James SurowieckiTuesday July 23, 2002The Guardian
If you were interested in finding a culprit for the deluge of bad news that has engulfed American business and brought the stock market crashing down, the name of Lee Iacocca would probably not be high on your list of suspects. But if it weren't for Iacocca, it is unlikely that we would be talking about Enron and WorldCom today.
In the early 1980s, as chief executive officer (CEO) of Chrysler, Iacocca helped rescue that company from bankruptcy. He starred in a series of legendary (as these things go) television ads, each of which ended with him gazing earnestly into the camera and saying: "If you can find a better car, buy it." His marketing pizzazz, coupled with a not-so-subtle appeal to nationalist sentiment (who wanted to let the Japanese kill off one of the Big Three?) revitalised Chrysler's image and got the company off its deathbed.
The resurrection of Chrysler turned Iacocca into the symbol of a resurgent US capitalism. This was rather ironic - Chrysler only survived, after all, because of a government bail-out and some well-timed intervention against Japanese imports, and was hardly evidence of the virtues of the free market. But Iacocca's combination of tough-guy individualism and earnest Americanism fit the country's mood in the heyday of the Reagan years. He appeared on the cover of Time magazine, above the tagline "America loves listening to Lee", he bandied about the idea of running for president, and his autobiography - the cleverly titled Iacocca - became one of the best-selling books of the decade.
Iacocca's ascent signaled a dramatic change in American culture. Prior to him, the popular image of the American CEO had been of a buttoned-down organisation man, pampered and well paid, but essentially bland and characterless. The idea of the businessman as an outsized, even heroic, figure seemed like the legacy of a long-forgotten past when men like JP Morgan and William Randolph Hearst were still around. In fact, in 1982, Forbes magazine wrote, "Tycoons are fairly rare birds in today's business world. We seldom hear of moguls." Within just a few years, that had all changed, with business journalists turning every clever executive with a good idea into the next Henry Ford, and with the Rupert Murdochs, Sumner Redstones, and Donald Trumps of the world actively cultivating the "mogul" label.
By the time the boom of the 1990s rolled around, CEOs had become America's superheroes, accorded celebrity treatment and followed with a kind of slavish scrutiny that Alfred P Sloan could never have imagined. Dennis Kozlowski and Bernie Ebbers reaped what Iacocca had sown. "In the 1980s, there was a sea change in the way the media and the culture at large responded to CEOs," says Jim Collins, author of the seminal studies of business history Built to Last and Good to Great. "And you can pinpoint that change to one single event: the publication of the Iacocca book. That was the moment when it became clear that everything was different."
The shift in Main Street's perception of CEOs would not have mattered so much had the people in the boardrooms not also bought into the myth of the CEO as superhero. But they did. Companies everywhere wanted their own Iacocca. They didn't just want someone who knew his industry and was good at nuts-and-bolts execution. They wanted someone who was good on television, who had a touch of glamour, who could sell the company's story on Wall Street, who had a handle on the vision thing (and who was good at nuts-and-bolts execution, too). As Harvard Business School Rakesh Khurana, author of a forthcoming book on the CEO job market, puts it: "Companies were looking for a corporate saviour."
Now, as it happens, this was a futile quest. Although it may be hard to believe after a decade and a half of CEO worship, all the available evidence suggests that most chief executives have only a negligible impact on the performance of the companies they run. There are, of course, exceptions. But corporate performance depends far more on what industry a company is in, what proprietary advantages it has, and the general quality of its workforce, than it does on who's at the very top.
And in those cases where leadership does make a difference, the successful leaders don't fit the corporate-saviour model. In Collins' book Good to Great, for instance, all the "great" companies he studied were led by CEOs whose attitude toward fame and attention was more like that of Thomas Pynchon than Tom Cruise. "They were, by design, not celebrities," Collins said. "They did not attribute the company's success to their own genius. And they shunned the spotlight." By contrast, the executives who were constantly making star turns - who included men such as "Chainsaw" Al Dunlap and, yes, Iacocca - did a bad job of making their companies stronger.
No matter, though. Boards of directors were convinced that the CEO was the key to greatness (perhaps in part because so many directors were themselves CEOs), and they were willing to pay accordingly - after all, you don't treat a new messiah the way you would an ordinary mortal. So CEO pay packages skyrocketed, rising from 42 times the average worker's salary in 1980 to 531 times the average worker's salary in 2000.
And it wasn't just the very best CEOs who were rolling in filthy lucre, either. Since what one executive makes tends to depend on what other executives make - a typical corporate proxy statement will include a line such as "we want our compensation package to be competitive with the industry as a whole" - there was an irresistible ratcheting-upward effect. Then, too, in the 1980s and early 1990s, compensation committees were often made up of other CEOs. Who, really, was going to vote for what would have been an indirect pay cut for himself?
Executive pay was, on its own terms, scandalous. But what made it the engine of the kind of shenanigans we've seen at Enron and WorldCom was, of course, the fact that most CEO pay packages relied heavily on stock options. Options were not new - read any business history dating back to the 1950s, and it is clear that option packages were an important part of any CEO's compensation. But the nature of the options grants in the 1990s was qualitatively different.
In 1995, Congress passed a law limiting the tax-deductibility of corporate salaries of more than $1m. But it allowed an exemption for any pay that was incentive-related. So options were a way of paying executives without forgoing tax benefits. The bull market made options seem relatively costless (If everyone was winning, did we really need to worry if the CEO was clearing an extra $30-$40m a year?). And there was the one intellectually sound argument for options - they aligned the interests of the CEO with the people he was supposedly representing, the shareholders. Put all these things together, and you had stock-option grants on an unprecedented - and indeed practically unimaginable - scale.
