Business Ethics

Building Economic Democracy

I've been waxing nostalgic lately over the ethics scandals of old. They seem always to come in waves. There was the early wave of government procurement fraud, then medicare billing fraud, then insurance sales frauds rippling out from Prudential's scandals. After reading about Prudential in the book "Serpent on the Rock," I would have voted it Most Fascinating Scandal -- were it not for the gold-standard scandals of the 1980s, when Ivan Boesky and Michael Milken were hauled away in handcuffs for junk bond fraud, insider trading, and stock parking. That era holds a special place in my heart as my First Ethics Scandal. I remember the urgency I felt as it unfolded -- I was certain such a major ethics crisis wouldn't be seen again.

Well. Here we are a decade and a half removed from the savings and loans scandals, in the midst of a perfect storm in ethics. Turbulence patterns are converging from Enron, Arthur Andersen, Global Crossing, Tyco, Dynegy, Adelphia, WorldCom and the rest.

It's not hard to trace the route from today back to the 1980s. The two eras are (un)ethical bookends to the greatest bull market in history. The management excesses that seemed so shocking back then -- hostile takeovers, massive layoffs, and exorbitant CEO pay -- became ordinary stuff in the 1990s. It was fuel for a hungry market, and as that market became more ravenous it demanded greater sacrifices. Thus minimally acceptable excesses gave way to outrageously fraudulent excesses, until the whole thing blew up in a kind of July 4 extravaganza, with the explosions of Kenneth Lay and Andrew Fastow, the flame-out of Bernard Ebbers, the detonation of Dennis Kozlowski, and the little mauve starburst of Martha Stewart.

The debris from the pyrotechnics has been drifting to earth day after day for months now, leaving the business press hot to talk about business ethics. At Business Ethics magazine we've been getting as many journalists' calls in a month as we used to get in a year. So there seems to be a role for corporate social responsibility (CSR) folks, though not the role we had in mind when we began. What we all wanted to do back then was change things.

Looking back over the years, I'm struck by how little change of real substance has taken root. Codes of conduct have sprouted like weeds. Ethics officers at major corporations have grown from a handful to hundreds. Business for Social Responsibility has become a multi-million-dollar operation. Social investing assets have swelled into the trillions. Business schools have added endowed chairs and required courses in ethics. Awards and best-of lists have grown in profusion. Through it all, as ethical decision-making was taught to MBAs, good companies were sought out for stock portfolios, or descriptions were compiled of best practices, the underlying assumption was that managers had genuine freedom to be socially responsible. We believed CSR was about separating the good guys from the bad guys, and that good guys could be spotted by their exemplary policies and programs and sustainability reports. But the lessons of the perfect storm tell a different story.

As professor Sandra Waddock of Boston College Carroll School of Management noted in an unpublished paper, "Fluff is Not Enough," Enron rang all the bells of CSR. It won a spot for three years on the list of the 100 Best Companies to Work for in America. In 2000 it received six environmental awards. It issued a triple bottom line report. It had great policies on climate change, human rights, and (yes indeed) anti-corruption. Its CEO gave speeches at ethics conferences and put together a statement of values emphasizing "communication, respect, and integrity." The company's stock was in many social investing mutual funds when it went down.

Enron fooled us. But that's not the real lesson here. The lesson is that all the things CSR has been measuring and fighting for and applauding may be colossally beside the point, because they fail to tell us what's really going on inside companies. What's going on is a single thing: unremitting pressure to get the numbers, by any means possible.

This is happening even at the "best" firms. I've had candid conversations with managers at top-tier firms among our 100 Best Corporate Citizens, and what I hear is disheartening.

One executive with his firm 20 years told me recently, "I'm inside the most enlightened company, and I'm telling you, it is no more." Another legendary CSR firm, once known for its employee-friendly practices and no-layoff policy, has in recent years been laying off tens upon tens of thousands, and sucking money from an "over-funded" pension plan to feed its bottom line.

