Samuel Bowles and Michael Edwards, “Government: Capitalist or Democratic?

” (excerpts)

The Expansion of Government Economic Activity

Over the past half-century, the economic importance of the government has grown. There is no single
adequate measure by which its growth could be gauged, in part because not all government activities are
equally important from an economic standpoint. For this reason, measures of the size of the government -- its
total expenditures, total employment, or other measures-can capture only roughly the economic impact of
the government. But there is little doubt that the growth has been substantial. Though the economic
importance of the government has grown in the United States, it is still considerably less than in most other
advanced capitalist economies. . . .
The reasons for this growth in the economic importance of the government are much debated. Some
see it as a triumph by the ordinary citizen over the self-serving interests of business. Others see it as a
carefully orchestrated strategy of business to provide itself with ever-greater opportunities for profit. Still
others see it as a triumph of the bureaucratic mentality, which thinks that if there is a problem, there must
be or should be some government office to deal with it.
But there is a more persuasive explanation. The survival and workability of capitalism as a system
required the government to grow. The ceaseless search for extra profits and the ensuing social, technical, and
other changes . . . created conditions that provoked demands for a more economically involved government.
These demands, as we will see, have come as often from businesspeople as from workers, as often from the
Chamber of Commerce as from the AFL-CIO, as often from Republicans as from Democrats.
The growth of government is not something that happened in opposition to capitalism, but rather in
very large measure because of capitalism. . . .

1. Economic Concentration Much of the growth of governmental economic activity can be explained by the
growth of large corporations and the decline of small competitive producers. The enormous power of modern
corporations has allowed its owners to engage more effectively in lobbying and in the formation of public
opinion. Partly for this reason, big business has become more confident that it can put the government to
work to raise its profits. The government involvement in the nuclear power industry and in the production of
military goods are good examples of this. Corporate leaders have also supported the expansion of
government regulation in those many cases in which they wanted protection from competitive pressures that
might lower profits. Examples include regulation of the quality of meat and other food, and milk price
supports. Consumers and workers have also supported an expansion of the economic activities of the
government, in part to protect themselves from the power of giant corporations. . . .

2. International Expansion The increasing international involvement of the large corporations and of the
U.S. economy generally contributed to the development of a worldwide conception of “U.S. interests.” As
corporations expanded from national to international businesses, they changed from wanting the
government to impose tariffs to keep out goods made abroad to insisting that the government protect
“American” (their) investments around the world. They promoted an increasingly expensive military system to
defend these interests. The preparation for war and the payment for past wars have accounted for much of
the economic expansion of the government. Capitalism did not invent war, but the degree of international
economic interdependence and rivalry produced by the expansion of capitalism did make world wars more
likely. After World War II, high levels of military expenditure became a permanent feature of the U.S.
economy. In 1990 military expenditures were about 6 percent of net output; an amount equal to the
agriculture, forestry, fisheries, and mining sectors of the economy combined.

3. Economic Instability The increasing instability of the economy, marked by periods of severe
unemployment and dramatized by the Great Depression of the 1930s, has provided another impetus for the
growing economic importance of the government. The stabilization of the economy was a major objective of
the businessmen who promoted the formation of the Federal Reserve System in 1913 and the Securities and
Exchange Commission in 1935. Much more important was the inability of the economy to revive from the
Great Depression without the stimulus of massive World War II military expenditures. During the depressed
1930s, political instability and radical political movements spread as people came face-to-face with the
failure of the capitalist system to provide for even a minimal livelihood. . . .

4. Income Support During the Great Depression, large majorities of Americans became convinced that
those unable to make a living should be supported, at least at some minimal level, by the government.

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Government programs to support poor people replaced informal support systems and private charity, both
because people who fell on hard times could no longer count on their families or neighbors to tide them over
and because private charity (church and private philanthropy) did not have the funds necessary to do the job.
When most Americans were self-employed and families and neighborhoods formed tight communities, the
families and communities provided much of the support for the handicapped, the elderly, and others unable
to work or unable to find work. But as families and communities became less tightly woven, this system of
support began to leave increasing numbers of people with little place to turn for help during hard times.
More recently, unemployment has inflicted a form of economic hardship for which even hard work is
no remedy, and it has greatly increased the need for income supports. During the Great Depression, for
instance, sources of private charity were simply overrun with people needing help. Only the government could
provide income support on the scale needed.
Ironically, workers’ constant moving around in search of work played a major part in undermining the
ability (or perhaps the inclination) of families and neighborhoods to take care of those who did not find
paying work. Equally important was that the capitalist accumulation process spelled the doom of the family
farm and the small family business. For earlier generations, going home to the family farm or business had
been a way of making it through a period of unemployment, but now there was no family farm or business to
go home to. . . .

5. Public Safety Many groups have demanded that government regulate the conflict between profitability
and public safety. While competition pushed firms to develop technology in the most profitable directions,
advances in these developments have not always benefited society. The pharmaceutical industry dramatizes
the danger of leaving economic decision making solely up to the profitability criterion -- drugs dangerous to
people’s health may be very profitable. For example, drugs that earn big profits for drug companies may have
effects that are complicated, long delayed, and potentially lethal for individual consumers. The chemical
industry illustrates another conflict between profits and public safety. Some production processes, developed
because they are highly profitable, may ultimately inflict brain damage, sterility, and cancer on workers; their
effects often become known only after many years of exposure. . . .

6. Environmental Protection Many people pressed government to protect the natural environment from
capitalist development. Our natural surroundings -- our land, fresh water, air, and oceans -- were not only
being used, they were being used up. Part of the reason was that no one was charged a price for using most
of these things. In many cases, the most profitable way of disposing of wastes-even very hazardous ones-was
simply to throw them away, using our natural environment as a free dumping ground. . . .

