive acquirer
during the US mergers and acquisitions boom of the 1990s.
WorldCom's stock market success even surpassed that
of Enron. Before the US stock market started to sag
in 2001, WorldCom's asset value had soared to $180bn
- nearly three times that of Enron at its peak.
WorldCom has now admitted that $3.8 billion of operating
costs were treated as capital spending, forcing it to
restate results for 2001 and the first quarter of 2002.
Since the company is already facing losses, it is likely
that it will soon file for bankruptcy and default on
its $35 billion debt.
Just a few days later, Xerox admitted that it would
have to reclassify more than $2 billion of its revenues.
Under pressure from the SEC, it has subsequently announced
that the extent of overstatement of revenues for a five-year
period was even greater, at more than $6.4 billion.
Once again the auditors at Xerox, as usual one of the
international "Big Five", had apparently not
noticed the discrepancies for all these years.
Obviously, the story is not going to end here, and many
more such cases will probably emerge in the near future.
What exactly is going on? What explains this sudden
flurry of unsavoury revelations and the apparent collapse
of even minimal corporate accounting norms that these
cases are bringing to light?
Forget, for a moment, the issues of morality, corporate
ethics, and all that. Forget even the interests of the
unfortunate shareholders of all these companies, which
include not just get-rich-quick financiers but also
workers' pension fund managers and other presumably
worthy groups. The real question is what all this tells
us about the current phase of international capitalism,
and what implications there are for the near future.
The first point to note is that such scams are not new
or unexpected; in fact they are part of capitalism's
normal functioning. Only the most naïve of interpretations
of the history of capitalism would leave out the crucial
role played by fraud, deceit and skullduggery in the
accumulation of capital and its subsequent use. And
the notion that the "new" capitalism is somehow
more open, accountable and democratic, is a false illusion
purveyed by the media which also have major stakes in
the system.
The second point is that such scams typically emerge
at the end of a boom, or when it is beginning to peter
out. It is not that the scams cause the financial or
economic collapse; rather, they are symptoms of the
turning point, when companies find that profit expectations
are not being met, and try to prevent or delay the anticipated
downturn with whatever means they possess, including
fraud. Thus, while many of the financial malpractices
have been going on for several years, they have been
exposed only recently, as the economic slowdown and
the stock market bear trend have fed into each other.
This is characteristic of the "revulsion"
phase of the financial cycle.
The third point has to do with the specific nature of
US capitalism, which is "capital-market-based"
rather than "bank-based". After the financial
crises in Japan and South Korea, bank-based systems
(especially in Asia) came in for a lot of criticism
internationally, for being opaque and prone to "crony"
behaviour and clientelism. The current spate of scandals
in the US shows that capital-market-based systems can
be even more problematic. Not only do they allow (and
even encourage) creative accounting, they are prone
to the worst forms of "insider" excesses.
More to the point, they may even force managements to
misstate actual results, since so much of the stock
market value depends on this, and the stock value in
turn typically determines not just assets but even management's
own remuneration. Those investigating WorldCom have
found that the important sums involved in recent wrongly
classified transactions — which reduced reported
operating expenses over the last five quarters —
were exactly those needed for WorldCom to meet its profit
margin goals, and so keep its shareholders satisfied.
This does not mean that it is only the US corporate
world which is in trouble. It is likely, as some European
analysts have suggested, that because Western European
accounting norms are stricter such cases of fraud will
be less common and the European bourse may even benefit
from the current revulsion away from US stocks. Indeed,
the recent downward drift of the dollar – which
has required co-ordinated central bank intervention
to slow down – is one indication of this. But
European corporations are by no means immune, as may
become clear quite soon. First, the same macroeconomic
forces of slowdown and reduced investor confidence are
likely to affect European companies just as they have
already hit Japanese and US corporations. Second, across
the world the pattern has been to take on more and more
elements of the "US model", even in bank-based
systems such as in France and Germany, and so such financial
scandals are more likely there now than in the past.
It is clear the SEC-type regulation is inadequate to
monitor and regulate markets which are so open to fraud
because of the severe information problems they suffer
from. It is also clear that during a slowdown, more
and more cases of explicit and implicit fraud are likely,
and they in turn can add to the more bearish investor
sentiment which in turn would worsen the slowdown.
All these instances – and the new ones that are
almost inevitably going to emerge from the woodwork
quite soon – add up to a really big financial
mess, and certainly do portend a major crisis of confidence
for corporate US. Unfortunately, however, they still
do not signify the end of capitalism as we currently
know it. In fact, they do not even mean that the corporate
world will necessarily become much cleaner and more
"ethical" as a result. But if they do bring
about a much more serious public reconsideration of
the system as a whole, then they are probably to be
welcomed.
July 02, 2002. |
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