And those are the good guys. Elsewhere firms stoop to buying "janitor insurance" so they can profit when employees die, or move incorporation to Bermuda to evade taxes. No steps seem too brazen or shameless to take, when they boost the numbers enough. If we want to know why the corporate social responsibility movement has accomplished so little of substance, here's the reason: The pressure to get the numbers overrides everything else. It overrides not because God-given, organic "market" forces are at work, but because the system is designed that way. It is designed to serve certain people and not others.

The Financial Elite

Of course, in getting "the numbers," companies are not compiling bloodless digits at the bottom of an income statement. Corporate profits lead to share price increases which represent dollars in the pockets of real-life human beings, primarily two groups of human beings: executives and wealthy investors. Chief executives get most of the blame, and certainly their pay has gone from outrageous to usurious. But they're not the only ones pocketing unconscionable wealth these days.

In just the waning years of the bull market, from 1997 to 2000, the wealth of the Forbes 400 went up by $1.44 billion each. That's an increase of $1.9 million each day, for more than a thousand days on end. We're told that everybody's retirement portfolios shared in the gains. But since 1983, two out of three American households saw no increase in retirement wealth from pensions. Among the wealthiest 5 percent pension wealth went up 160 percent.

Somebody's profiting from the overwhelming drive to get the numbers, and that somebody is not "everybody." It's the financial elite. They prosper not because they're more productive or virtuous than the rest of us, but because they wield power. CEOs select their own board members and craft their own pay packages, rigging the game to make themselves wealthy. Yet they keep their jobs only if they make shareholders wealthy, and get fired when they don't. In the last couple of decades when we dreamed we were working a CSR revolution, the real revolution was the shareholder revolt happening in corporate boardrooms.

Back in the days of Ivan Boesky, hostile takeover artists awakened slumbering boards and forced them to better maximize gains for shareholders. A new tool for doing so was firing CEOs, which boards did at two dozen major firms between 1991 and 1993, including General Motors, IBM, American Express, and Kodak. Another new tool for enforcing shareholder primacy was massive stock option packages, the same options packages that led directly to the ethical scandals of our day.

It was the laser focus on stock price gain that encouraged executives to drive their beasts so hard they collapsed. CEOs were the visible villains, but there were whips wielded to keep them driving toward maximum share price: whips of firing, stock options, and hostile takeovers. These are among the tools of corporate power. And they are tools available only to the financial elite. They are among the tools that make corporations and CEOs do what they do.

It's time we in CSR began studying these mechanisms, talking about system design, understanding why corporations behave so single-mindedly. And that means focusing on power. Because power is what it's all about, not good intentions or voluntary initiatives or toothless codes of conduct. Power.

If the financial elite wields power, the CSR movement wields talk. We put managers through ethics training, help them craft voluntary codes, applaud their environmental stewardship, or launch dialogues with shareholder resolutions, assuming that well-meaning managers can overcome the system-wide pressure to get the numbers. But they can't. To use an extreme analogy, it's like talking ethics to an S.S. officer in Weimar Germany, while ignoring the system in which he must function.

System Design

If CSR has been riveted on things colossally beside the point, it's because we haven't focused enough on system design, particularly on how the system lends power to the financial elite. We haven't fully addressed this issue of power. We haven't adequately studied how it's currently used, or fully imagined how to craft new structures of power, structures where power is wielded not by the few but by the many; structures that can turn stakeholder management from rhetoric into reality.

If we wish to stop being beside the point, if we wish to accomplish in the next 15 years what we failed to accomplish in the last 15, we would do well to focus on democratizing structures of power. Than means imagining, and then creating, economic democracy. Democracy is about two things. First, it is about purpose. In the political realm, it's about an overriding concern for the common good. In the economic realm, it's about having the common good trump the narrow self-interest of the financial elite. It's about broadening corporate purpose from serving shareholders to serving stakeholders, and releasing executives from the destructive mandate to maximize shareholder gain at any cost.