7. Discrimination Over the last three decades people have come to realize that the unrestricted exercise of
rights in private property and in capital goods often results in racial and sexual discrimination against both
customers and workers. The lunch counter sit-ins that began the civil rights movement of the 1960s posed
the issue sharply-the right of owners of the restaurants and lunch counters to do what they pleased with their
property, including the exclusion of black customers, versus the rights of black people to be treated equally in
public places. Since 1964 the U.S. Civil Rights Commission has brought suits against companies, unions,
and, other institutions, seeking to force them to eliminate discriminatory practices.

Many of these seven sources of expanded government economic activity may be understood as
responses to particular aspects of the accumulation process of the capitalist economy. The growth of the
government is as much a part of the capitalist economic growth process as is the growth of investment or the
growth of technology.
But if government has had to grow to repair the problems and hardships caused by capitalist
development, it does not follow that this has been an adequate response. It is quite debatable whether
people are today more secure economically than they were a hundred years ago, or less susceptible to
environmental or natural disaster, or less likely to encounter health hazards in their workplace or in their
food, or better protected from the unaccountable power of the giant corporations. It seems highly unlikely, in
fact, that bigger government programs have managed to keep pace with the escalating challenges posed by
the pattern of capitalist economic growth. . . .

The Limits of Democratic Control of the Capitalist Economy

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 Yet can the government really control the economy? . . . Can the citizens of a democratic government
control the economy? . . . The ability of the voters -- even large majorities of them -- to alter the course of
economic events in our economy is quite limited as long as the economy remains capitalist. . . .
Our economy may be considered to be like a game in which there are two different sets of rules. One
set of rules -- the rules of the capitalist economy -- confers power and privilege on those who own the capital. .
. used in production, particularly on the owners and managers of the largest corporations. The other set of
rules-the rules of the democratic government confers substantial power on the electorate, that is, on the
great majority of adult citizens. Thus our social system gives rise to two types of power: the power of capital
and the power of citizenry. . . . The basic idea of democratic government -- that government leaders will be
selected by the principle of voting, with each person having one vote, after an open competition among
competing candidates and ideas -- is very different from the rules that govern the capitalist economy.
The heads of a corporation -- the management -- are not elected by the people who work there, nor
by the community in which the firm is located. In fact, they are not elected at all in the sense that we usually
use the word election, for they are selected by those who own the corporation; with each owner having as
many votes as the number of shares of stock he or she owns. Similarly, freedom of speech and other civil
liberties are very limited in the workplace. The majority of businesses place restrictions on workers’ freedom
to post information concerning unions, for example. . . .
Those powers are often at loggerheads, as when the citizens want to restrict the power of capital to
sell dangerous or environmentally destructive products. In most of these conflicts, capitalists have immense
and often overwhelming advantages, despite the fact that the owners of businesses (and particularly large
businesses) are greatly outnumbered. There are three sources of their power -- one obvious, the others not so
obvious.
One reason capitalists have great political power is that economic resources can often be translated
directly into political power. This happens when businesses or wealthy individuals contribute to political
campaigns; advertise to alter public opinion; hire lawyers, expert witnesses and others to influence the
detailed drafting and implementation of legislation; and otherwise apply their economic resources to the
political system. Corporate control of economic resources implies substantial corporate political influence
over government officials.
There is a second, more indirect reason for the disproportionate political power of business leaders.
It is that mass communications are run by businesses: capitalists in this industry own the TV stations,
newspapers, publishing houses, and other capital goods used in production. Even “public” radio and TV
depend heavily on corporate contributions. Freedom of speech and of the press (which includes TV and radio)
guarantees that people can say, and journalists can write, whatever they please. On the other hand, the
private ownership of . . . the TV industry, for example, guarantees that what is broadcast is in the end
controlled by capitalists either by the owners of the station or by owners of the major corporations that buy
the advertising for the programs. These are people who understandably have little interest in seeing the idea
of citizen power applied in ways that limit the freedom or profits of those who own the capital goods used in
production, whether in the TV industry or elsewhere.
There is a third way in which money brings power-capitalists control investment, and so they
determine the fate of the economy. . . . If profits are low, businesspeople will complain of a bad investment
climate. They will not invest, or they will choose to invest in some other country. The result will be
unemployment economic, stagnation, and perhaps a decline in living standards of the majority of the people,
who will lose no time expressing their disappointment on election day.
Since capitalists control investment and hence hold one of the keys to a healthy economy, political
leaders often must do what capitalists want, in order to create the right investment climate. They know that
in the end it is capitalists who make the decisions on whether to invest and where to invest. Business thus
holds a kind of blackmail over democratically elected political leaders
This form of blackmail is called a capital strike, because it involves capital going on strike. When
workers strike they refuse to do their part in the economy-they do not work. When capitalists strike they also
refuse to do their part-they do not invest. But here the similarity ends. When workers strike they must
organize themselves so that they all strike together. A single worker cannot go on strike (that is called
quitting). By contrast, when capital goes on strike, no coordination is needed. . . Each corporation routinely
studies the economic and other conditions relevant to its decision to invest. If they do not like what they see,
they will simply not invest or will invest elsewhere. Nobody organizes a capital strike. It happens through the
independent decisions of corporate leaders. If things look bad to a large number of corporations, the effect of
their combined withholding of investment will be large enough to alter the course of the economy. Capital

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strike severely limits what citizen power can accomplish when citizen power conflicts with the power of
capital. . . .
Thus a democratic government is not the same thing as a democratic society, for in a democratic
society decision making in the economy as well as in the government, would be accountable to the majority.

