Why the Enron fiasco affects us all

COMMENTARY--The ugly collapse of Enron and its fallout in the stock market and in Washington, D.C., has captured more media attention than the Olympics--and on some days, even more attention than this country's war on terrorism.

The allegations of misbehavior on the parts of Kenneth Lay, Andrew Fastow, Jeffrey Skilling, other Enron executives, Enron board members, and Arthur Anderson, were made even more sensational when key players in the company's downfall either took the Fifth Amendment to protect themselves from self-incrimination, or alleged that they hadn't the faintest idea that there were financial problems at Enron.

The events that have been reported are pretty sensational, but as accusations of wrongdoing, denials and finger pointing flash across the television screens of American homes, I am concerned that a very important business practice is being lost. The issue is simple to define and understand, and it should concern you. It certainly concerns me because it's fundamental to running a successful business here in the U.S. or in any capitalist society.

One of the verities of doing business in a capitalist society is that for a business to be successful its management must strike a balance in satisfying its constituencies. In the simplest case, a public stock corporation such as Enron has three constituencies: its customers, its employees, and its stockholders. To be in business at all, a company has to make its customers happy, or it won't make sales and generate revenue. It must pay its employees adequately and give them good working conditions or they won't fulfill their responsibilities or even come to work. And it must generate sufficient profits to satisfy its stockholders or they won't invest. Some companies, such as public utilities, automobile companies, and electronics companies, must also satisfy government constituencies, and many companies feel a need to satisfy the press and other media's requirements, but those are external to the fundamental constituencies noted above.

By striking a balance among its constituencies and their needs, management can then establish a trusting relationship among them--which is important if a company is to survive and grow. If management begins to focus too closely on one constituency or another it will find itself in trouble because trust will break down, and so will the business. For example, if a company over-emphasizes customer satisfaction, it will reduce its prices too far or increase its customer service to a level where the cost is overly high, either of which will reduce or eliminate profits. If a company pays its employees too well or gives them working environments that are too luxurious, it will raise its costs and thereby reduce its profits. In either case, trust breaks down.

All about the stockholders?
The most common mistake that companies make these days is to focus too closely on the needs of stockholders and to sacrifice everything to satisfy whatever performance requirements those stockholders may make. Years ago, stockholders were focused on profits, especially profits that were high enough to yield cash dividends. That made sense because profits require a decent balance of costs and revenues, which implies a balance with the company's two other principal constituencies.

But today, the focus of stockholders is on the growth of the stock's price, which is the fastest route to cash riches. A stock's price these days is more subject to the whims and wishes of Wall Street analysts and traders than it is to pure business principles, such as profits. Lately, Wall Street has been focused on growth in revenue and growth in market share, regardless of their impact on other measures of company performance. Making things even more poignant, most company managers today have significant personal interests in the stock, as do board members whose real responsibility is to represent the interests of the broader population of stockholders.

The result of this concentrated focus on the company's stock price combined with this overwhelming self-interest on the parts of board members and management is behavior such as we have seen at Enron where even the simplest of accounting principles was cast aside in order to make the company's growth numbers look so good on Wall Street. It didn't matter what form the financial legerdemain took. Asset sales were reported as revenues while other revenues were somehow inflated. Liabilities were pushed off the balance sheet and costs that could lead to losses were stuck in a corner or stricken entirely from income statements so that they could not be clearly seen by analysts.

The result of course was that Enron's stock price went nuts during the late 1990's. So, when the truth began to came out and when bond rating agencies downgraded the company's debt and billions of dollars in previously reported profits were suddenly written off, the stock had much further to fall, and so did the interests of the wider population of investors. Those in the know, those with enormous self-interest in how the stock price was manipulated, were able to get most or even all of their Enron stock irons out of the fire in time. But most people were not in the know and could not get out--a group which sadly includes Enron's employees who participated in the company's stock-laden 401(k) plan.

Enron and the Internet bubble
Enron is by no means unique. The accounting tricks were different, but the same sort of management behavior led to the collapse of the Internet stock bubble only a few short months before the Enron crash. Everyone in charge in the dot-com wave was completely focused on the valuation of their companies before or after they went public or got sold. The only reason we don't have captains of the Internet industry sitting before congressional committees is that none of the companies that went belly-up in were big enough or hurt enough people on the way down to individually make big news. With few exceptions, it was only the collection of failed Internet companies that made the papers.

Certainly Enron's stockholders--except those that took the money and ran in time--are no longer satisfied with the company's performance. It's also obvious that Enron's other constituencies are far from satisfied. Most of its employees are out of work and their pension funds have evaporated. Enron's customers, especially in California, were seriously overcharged for the product they bought and are suing to get their money back, while supplies of power coming from Enron are of questionable reliability as it moves through reorganization. One of Enron's singular achievements during its brief life was to get power regulators off its back, so I'm sadly forced to skip over that constituency.

Commentators and politicians are calling for more regulation of businesses, more oversight of auditors, and performance and ethical standards for stock market analysts, but I don't think that any of those or the myriad of other regulatory proposals are the things we need. Instead we need a business climate, and business and investment banking leadership that eschews management by one-constituency-at-a-time methods. We need to bring companies back into some sort of reasonable balance so that fair prices and fair compensation can lead to fair profits, and even to the occasional cash dividend. We need to bring back the trust this country used to have in the management of its corporations.

We also need those managers to take responsibility for what they do, and for board members to fulfill their fiduciary responsibilities. That means they have to work hard to understand what is happening at companies so that they can adequately oversee its management on behalf of the shareholders they are supposed to represent. Auditors need to remember that even though the corporations hire them, they are there on behalf of the stockholders, not company management, and they too need to understand the businesses and accounting practices they sign off on. It is more than a little disheartening to hear Enron's auditors, managers and board members tell us that they just didn't understand what was going on at the company.

So, why should you be concerned about this personally? Well, look around you. The next Enron could be your company. Or it could be the company you depend on to keep your mortgage paid, or it could be a key supplier who you depend on for parts and services in your business, or it could even be one of the customers whose revenue keeps your business running. You might even own stock in the next one. Even as I write this, Global Crossing has declared bankruptcy and the possibly questionable accounting practices of that company and its brethren in the telecommunications business are being called into question. And IBM, under the up-till-now heroic management of Lew Gerstner, reported a $300 million asset sale as operating revenue.

So yes, be concerned and watch your back as you go through your business day. Nobody's going to do it for you.

John Dickinson has worked in the computer industry for more than 30 years in positions ranging from systems analyst and software engineer to editor, writer, critic and industry analyst. His most recent engagement was at eMachines, where he managed the company's Internet and software business units.