Second, democracy is about structures that bring this purpose to life. It's not about separating good corporations from bad, but about shaping the system forces that act on all corporations. It's about consciously crafting new democratic system structures, structures of voice, structures of decision making, structures of conflict resolution, structures of accountability. Eventually this will mean changes in law. But legal changes must be of a different sort than we've attempted thus far. Laws controlling corporations now amount to a patchwork of regulations about working conditions, pollution, or consumer well-being, focusing on outcomes rather than underling mechanisms. Thus we've been like homeowners chopping down nuisance trees which continually spring back, because we have failed to eradicate the roots.

As Abram Chayes remarked in "The Corporation in Modern Society," it was the judgment of America's constitutional convention "that limitations of structure rather than limitations of substance would best secure our liberties." If the founding generation's work has proved "effective, durable, adaptable," economic reforms have proved less so. It is quite possible, Chayes wrote, "that the difference in approach contributed to the difference in the quality of the result."

Taking on the challenge of economic democracy is a tall order, but there are tall leaders in the CSR movement today; leaders at the peak of personal power, with time yet in their professional lives for another major challenge. I'm thinking, for example, of the first generation of socially responsible entrepreneurs, the founding fathers and mothers of socially responsible mutual funds, the authors of books, the heads of nonprofits, the creators of stakeholder theory. I'm thinking of all the people who have defined CSR and built it into the industry it is today. When this generation passes, their like may not be seen again.

So the people who can lead the way are among us. The need for economic democracy is self-evident. And the historical moment for change is opening, as the Watergate of Wall Street unfolds. What we're witnessing today is not another scandal du jour: We are seeing the weakness of the system design itself, laid bare for all to see, if we can help people to understand what they're seeing.

We are experiencing a unique convergence of forces, not only the forces of scandal, but the forces of change. We can use this moment to take corporate social responsibility to the next level, the level of economic democracy. We can become a new founding generation, completing the design in the economic realm that our forefathers began in the political realm. Instead of chasing one form of corporate wrongdoing at a time, we can put in place enduring structures of justice, effective structures of checks and balances. For it is only in this way that we can truly safeguard the common good, not only for today, but for generation after generation to come.

Marjorie Kelly is editor of Business Ethics.

Enron and the Myths of Runaway Capitalism

Sometimes it's the little things that say it all. The little thing that lingers in my mind is the story about Enron's creation, when the original plan was to call it Enteron -- until somebody figured out this was the Greek word for "intestines." There you have it. In the end, the story of Enron's implosion is not about one diabolical company. It's about the guts of our economy.

It's about many gut-level issues that confront us: corporate control of politics, executives getting rich while their company sinks, employees laid off by the thousands, 401(k) plans tanking, messes left by deregulation, a corporate board asleep at the switch. All are themes in the Enron soap opera, yet not one is unique to Enron. The problems the scandal reveals are systemic. The individuals involved may have been uniquely greedy and unethical, but they were empowered by a system that exalted greed as it diminished ethics and accountability.

The most basic issues of Enron are system issues. These come down to two, not unrelated truths:

1) The ideal of the unregulated free market is flawed, and it's time we said goodbye to the invisible hand.

2) Managing a company solely for maximum share price can destroy both share price and the entire company.

These are foundational flaws in theory, flaws in how we conceive of markets and how we define business success. They are system design flaws. For beyond the juicy tales of villainy at Enron, the deeper issue is why the system lent so much power to villainy, and why there were so few checks and balances to stop it.

A key reason is that we are told -- and, more incredibly believe -- that checks and balances are bad, because free markets are good. Unregulated markets are ideal. Left free to work its magic, self-interest (ie. greed) ostensibly leads things to work out to the benefit of all, as though guided by an invisible hand. This myth is taught in Economics 101 as gospel truth, trumpeted routinely in the business press, and sold abroad as the cure for what ails all economies.

The lie of it has been exposed many times. Think of the Great Depression, the savings and loan crisis, or the collapse of Asian economies in 1997-98. Unregulated free markets often lead to disaster. Self-interest is an insufficient regulator for a complex economy. (Duh.) Yet we seem to have to learn this lesson again and again.