David Cay Johnston, “Income Gap Is Widening, Data Shows,”

New York Times, March 29, 2007

Income inequality grew significantly in 2005, with the top 1 percent of Americans -- those with
incomes that year of more than $348,000 -- receiving their largest share of national income since 1928,
analysis of newly released tax data shows. The top 10 percent, roughly those earning more than $100,000,
also reached a level of income share not seen since before the Depression. While total reported income in
the United States increased almost 9 percent in 2005, the most recent year for which such data is available,
average incomes for those in the bottom 90 percent dipped slightly compared with the year before, dropping
$172, or 0.6 percent.
The gains went largely to the top 1 percent, whose incomes rose to an average of more than $1.1
million each, an increase of more than $139,000, or about 14 percent. The new data also shows that the top
300,000 Americans collectively enjoyed almost as much income as the bottom 150 million Americans. Per
person, the top group received 440 times as much as the average person in the bottom half earned, nearly
doubling the gap from 1980.
Prof. Emmanuel Saez, the University of California, Berkeley, economist who analyzed the Internal
Revenue Service data with Prof. Thomas Piketty of the Paris School of Economics, said such growing
disparities were significant in terms of social and political stability. “If the economy is growing but only a few
are enjoying the benefits, it goes to our sense of fairness,” Professor Saez said. “It can have important
political consequences.”
The disparities may be even greater for another reason. The Internal Revenue Service estimates that
it is able to accurately tax 99 percent of wage income but that it captures only about 70 percent of business
and investment income, most of which flows to upper-income individuals, because not everybody accurately
reports such figures.
The Bush administration argued that its tax policies, despite cuts that benefited those at the top
more than others, had not added to the widening gap but “made the tax code more progressive, not less.”
Brookly McLaughlin, the chief Treasury Department spokeswoman, said that this year “the share of income
taxes paid by lower-income taxpayers will be lower than it would have been without the tax relief, while the
share of income taxes for higher-income taxpayers will be higher.” Treasury Secretary Henry M. Paulson Jr.,
she noted, has acknowledged that income disparities have increased, but, along with a “solid consensus” of
experts, attributed that shift largely to “the rapid pace of technological change has been a major driver in the
decades-long widening of the income gap in the United States."
Others argued that public policies had played a role in the shift. Robert Greenstein, executive director
of the Center on Budget and Policy Priorities, an advocacy group for the poor, said that the data understates
the widening disparity between the top 1 percent and the rest of the country.
He said that in addition to rising incomes and reduced taxes, the equation should take into account
cuts in fringe benefits to workers and in government services that middle-class and poor Americans rely on
more than the affluent. These include health care, child care and education spending.
“The nation faces some very tough choices in coming years,” he said. “That such a large share of the
income gains are going to the very top, at a minimum, raises serious questions about continuing to provide
tax cuts averaging over $150,000 a year to people making more than a million dollars a year, while saying
we do not have enough money” to provide health insurance to 47 million Americans and cutting education
benefits. A major issue likely to be debated in Congress in the year ahead is whether reversing the Bush tax
cuts would slow investment and, if so, how much that would cost the economy. Mr. Greenstein's organization
will release a report today showing that for Americans in the middle, the share of income taken by federal
taxes has been essentially unchanged across four decades. By comparison, it has fallen by half for those at
the very top of the income ladder.
Because the incomes of those at the top have grown so much more than those below them, their
share of total income tax revenue has risen despite the reduced rates. The analysis by the two professors
showed that the top 10 percent of Americans collected 48.5 percent of all reported income in 2005. That is
an increase of more than 2 percentage points over the previous year and up from roughly 33 percent in the

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late 1970s. The peak for this group was 49.3 percent in 1928. The top 1 percent received 21.8 percent of all
reported income in 2005, up significantly from 19.8 percent the year before and more than double their
share of income in 1980. The peak was in 1928, when the top 1 percent reported 23.9 percent of all income.
The top tenth of a percent and top one-hundredth of a percent recorded even bigger gains in 2005
over the previous year. Their incomes soared by about a fifth in one year, largely because of the rising stock
market and increased business profits. The top tenth of a percent reported an average income of $5.6
million, up $908,000, while the top one-hundredth of a percent had an average income of $25.7 million, up
nearly $4.4 million in one year.

John Byrne, Louis Lavelle, Nanette Byrnes, Marcia Vickers, and Amy Borrus
“How to Fix Corporate Governance,” Business Week, May 6, 2002 (excerpts)

Excessive pay, corrupt analysts, auditing games: It all adds up to capitalism’s biggest crisis since the
trustbuster era. What will it take to restore the public’s faith in the system? Faith in Corporate America hasn’t
been so strained since the early 1900s, when the public’s furor over the monopoly powers of big business led
to years of trustbusting by Theodore Roosevelt. The latest wave of skepticism may have started with Enron
Corp.’s ugly demise, but with each revelation of corporate excess or wrongdoing, the goodwill built up by
business during the boom of the past decade has eroded a little more, giving way to widespread suspicion
and mistrust. An unrelenting barrage of headlines that tell of Securities & Exchange Commission
investigations, indictments, guilty pleas, government settlements, financial restatements, and fines has only
lent greater credence to the belief that the system is inherently unfair. Some corporate chieftains claim that
the backlash is overblown, but increasingly, the public perception is that too many corporate executives have
committed egregious breaches of trust by cooking the books, shading the truth, and enriching themselves
with huge stock-option profits while shareholders suffered breathtaking losses. Meanwhile, despite a decade
or more of boardroom reforms, many directors seem to have become either passive or conflicted players in
this morality play, unwilling to question or follow up on even the most routine issues.
The sight of Enron employees tearfully testifying before Congress was a watershed moment in
American capitalism. They painted a picture of betrayal by company leaders that left them holding huge
losses in their pension plans. Enron added to the sense that no matter how serious their failure or how
imperiled the corporation, those in charge always seem to walk away vastly enriched, while employees and
shareholders are left to suffer the consequences of the top managers’ ineptitude or malfeasance.
In many ways, Enron and its dealings with Arthur Andersen are an anomaly, a perfect storm where
greed, lax oversight, and outright fraud combined to unravel two of the nation’s largest companies. But a
certain moral laxity has come to pervade even the bluest of the blue chips. When IBM used $290 million
from the sale of a business three days before the end of its fourth quarter last year to help it beat Wall
Street’s profit forecast, it did what was perfectly legal -- and yet entirely misleading. That one-time
undisclosed gain, used to lower operating costs, had nothing to do with the company’s underlying operating
performance. Such distortions have become commonplace, as companies strive to hit a target even at the
cost of clarity and fairness.
Whether through actual stock ownership or option grants, many executives and directors realized
that their personal wealth was so closely tied to the price of the company stock that maintaining the share
price became the highest corporate value. Investors rode the boom along with management, leading to the
“irrational exuberance” of the late 1990s.
But there was a dark side to runaway stock prices. As the market overheated, it became less and
less tolerant of even the slightest whiff of bad news -- rumors of which could wipe out hundreds of millions of
dollars of market value at a stroke. “Through the 1980s and 1990s, we constructed an architecture that
emphasized reporting good news, to the point where CEOs and CFOs could not be frank with the investment
community,” says Anita M. McGahan, a Boston University business professor. “Many of these companies
needed a course correction. But the stakes in admitting problems were very high, both because the market
overvalued their stock and because of executive pay.”
The tyranny of the daily stock price has led to borderline accounting and in some cases, outright
fraud. And why not, when every upward tick of the stock means massive gains for option-rich executives?
“Excessive CEO pay is the mad-cow disease of American boardrooms,” says J. Richard Finlay, chairman of
Canada’s Center for Corporate & Public Governance.
A study by Finlay shows that many boards devote far more time and energy to compensation than to
assuring the integrity of the company’s financial reporting systems. At Oracle Corp., where CEO Laurence J.
Ellison’s exercise of stock options just before the company issued an earnings warning led to a record $706.1

