US fraud a product of sickness at heart of corporatism

 

The reported $4 billion accounting fraud at WorldCom will be seen as a major changing point in global corporate management and regulation, writes Ray Kinsella

The obsession of maximising, at all cost, shareholder value - within a culture that esteems the next quarter's earning as more important then long-run sustainability of the business is both flawed and untenable. There are no obvious answers. But the G8, which is meeting in Canada, had better start thinking long and hard about the issue.

The WorldCom debacle is considerably larger than that which brought down Enron. WorldCom has shed 17,000 people. Now the future of the company is in the balance. Investors - including those managing major pension funds - have seen that value of their shares fall from over $60 in 1999 to some 30 cents. What we are talking about here is not economics. Nor are we talking about the volatility of financial markets. This would be off the wall if it weren't so catastrophically damaging to the world economy.

There are important differences between the manipulation of off-balance sheet vehicles that was at the heart of the Enron crisis and the massive mis-statement of WorldCom's profits that is the immediate cause of the WorldCom crisis. But they have much in common, most obviously the deficiencies in auditing practice - and in the corporate culture that facilitated and indeed incentivised these deficiencies.

The reaction of global stock-markets to WorldCom nails down the markets' belief that Enron and WorldCom are not isolated events. They are the product of a sickness at the heart of global corporatism. It is spreading - and the collateral damage can not yet be estimated. There are, of course, many multi-national companies that are managed with great integrity. But the wider culture in which they operate militates against these virtues. And a process of contagion, which has been triggered by Enron and now reinforced by WorldCom, does not discriminate very well - at least in the short term - between the good, the bad, and the very, very ugly. The first casualty is a lack of confidence in the system.

There are a number of reasons why the WorldCom crisis has-finally brought us to this point in global corporatism. The WorldCom crisis is a massive shock to the new economy and to the global business environment. Ireland and other small open economies are right in the firing line.

It simply should not be possible for multinational companies to play fast and loose with accounting standards. In reality, the standard-setters are continually playing catch-up - or being ignored. Most important is the fact the auditing profession, which in a number of countries, including Ireland, is an integral part of the formal regulatory process has been found wanting - not all of them of course. But the action of the few has corroded confidence, with all of the knock-on damage that is now evident in company valuations and, by extension, investment capability.

All of the recent evidence resonates with the dance of death by some investment analysts, stressed-out management and institutional investors around the culture of maximising shareholder value: of optimising, manipulating quarterly earnings and short-term market value.

In the wake of the Enron debacle, the Bush administration set out a series of proposed reforms, aimed at strengthening corporate governance as well as accounting and auditing practices. But with this latest debacle, we are well past the stage where any 10-point plan would be regarded as remotely credible. This is a problem embedded in the bowels of the present corporate culture and it is not going away without radical surgery. It is a global problem and neither regulatory practice nor corporate governance have yet adapted to the global business environment and to the enormous collateral damage that is transmitted through failures such as those of WorldCom.

The large institutional investors must have a much more active role to play - within a more formal system that is closely monitored. Better regulation is imperative. But delivering that better regulation within a fragmented EU regulatory system is a major challenge. More regulation is not the answer. Quite the contrary, it simply highlights the new rules of the game that are there to be shot at by would-be "successful" corporates.

The real issues to be addressed have to do with the shareholder-driven corporate culture, which is rooted in greed. At the risk of overstating, the shareholder value paradigm is redundant. Think about it. Over the last century, we have moved through a series of economic models. We have never seriously questioned the system of ethics that should be the custodian of these models - including the present global market-based economy, within which is embedded a new set of responsibilities that are quite alien to the mid-twentieth century model.

The former managing director of Lazard Frêres and former US ambassador to France, Mr Felix Rohatyn, was right when he recently pointed out that "ultimately rules are no substitute for ethics... will turn out to be more than a moral imperative: it will turn out to be good business". If we are to seriously address the issues raised by Enron and WorldCom this is a first, and necessary, starting point.

Ray Kinsella is director for the Centre for Insurance Studies at the Michael Smurfit Graduate School of Business, and author of Internal Controls in Banking