Enron is the latest case in point. Consider California's experiment with electricity deregulation. At an Enron Senate hearing, Sen. Barbara Boxer demonstrated how the experiment left the state "bled dry by price gouging." Jeffrey Skilling, as CEO of Enron, had predicted deregulation would save California $9 billion a year. But as Boxer noted, the state's total energy costs instead soared from $7 billion to $27 billion in a single year. Prices rose a gut-wrenching 266 percent.

Not coincidentally, Enron's stock also shot up. Total return to shareholders in 1998 was a remarkable 40 percent. The next year, a miraculous 58 percent. And in 2000, a jaw-dropping 89 percent. Deregulation did indeed work the magic it was designed to work, by turning Skilling's stock options into a gold mine -- just before it turned the company into rubble.

California wasn't the only one duped by the magical thinking of deregulation. Enron helped convince Massachusetts, New York, and Pennsylvania to deregulate energy markets. And it did the same with Washington.

In 1993 Enron persuaded the SEC to grant it an exemption from the Public Utility Holding Company Act (PUHCA), a Depression-era law that prevented utilities from diversifying into unrelated risky businesses. Enron pursued this diversification, to its disaster. As Rep. Ed Markey (D-Mass.) put it, "If Enron had been regulated under PUHCA, I seriously doubt that the types of transactions that brought this company down would have occurred."

Strike two against the myth of deregulation came in 1997, when the company won exemption from the Investment Company Act of 1940, allowing it to leave debt from foreign power plants off its books. This led to dubious offshore partnerships, which contributed to the firm's undoing.

Strike three came in 1999, when Congress killed the Glass-Steagall Act of 1933, which had separated commercial from investment banking. This allowed J.P. Morgan, to use one example, to entangle itself with Enron in dangerous conflicts of interest. It underwrote bonds for Enron, traded derivatives contracts with the company, bought stock in the firm, and had a research analyst covering the company (recommending it as a buy until last fall), even as the bank risked billions in loans to Enron. Lured by millions in investment banking fees, J.P. Morgan was left holding the bag on $2.6 billion in Enron debt. And that's what Glass-Steagall was designed to prevent.

One could go on. Enron successfully opposed regulation for derivatives trading, then used such trades to mask debt. Arthur Andersen helped defeat a proposal to separate auditing and consulting practices, which left it reluctant to challenge a client. Businesses across the board opposed truthful accounting for stock options, which led to over-reliance on options and in some cases inflation of stock prices.

Piece by piece, protections that might have prevented the debacle were defeated. Layer by layer, existing protections were removed. The result was the train wreck of Enron.

What's astonishing is not that this wreck occurred, but that -- time and again -- we bought the deregulation myth that led inexorably to it. We swallowed this absurd fairy tale about some invisible hand.

An earlier generation wasn't so credulous. Those who lived through the Depression saw the absurdity of economic faith healing ("only believe in free markets and all ills shall be healed"). They knew what we have forgotten. Even the editors of Fortune magazine acknowledged, in a June 1938 editorial, that what failed in the Depression "was the doctrine of laissez-faire." They wrote, in language that would get a business editor fired today: "Every businessman who is not kidding himself knows that, if left to its own devices, business would sooner or later run headlong into another 1930."

Or an S&L crisis. Or Medicare fraud. Or Enron.

As though under mass hypnosis, we have denied what we know in our gut: the theory of laissez-faire is bankrupt. It's a hoax. Why were there so few checks and balances to stop the villainy of Enron? Because we pretended we didn't need them. We believed the hucksters who sold us the elixir of unregulated free markets.

Of course, unregulated markets are never really unregulated. Complex economic interactions need rules. The question is who makes those rules: elected representatives serving the public good, or a financial elite serving only itself.

With Enron, the rules were made by folks like CEOs Kenneth Lay and Jeffrey Skilling, and chief financial officer Andrew Fastow, as well as the financial powers entangled with them. Like all elites, they preferred to run things without public oversight. This is why the invisible hand keeps rising out of the grave. As I show in my book The Divine Right of Capital (Berrett-Koehler, Nov. 2001), free market mythology is a smokescreen that disguises the real nature of elite power -- much like the divine right of kings. It allows elites to run our economy to suit themselves, without interference, and with a veneer of legitimacy.