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million payout last year, the full board met on only five occasions and acted by written consent three times.
The compensation committee, by contrast, acted 24 times in formal session or by written consent. “Too
many boards are composed of current and former CEOs who have a vested interest in maintaining a system
that is beneficial to them,” says Finlay. “If you look at the disconnect between audit and compensation
committees, you begin to understand how misplaced the priorities of many boards are.”
Enron’s implosion is the most visible manifestation of a system in crisis. Self-interested executives
gorged with stock-option wealth, conflicted outside advisers, and a shockingly uninvolved board: Rarely has a
total breakdown in corporate governance been so clearly documented -- and oddly enough, by other directors,
in a report filed by William C. Powers Jr., an Enron board member. He and his colleagues found an almost
total collapse in board oversight. The Powers report concluded that the board’s controls were inadequate,
that its committees carried out reviews “only in a cursory way,” and that the board failed to appreciate “the
significance of some of the specific information that came before it.” That is as complete a definition of
“asleep at the wheel” as you’ll ever find.
With many directors lulled into complacency by climbing stock prices and their own increasing
wealth, all too often the last vestige of internal control was lost. “There was this convergence of self-interest,”
says Edward E. Lawler III, director of the Center for Effective Organizations at the University of Southern
California. “They were all doing well, and nobody wanted to rock the boat. With the escalation in board
compensation through stock options, directors were the last people to the feeding trough. Once they got tied
in, there was really no restraining force.”
It’s not just the corporation that is at fault. Many of the corporation’s outside professionals fell prey
to greed and self-interest as well, from Wall Street analysts and investment bankers to auditors and lawyers
and even regulators and lawmakers. These players, who are supposed to provide the crucial checks and
balances in a system that favors unfettered capitalism, have in many cases been compromised.
Many analysts urged investors to buy shares in companies solely because their investment banker
colleagues could reap big fees for handling underwriting and merger business. Far too many auditors
responsible for certifying the accuracy of a company’s accounts looked the other way so their firms could
rake in millions from audit fees and millions more from higher-margin consulting work. Some outside lawyers
invented justifications for less-than-pristine practices to win a bigger cut of the legal fees. Far too often, CEOs
found they could buy all the influence they wanted or needed. Enron managed to help write energy policy in
the Bush Administration, while the Business Roundtable and Silicon Valley combined to derail efforts to
change the accounting treatment for stock options.
Ending the crisis in Corporate America will take more than a single initiative or two. The breakdown
has been so systemic and far-reaching that it will require major reforms in a number of critical areas. Here’s
where to start:

EXECUTIVE PAY
As a matter of basic fairness, Plato posited that no one in a community should earn more than five
times the wages of the ordinary worker. Management guru Peter F. Drucker has long warned that the
growing pay gap between CEOs and workers could threaten the very credibility of leadership. He argued in the
mid-1980s that no leader should earn more than 20 times the company’s lowest-paid employee. His
reasoning: If the CEO took too large a share of the rewards, it would make a mockery of the contributions of
all the other employees in a successful organization.
After massive increases in compensation, Drucker’s suggested standard looks quaint. CEOs of large
corporations last year made 411 times as much as the average factory worker. In the past decade, as rank-
and-file wages increased 36%, CEO pay climbed 340%, to $11 million. “It’s just way off the charts,” says
Jennifer Ladd, a shareholder who is fighting for lower executive pay at companies in her portfolio. “A certain
amount of wealth is ridiculous after a while.”
Oddly enough, CEOs came to command such vast wealth through the abuse of a financial instrument
once viewed as a symbol of enlightened governance: the humble stock option. Throughout the 1990s,
governance experts applauded the use of options, maintaining that they would give executives a big payday
only when shareholders profited. And for a while, as the bull market ran its course, that’s the way it worked.
But as the market cratered during the past two years, a funny thing happened: Shareholders lost their shirts,
but executives went right on raking in the dough.
In recent months, especially, shareholder anger has boiled over, as company proxies disclosed the
many ways compensation committees subverted pay for performance. There is, of course, a fundamental
difference between investors who have their own money at risk in the market and option holders, who do not.
But companies have gone even further to shield top executives from losses in a falling market. Some

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awarded huge option grants despite poor performance, while others made performance goals easier to
reach. Nearly 200 companies swapped or repriced options -- all to enrich members of a corporate elite who
already were among the world’s wealthiest people.
When CEOs can clear $1 billion during their tenures, executive pay is clearly too high. Worse still, the
system is not providing an incentive for outstanding performance. It should be a basic tenet of corporate
governance never to reprice or swap a stock option that is under water. After all, no company would hand out
free shares to stockholders to make them whole in a falling market.
To really fix the problem, Congress needs to require companies to expense options. If every option
represented a direct hit to the bottom line, boards would be less inclined to dole them out by the millions.
Determining the value of an option for accounting purposes is no slam-dunk. It may be that companies
should mark-to-market all or a portion of the actual gains or losses in vested stock options every year. At the
very least, Congress should provide preferential tax treatment to encourage boards to replace their plain-
vanilla option grants, which reward CEOs if the stock rises, with indexed options, which provide a payday only
when the stock appreciation outstrips that of peer companies.

THE BOARD
When Enron collapsed, many pointed an accusing finger at the board, and rightly so. Rarely has
there been a management team so intent on deception or a group of directors so sound asleep. But
accountability is a two-way street. It’s not enough that the board keep a watchful eye on management. Just
as important, the shareholders must keep an eye on the board.
That’s difficult to do. Shareholders aren’t invited to board meetings, individual board members rarely
speak out, and when they do it’s usually to trumpet the company line. Investors know practically nothing of
what goes on behind the closed doors of the boardroom. They must instead rely on directors to represent
their interests vigorously. To make sure that happens, changes are badly needed.
In recent weeks, Congress, the White House, federal regulators, and the stock exchanges have all
proposed reforms, including some that would require CEOs to vouch for the accuracy of company disclosures
and disgorge personal profits from corporate wrongdoing. But the reforms would not guarantee the thing in
greatest demand and shortest supply: accountability of all directors.
To ensure accountability, shareholder resolutions that pass by a majority of the shares voted for
three consecutive years should be binding. Today when a resolution passes, it is frequently ignored. At Bristol-
Myers Squibb Co., for example, a proposal to hold annual elections for directors has won a majority of votes
cast for five straight years. But the company has never acted on it, claiming that it failed to get a majority of
all the shares outstanding. Making resolutions binding would make companies profoundly answerable to
shareholders.
In addition, the stock exchanges, which set many of the governance rules companies must follow,
should come up with meaningful regulations and enforce them. The exchanges should limit every board to no
more than two insiders, assign only independent outsiders to the audit, compensation, and nominating
committees, and restrict directors from serving on more than three boards.
Other reforms could help to make boards more inclined to act ahead of a crisis. A ban on stock sales
by directors for the duration of their terms would encourage them to blow the whistle on management when
necessary without fear of the short-term price declines that may follow. Mandatory term limits -- requiring
directors to resign after 10 years or at age 70, whichever comes first -- would prevent board members from
becoming entrenched.

ACCOUNTING
The past few months have pointed up so many weak spots in corporate accounting that it’s hard to
prioritize what needs fixing the most. Clearly, auditors are not always skeptical enough.
To help restore investor confidence, there should be limits put on consulting work done by a
company’s auditing firm. Auditors should rotate every few years to ensure a “fresh look” by a new firm. There
should be more forensic auditing to dig behind the journal entries.
The proxy statement should clearly delineate which responsibilities fall to the board and which to
management. At Enron, the audit committee was charged with reviewing related party transactions. The
committee carried out only cursory reviews, but shareholders had no way of knowing it was even part of their
duties.
An expanded auditor statement in the annual report would also help. Instead of just asserting that
the financials meet generally accepted accounting principles, the auditors’ statement should illuminate just
where in the wide range of acceptable practices a particular company falls. As an up-close reviewer of the

7
numbers, the auditor is in a unique position to judge how dependent the financial statements are on
assumptions that could prove faulty.
Finally, a price must be exacted for failure to do the right thing. “I don’t think anybody has gone to
jail yet, and I don’t know why,” says Philip B. Livingston, president of Financial Executives International, a
professional group of finance managers. “When the SEC and the Justice Dept. get their act together and start
sending some CFOs and CEOs to jail, you’ll see a real wake-up call.”

ANALYSTS
If investors have learned anything from this crisis, it’s that Wall Street’s analysts are often loath to
put a bad spin on a stock. Historically, “sell” ratings have constituted fewer than 1% of analysts’
recommendations, according to Thomson Financial/First Call.
Analysts are often rewarded for their ability to attract and maintain investment banking business.
They’re often under pressure from the companies they cover, big institutional investors, and their own
employers to maintain positive ratings. These are conflicts that may never be resolved. But there are some
steps that could alleviate the pressures that prevent analysts from telling the truth.
“Investors need to realize that the free research they’re getting is often just a marketing tool,” says
Kent Womack, a professor at Dartmouth College’s Amos Tuck School of Business. Better disclosure also
could help. It should be mandatory that reports prominently disclose a firm’s specific investment banking
relationship with the company it’s covering.
And an overhaul of the language of ratings would be helpful as well. In normal English, most ratings
sound like variations on “we think this is a decent stock that you should own.” In ratings land, terms such as
“accumulate” and “hold” are part of an elaborate web of euphemisms in which “neutral” means “dump this
loser, and run for your life.”
To help restore analysts’ integrity, their compensation should not be dependent on investment
banking fees earned from the companies they cover. At the least, that conflict should be disclosed. Two
prominent securities-industry trade groups have recommended that analysts be paid on stock-picking and
earnings-estimate prowess, a practice some firms are adopting. Some groups have already barred analysts
from owning stocks that they cover.