Which brings us to our second question about Enron: Why did the system design lend so much power to greed? Because doing so was in the interest of the financial elite, including Enron executives and Wall Street. Lay and Skilling both were "laser-focused" on shareholder gain, which led to their own option gains. They succeeded at this so well -- with annual gains of 40, 60, 90 percent -- no one asked questions. Those who did were brushed aside, like Sherron Watkins and her memo to Lay. Why disturb the goose laying so many golden eggs?

In the wake of Enron, some have called for closer alignment between executive and stockholder interests. But this close alignment was itself the problem. When we define business success as maximum share price, a soaring price makes it impossible to see problems. What could be wrong? The business is succeeding beyond anyone's wildest dreams.

We fail to recognize that managing a corporation with the single measure of share price is like flying a 747 for maximum speed. You can shake the thing apart in the process. It's like a farmer forcing more and more of a crop to grow, until the soil is depleted and nothing will grow. It's like an athlete using steroids to develop more and more muscle mass, until the body itself is destroyed.

The problem with Enron was not a lack of focus on shareholder value. The problem was a lack of real accountability to anything except share value. This contributed to a kind of mania, a detachment from reality. And it led to a culture of getting the numbers by any means necessary.

If maximum share price is an irresponsible management theory, and deregulation a flawed economic theory, there are better theories already at hand. It's intriguing that the movie "A Beautiful Mind" is up for Academy Awards during the Enron scandal -- because its protagonist John Nash won a Nobel Prize for proving Adam Smith's theory was incomplete. Self-interest alone can lead to disaster for all, Nash demonstrated mathematically. Self-interest coupled with concern for the good of the group is most likely to lead to the benefit of all.

Nash's mathematics revolutionized "game theory" and is central to the "evolutionary economics," which emphasizes that cooperation is as vital as competition. It's a more evolved theory than the invisible hand, more appropriate for an economy that has become more humane than the aristocratic world of Smith.

Viewed through the lens of Nash's theory, the Enron scandal can lead us to question our fundamental assumptions. Do we really believe corporations are only about making money? Or do we care how they make their money? Do we really care about ethics and public accountability?

If we do, then we need real accountability. We need actual sanctions for ethical infractions, not a flimsy ethics code that the Enron board could waive on a moment's notice, as it did in allowing Fastow to earn millions from off-balance sheet partnerships.

We need checks and balances not only on the side of shareholder value, but on the side of public accountability. That means changing the system design. What a new design might look like is explored at length in The Divine Right of Capital, but the concept most appropriate to Enron is the idea of graduated penalties for unethical conduct.

Firms caught cooking the books, for example, might lose all government contracts. A federal contractor responsibility rule could prohibit the government from contracting with egregious corporate law-breakers. Such a rule was put in place by President Clinton as he left office, but was overturned by President Bush. It should be reinstated and made permanent through legislation.

If Enron had faced the prospect of losing millions in revenues, it wouldn't have waived its ethics rules so blithely. Watkins might have been empowered to approach the board, and the board might have been inclined to listen -- since real financial consequences were at stake.

A more serious penalty was suggested by the attorney general of Connecticut, who recommended pulling the license of Arthur Andersen, so it could no longer do business in the state. If all accounting firms -- and all corporations -- knew they faced this ultimate sanction, they would be less inclined to push the limits. We would start to see ethics and accountability with real teeth.

The ultimate lesson of Enron is that effective system design requires our conscious choice. It cannot be left to some invisible hand. It's time we sent that creepy appendage back to the grave where it belongs.

Marjorie Kelly ( is publisher of Minneapolis-based Business Ethics magazine and author of the recently released The Divine Right of Capital (Berrett-Koehler, Nov. 2001,, from which portions of this are adapted.

How the Socially Responsible Investment World Reacted to 9-11

My mind's eye chooses odd images from the World Trade Center devastation Sept. 11 -- somehow avoiding the obvious, lingering instead on the peripheral. What I keep seeing in my inner eye are all the documents and faxes drifting down from the sky, littering the wreckage like confetti tossed by some macabre hand.