REGULATORS
Business abuses have raised fresh concerns about the power and influence of Corporate America
over elected officials and policymakers in Washington. From Enron’s cozy ties to energy policy mandarins to
the ease with which the accounting industry defeated a proposal to sever their consulting operations from
audit in 2000, there’s plenty of evidence that regulators often are outgunned or co-opted by special interests.
It’s not surprising, then, that a mid-February Harris Poll found that 87% of American adults thought big
companies wielded too much clout in the nation’s capital.
Since politicians depend on money from private interests to fund their campaigns, there’s not much
that can be done to reduce radically the influence industry holds over regulators. But some small steps could
make a difference. For starters: more transparency in regulatory decision-making. At the SEC, for example,
some key decisions are deliberately relegated to staff, which can meet in private, unlike the commissioners.
More of the agency’s business should be out in the open.
SEC Chairman Harvey L. Pitt’s “two strikes and you’re out” proposal for corporate bigwigs is also on
the right track. He wants the power to ban corporate miscreants from serving as officers and directors. But
the proposal’s effectiveness hinges on the fine print. If it applies only to those convicted of financial crimes, it
could be meaningless, since the SEC settles most cases.
Without adequate funding, though, the financial cops won’t be able to police their beat. The SEC’s
workload has soared even as staffing has remained stagnant. Congress should approve a hefty increase in
the agency’s budget, including Pitt’s request for pay parity to retain top lawyers and accountants. Likewise,
lawmakers should require accounting firms to pony up annually to fund the Financial Accounting Standards
Board instead of forcing the rulemakers to go hat-in-hand to the firms they joust with.

LEADERSHIP
As the 1990s unfolded, Enron came to represent the triumph of New Economy thinking over Old
Economy principles. It was fast, adaptive, innovative, and profitable -- a corporate culture perfectly suited to
what it did: creating and exploiting new markets. Everyone envied and emulated Enron.
While Enron’s culture emphasized risk-taking and entrepreneurial thinking, it also valued personal
ambition over teamwork, youth over wisdom, and earnings growth at any cost. What’s more, the very ideas

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Enron embraced were corrupted in their execution. Risk-taking without oversight resulted in failures. Youth
without supervision resulted in chaos. And an almost unrelenting emphasis on earnings, without a system of
checks and balances, resulted in ethical lapses that ultimately led to the company’s downfall. While Enron is
the extreme case, many other companies show the same symptoms.
If the challenge for executives in the 1990s was to transform corporate behemoths into nimble
competitors, the challenge in coming years will be to create corporate cultures that encourage and reward
integrity as much as creativity and entrepreneurship. To do that, executives need to start at the top,
becoming not only exemplary managers but also the moral compass for the company. CEOs must set the
tone by publicly embracing the organization’s values. How? They need to be forthright in taking responsibility
for shortcomings, whether an earnings shortfall, product failure, or a flawed strategy and show zero tolerance
for those who fail to do the same.
The best insurance against crossing the ethical divide is a roomful of skeptics. CEOs must actively
encourage dissent among senior managers by creating decision-making processes, reporting relationships,
and incentives that encourage opposing viewpoints. At too many companies, the performance review system
encourages a “yes-man culture” that subverts the organization’s checks and balances. By advocating dissent,
top executives can create a climate where wrongdoing will not go unchallenged.

Paul Krugman, “Flavors Of Fraud,” New York Times, June 28, 2002

So you’re the manager of an ice cream parlor. It’s not very profitable, so how can you get rich? Each
of the big business scandals uncovered so far suggests a different strategy for executive self-dealing.
First there’s the Enron strategy. You sign contracts to provide customers with an ice cream cone a
day for the next 30 years. You deliberately underestimate the cost of providing each cone; then you book all
the projected profits on those future ice cream sales as part of this year’s bottom line. Suddenly you appear
to have a highly profitable business, and you can sell shares in your store at inflated prices.
Then there’s the Dynegy strategy. Ice cream sales aren’t profitable, but you convince investors that
they will be profitable in the future. Then you enter into a quiet agreement with another ice cream parlor
down the street: each of you will buy hundreds of cones from the other every day. Or rather, pretend to buy --
no need to go to the trouble of actually moving all those cones back and forth. The result is that you appear
to be a big player in a coming business, and can sell shares at inflated prices.
Or there’s the Adelphia strategy. You sign contracts with customers, and get investors to focus on
the volume of contracts rather than their profitability. This time you don’t engage in imaginary trades, you
simply invent lots of imaginary customers. With your subscriber base growing so rapidly, analysts give you
high marks, and you can sell shares at inflated prices.
Finally, there’s the WorldCom strategy. Here you don’t create imaginary sales; you make real costs
disappear, by pretending that operating expenses -- cream, sugar, chocolate syrup -- are part of the purchase
price of a new refrigerator. So your unprofitable business seems, on paper, to be a highly profitable business
that borrows money only to finance its purchases of new equipment. And you can sell shares at inflated
prices.
Oh, I almost forgot: How do you enrich yourself personally? The easiest way is to give yourself lots of
stock options, so that you benefit from those inflated prices. But you can also use Enron-style special-purpose
entities, Adelphia-style personal loans and so on to add to the windfall. It’s good to be C.E.O.
There are a couple of ominous things about this menu of mischief. First is that each of the major
business scandals to emerge so far involved a different scam. So there’s no comfort in saying that few other
companies could have employed the same tricks used by Enron or WorldCom -- surely other companies found
other tricks. Second, the scams shouldn’t have been all that hard to spot. For example, WorldCom now says
that 40 percent of its investment last year was bogus, that it was really operating expenses. How could the
people who should have been alert to the possibility of corporate fraud -- auditors, banks and government
regulators -- miss something that big? The answer, of course, is that they either didn’t want to see it or were
prevented from doing something about it.
I’m not saying that all U.S. corporations are corrupt. But it’s clear that executives who want to be
corrupt have faced few obstacles. Auditors weren’t interested in giving a hard time to companies that gave
them lots of consulting income; bank executives weren’t interested in giving a hard time to companies that,
as we’ve learned in the Enron case, let them in on some of those lucrative side deals. And elected officials,
kept compliant by campaign contributions and other inducements, kept the regulators from doing their job --
starving their agencies for funds, creating regulatory “black holes” in which shady practices could flourish.