Moments before, each document had its own unique place -- the upper left corner of a particular desk, the lower drawer of a certain file cabinet -- and each document had in its own way been numinous with meaning. There were stock certificates, options trading documents, desk calendars, overnight packages too urgent to wait another day, faxes too urgent to wait another hour. Yet each of these documents was reduced, in an instant, to litter.

In that instant, it became clear to an entire nation that what matters is not documents but lives. What matters is not investments or appointments or the little urgencies of all our days, but life itself. Each other. Our bodies, breathing.

I think of this now, as I look at the messages and documents littering my own desk, and I am grateful in some odd way for the reminder that ultimately they may matter little. As I've been making phone calls in recent days, I've found myself focusing more on the real human beings on the other end of the line, less on the business I want to transact with them. It's the kind of shift I think many of us are making in the wake of September 11, canceling travel plans to be with loved ones, working late a little less often. It seems to me one of those small gifts that tragedy sometimes brings: refocusing us on what really matters.

In a larger sense, a refocusing of priorities is what the responsible business community, at its best, is all about. It's especially what the socially responsible investing community is about. I was fortunate enough to be in the midst of that community at the annual gathering of social investing professionals -- SRI in the Rockies in Tucson, Arizona -- when news broke of the attack on the World Trade Center. It was an extraordinary group to be with at such a time, a group that for me is like an extended family of the heart. As the crisis brought the conference to a halt that Tuesday, the generous soul of the group emerged. We came together the morning of the attack with little mention of markets or portfolios but instead prayers led by the religious leaders among us, small groups where each of us could express our fears, and ad hoc committees focused on matters of group care -- like chartering a bus so 50 folks could make the three-day drive to the East Coast.

Through it all, we were guided by the rules of the road articulated by Alisa Gravitz of Co-op America and the Social Investment Forum, who called on us to "work from a place of connection and love," to "change what we're doing when we need to change," and to "nurture the wells of goodwill."

This tone of compassion and flexibility would be echoed spontaneously in the week ahead by other social investing professionals -- like those at Walden Asset Management in Boston, who wrote to clients on Sept. 18 suggesting that we as a nation "address the underlying causes of terrorism," "dispense with our false sense of security," and "curb our extreme sense of entitlement in our standard of living and redirect our wealth from private interest to the care of others."

How striking these reactions were, coming from investment professionals -- and how different from those which surfaced in the mainstream financial press. In a Sept. 17 issue of Barron's financial weekly headlined "War on Wall Street," columnist Thomas Donlan urged that we "demonstrate that humans do not make war on mosquitoes. We eradicate them." He urged also that the twin towers be rebuilt "as symbols of capitalism as before." Jonathan Laing similarly observed that a resumption of economic activity would provide "a certain measure of revenge."

Absent from such sentiments was the self-reflectiveness I had seen among SRI folks -- the willingness to recognize that the poverty from which resentment springs is not somehow isolated from our own prosperity. As Afghan writer Tamin Ansary said in a widely circulated article, "Suffering and poverty are the soil in which terrorism grows."

Beyond the financial community, like-minded sentiments bubbled up among others, like Brooklyn novelist Trace Farrell. "We've been playing like privileged children ... while people outside the circle of comfort have been paying for our privileges with endless varieties and gradations of suffering," she wrote in an eloquent e-mail. "If we cannot figure out what this attack has to do with us, then we should be prepared for many more strikes 'out of nowhere.'" Because "nowhere," she continued, "is the enormous shadow we cast and never turn to look at but drag everywhere behind us."

It is sobering, to think the attacks have something to do with us, something to do with our economic system. If the social investing community is finding ways to articulate this, it is an awareness all of us in business might learn to cultivate. We might remember that as the little urgencies of our days go on, suffering too goes on. And suffering may be asking something of us.

Marjorie Kelly is editor and publisher of the bimonthly Business Ethics: Corporate Social Responsibility Report


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