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 (Even while loudly denouncing WorldCom, George W. Bush is trying to appoint the man who drafted
the infamous “Enron exemption” -- a law custom-designed to protect the company from scrutiny -- to a top
position with a key regulatory agency. And some congressmen seem more interested in clamping down on
New York’s attorney general, Eliot Spitzer, than in doing something about the corruption he has been
investigating.)
Meanwhile the revelations keep coming. Six months ago, in a widely denounced column, I
suggested that in the end the Enron scandal would mark a bigger turning point for America’s perception of
itself than Sept. 11 did. Does that sound so implausible today?

Paul Krugman, “Everybody is Outraged,” New York Times, July 2, 2002

Arthur Levitt, Bill Clinton’s choice to head the Securities and Exchange Commission, crusaded for
better policing of corporate accounting -- though he was often stymied by the power of lobbyists. George W.
Bush replaced him with Harvey Pitt, who promised a “kinder and gentler” S.E.C. Even after Enron, the Bush
administration steadfastly opposed any significant accounting reforms. For example, it rejected calls from
the likes of Warren Buffett to require deduction of the cost of executive stock options from reported profits.
But Mr. Bush and Mr. Pitt say they are outraged about WorldCom.
Representative Michael Oxley, the Republican chairman of the House Financial Services Committee,
played a key role in passing a 1995 law (over Mr. Clinton’s veto) that, by blocking investor lawsuits, may have
opened the door for a wave of corporate crime. More recently, when Merrill Lynch admitted having pushed
stocks that its analysts privately considered worthless, Mr. Oxley was furious -- not because the company had
misled investors, but because it had agreed to pay a fine, possibly setting a precedent. But he also says he is
outraged about WorldCom.
Might this sudden outbreak of moral clarity have something to do with polls showing mounting
public dismay over crooked corporations?
Still, even a poll-induced epiphany is welcome. But it probably isn’t genuine. As the Web site
dailyenron.com put it, last week “the foxes assured Americans that they are hot on the trail of those missing
chickens.”
The president’s supposed anger was particularly hard to take seriously. As Chuck Lewis of the
nonpartisan Center for Public Integrity delicately put it, Mr. Bush “has more familiarity with troubled energy
companies and accounting irregularities than probably any previous chief executive.” Mr. Lewis was referring
to the saga of Harken Energy, which now truly deserves a public airing.
My last column, describing techniques of corporate fraud, omitted one method also favored by
Enron: the fictitious asset sale. Returning to the ice-cream store, what you do is sell your old delivery van to
XYZ Corporation for an outlandish price, and claim the capital gain as a profit. But the transaction is a sham:
XYZ Corporation is actually you under another name. Before investors figure this out, however, you can sell a
lot of stock at artificially high prices.
Now to the story of Harken Energy, as reported in The Wall Street Journal on March 4. In 1989 Mr.
Bush was on the board of directors and audit committee of Harken. He acquired that position, along with a
lot of company stock, when Harken paid $2 million for Spectrum 7, a tiny, money-losing energy company
with large debts of which Mr. Bush was C.E.O. Explaining what it was buying, Harken’s founder said, “His
name was George Bush.”
Unfortunately, Harken was also losing money hand over fist. But in 1989 the company managed to
hide most of those losses with the profits it reported from selling a subsidiary, Aloha Petroleum, at a high
price. Who bought Aloha? A group of Harken insiders, who got most of the money for the purchase by
borrowing from Harken itself. Eventually the Securities and Exchange Commission ruled that this was a
phony transaction, and forced the company to restate its 1989 earnings.
But long before that ruling -- though only a few weeks before bad news that could not be concealed
caused Harken’s shares to tumble -- Mr. Bush sold off two-thirds of his stake, for $848,000. Just for the
record, that’s about four times bigger than the sale that has Martha Stewart in hot water. Oddly, though the
law requires prompt disclosure of insider sales, he neglected to inform the S.E.C. about this transaction until
34 weeks had passed. An internal S.E.C. memorandum concluded that he had broken the law, but no
charges were filed. This, everyone insists, had nothing to do with the fact that his father was president.
Given this history -- and an equally interesting history involving Dick Cheney’s tenure as C.E.O. of
Halliburton -- you could say that this administration is uniquely well qualified to chase after corporate
evildoers. After all, Mr. Bush and Mr. Cheney have firsthand experience of the subject.

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 And if some cynic should suggest that Mr. Bush’s new anger over corporate fraud is less than
sincere, I know how his spokesmen will react. They’ll be outraged.

Paul Krugman, “Succeeding in Business,” New York Times, July 7, 2002

On Tuesday, George W. Bush is scheduled to give a speech intended to put him in front of the
growing national outrage over corporate malfeasance. He will sternly lecture Wall Street executives about
ethics and will doubtless portray himself as a believer in old-fashioned business probity.
Yet this pose is surreal, given the way top officials like Secretary of the Army Thomas White, Dick
Cheney and Mr. Bush himself acquired their wealth. As Joshua Green says in The Washington Monthly, in a
must-read article written just before the administration suddenly became such an exponent of corporate
ethics: “The ‘new tone’ that George W. Bush brought to Washington isn’t one of integrity, but of
permissiveness. . . . In this administration, enriching oneself while one’s business goes bust isn’t necessarily
frowned upon.”
Unfortunately, the administration has so far gotten the press to focus on the least important
question about Mr. Bush’s business dealings: his failure to obey the law by promptly reporting his insider
stock sales. It’s true that Mr. Bush’s story about that failure has suddenly changed, from “the dog ate my
homework” to “my lawyer ate my homework -- four times.” But the administration hopes that a narrow focus
on the reporting lapses will divert attention from the larger point: Mr. Bush profited personally from
aggressive accounting identical to the recent scams that have shocked the nation.
In 1986, one would have had to consider Mr. Bush a failed businessman. He had run through
millions of dollars of other people’s money, with nothing to show for it but a company losing money and
heavily burdened with debt. But he was rescued from failure when Harken Energy bought his company at an
astonishingly high price. There is no question that Harken was basically paying for Mr. Bush’s connections.
Despite these connections, Harken did badly. But for a time it concealed its failure -- sustaining its
stock price, as it turned out, just long enough for Mr. Bush to sell most of his stake at a large profit -- with an
accounting trick identical to one of the main ploys used by Enron a decade later. (Yes, Arthur Andersen was
the accountant.) As I explained in my previous column, the ploy works as follows: corporate insiders create a
front organization that seems independent but is really under their control. This front buys some of the firm’s
assets at unrealistically high prices, creating a phantom profit that inflates the stock price, allowing the
executives to cash in their stock.
That’s exactly what happened at Harken. A group of insiders, using money borrowed from Harken
itself, paid an exorbitant price for a Harken subsidiary, Aloha Petroleum. That created a $10 million phantom
profit, which hid three-quarters of the company’s losses in 1989. White House aides have played down the
significance of this maneuver, saying $10 million isn’t much, compared with recent scandals. Indeed, it’s a
small fraction of the apparent profits Halliburton created through a sudden change in accounting procedures
during Dick Cheney’s tenure as chief executive. But for Harken’s stock price -- and hence for Mr. Bush’s
personal wealth -- this accounting trickery made all the difference.
Oh, and Harken’s fake profits were several dozen times as large as the Whitewater land deal --
though only about one-seventh the cost of the Whitewater investigation.
Mr. Bush was on the company’s audit committee, as well as on a special restructuring committee;
back in 1994, another member of both committees, E. Stuart Watson, assured reporters that he and Mr.
Bush were constantly made aware of the company’s finances. If Mr. Bush didn’t know about the Aloha
maneuver, he was a very negligent director.
In any case, Mr. Bush certainly found out what his company had been up to when the Securities and
Exchange Commission ordered it to restate its earnings. So he can’t really be shocked over recent corporate
scams. His own company pulled exactly the same tricks, to his considerable benefit. Of course, what really
made Mr. Bush a rich man was the investment of his proceeds from Harken in the Texas Rangers -- a step
that is another, equally strange story.
The point is the contrast between image and reality. Mr. Bush portrays himself as a regular guy,
someone ordinary Americans can identify with. But his personal fortune was built on privilege and insider
dealings -- and after his Harken sale, on large-scale corporate welfare. Some people have it easy.

Paul Krugman, “Steps To Wealth” New York Times, July 16, 2002

Why are George W. Bush’s business dealings relevant? Given that his aides tout his “character,” the
public deserves to know that he became wealthy entirely through patronage and connections. But more

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important, those dealings foreshadow many characteristics of his administration, such as its obsession with
secrecy and its intermingling of public policy with private interest.
As the unanswered questions about Harken Energy pile up, let me now turn to how Mr. Bush, who got
by with a lot of help from his friends in the 1980’s, became wealthy in the 1990’s. He invested $606,000 as
part of a syndicate that bought the Texas Rangers baseball team in 1989 -- borrowing the money and
repaying the loan with the proceeds from his Harken stock sale -- then saw that grow to $14.9 million over
the next nine years. What made his investment so successful?
First, the city of Arlington built the Rangers a new stadium, on terms extraordinarily favorable to Mr.
Bush’s syndicate, eventually subsidizing Mr. Bush and his partners with more than $150 million in taxpayer
money. The city was obliged to raise taxes substantially as a result. Soon after the stadium was completed,
Mr. Bush ran successfully for governor of Texas on the theme of self-reliance rather than reliance on
government.
Mr. Bush’s syndicate eventually resold the Rangers, for triple the original price. The price-is-no-object
buyer was a deal maker named Tom Hicks. And thereby hangs a tale.
The University of Texas, though a state institution, has a large endowment. As governor, Mr. Bush
changed the rules governing that endowment, eliminating the requirements to disclose “all details
concerning the investments made and income realized,” and to have “a well-recognized performance
measurement service” assess investment results. That is, government officials no longer had to tell the
public what they were doing with public money, or allow an independent performance assessment. Then Mr.
Bush “privatized” (his term) $9 billion in university assets, transferring them to a nonprofit corporation known
as Utimco that could make investment decisions behind closed doors.
In effect, the money was put under the control of Utimco’s chairman: Tom Hicks. Under his direction,
at least $450 million was invested in private funds managed by Mr. Hicks’s business associates and major
Republican Party donors. The managers of such funds earn big fees. Due to Mr. Bush’s change in the rules,
these investments were hidden from public view; an employee of Utimco who alerted university auditors was
summarily fired. Even now, it’s hard to find out how these investments turned out, though they seem to have
done quite badly.
Eventually Mr. Hicks’s investment style created a public furor, and he did not seek to retain his
position at Utimco when his term expired in 1999.
One last item: Mr. Bush, who put up 1.8 percent of the Rangers syndicate’s original capital, was
entitled to about $2.3 million from that sale. But his partners voluntarily gave up some of their share, and Mr.
Bush received 12 percent of the proceeds -- $14.9 million. So a group of businessmen, presumably with
some interest in government decisions, gave a sitting governor a $12 million gift. Shouldn’t that have raised
a few eyebrows?
All of this showed Mr. Bush’s characteristic style. First there’s the penchant for secrecy, for denying
the public information about decisions taken in its name. So it’s no surprise that the proposed Homeland
Security Department will be exempt from the Freedom of Information Act and from whistle-blower protection.
Then there’s the conversion of institutions traditionally insulated from politics into tools for rewarding
your friends and reinforcing your political control. Yesterday the University of Texas endowment; today the
Federal Energy Regulatory Commission; tomorrow those Social Security “personal accounts”?
Finally, there’s the indifference to conflicts of interest. In Austin, Governor Bush saw nothing wrong
with profiting personally from a deal with Tom Hicks; in Washington, he sees nothing wrong with having the
Pentagon sign what look like sweetheart deals with Dick Cheney’s former employer Halliburton.
So the style of a future Bush administration was easily predictable, given Mr. Bush’s career history.

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