In 2000, Steve Jobs of Apple was given a package that would be worth $550m if Apple's stock rose just 5% a year over the next decade. In the same year, Larry Ellison of Oracle was given 20m options worth around $400m, even though he already owned 700m shares in the company. (Were the extra 20m options really going to make him work harder?) The idea of the CEO as superhero was radically misconceived, and the idea that stock options were free money was senseless. Together, they created an environment in which one of corporate capitalism's perennial problems - self-dealing - could flourish.
Self-dealing, essentially, occurs when managers run companies to line their own pockets instead of those of the companies' owners. Most of the great scandals of the gilded age in America during the 19th century involved American managers who set up corporations (generally railroads) and then siphoned off the money of outside investors - who more often than not were British.
When a British emissary was sent to America in the 1890s to find out what had happened to the money his bosses had put into an American firm, he wrote to them that he had asked one of the company's directors where all the invested capital was, and had received this less-than-reassuring reply: "Well, really, sir, that is what I am always asking, but which I can never get to know." As American capitalism moved toward a model in which corporations would be run by professional managers who had only small ownership stakes, the threat of self-dealing increased. In their seminal book The Modern Corporation and Private Property in 1932, Adolf Berle and Gardiner Means identified the separation of ownership from control - the people running the company are not the people who own it - as the system's central dilemma.
One of the answers to that dilemma, ironically, was stock options. But in practice, option packages actually turned out to facilitate - rather than curb - self-dealing. As economist David Yermack of New York University has shown, stock option grants tended to be issued just before good news was released (thereby locking in a lower price for the option). Issuing more options didn't increase executives' stake in companies. They just cashed in existing options. And the way options were awarded encouraged executives to adopt risky strategies. If stock prices skyrocketed, they got massive options grants as a reward; if stock prices plummeted, they got massive options grants as an incentive, or they had their options repriced. Either way, executives couldn't really lose.
Finally, the sheer size of the grants exacerbated the problem. In the past, one check on managers' greed was that they stood to gain more from staying with a company for a long time than they did by playing fast and loose and cashing out early. But when you give CEOs the chance to make $300m in a year by stretching the rules a little bit, it's not too surprising that some of them will take you up on it. So if in the old days investors worried about executives paying themselves high salaries, lavishing perks on themselves, and spending money to redecorate the executive dining room, now they have to worry about executives using deceptive numbers to jack up the stock price in order to dump their stakes and put hundreds of millions in the bank before anyone can figure out what's wrong. (It is true, of course, that if you're a visionary investor, you could dump your stock too, and piggyback on the executives' malfeasance. But that's not exactly easy to do.)
In the past couple of months, it has become fashionable to say that what led to the scandals was that favourite mantra of every 1990s CEO: "shareholder value". But this is a red herring. Of course, investors brought much of this on themselves by blissfully ignoring the real cost of options and buying wholeheartedly into the myth that superhuman CEOs deserved superhuman pay packages (One stunning Burson Marsteller survey from the late 1990s said that 95% of investors would buy a stock based on what they thought of the company's CEO). And there were few investor complaints when the Nasdaq rose 273% in three years. Only after the crash did everyone get religion.
But it's none the less true that shareholders paid the price, rather than reaped the benefits, of corporate corruption. And although CEOs were obsessively concerned with their companies' stock price, at companies such as Enron and Tyco, top executives were less concerned with the performance of the company's stock over time than they were in getting out of the stock as quickly as possible. That's not exactly what the emphasis on shareholder value was supposed to mean. In fact, if you look at the hundreds of billions of debt that corporations took on in the 1990s in order to pay for the cost of issuing options, and you look at how little stock prices ended up rising over that same period, it now appears as if the past decade wit nessed the greatest transfer of wealth from shareholders to workers in the history of the US economy. Unfortunately, the workers were almost all ensconced in the executive suite.
The systemic questions raised by the bursting of the stock-market bubble and the revelations of corporate corruption don't, in the end, have much to do with the virtues or vices of markets per se, so much as they have to do with the vigilance and regulation that markets need in order to work. The delusion that everyone abided by in the 90s was that self-interest alone would point everyone in the same direction. What's only now becoming clear is that without the right kind of harnesses for self-interest, the system is given to fragmentation. The independent arbiters - accountants and Wall Street firms - whose businesses supposedly depended on the quality of the advice they gave sacrificed those reputations for higher fees, and were given a free pass. And shareholders who were supposed to aggressively monitor the companies they owned and toss out executives at the first sign that something was wrong succumbed instead to greed and inertia.
Obviously, much of this is already changing. The market is taking to the woodshed any company with even a hint of scandal about it. The New York stock exchange will now require its companies to follow a set of substantive, rather than cosmetic, rules about the independence of boards and the strengthening of shareholder rights. Congress looks set to make meaningful changes in the way corporate accounting works. And some of the country's most prominent mutual-fund managers, including John Bogle, the guru of indexing, and Bill Miller, the only fund manager to outperform the S&P index 11 years in a row, are adopting a far more aggressive and activist stance on the need for greater transparency and for limits on the use of options. But the stock market will be suffering the consequences of these scandals - in the form of lower stock prices and lowered expectations - for years to come.
The US, on the other hand, may escape from all this without any sustained damage to its real economy. Even as the stock market has continued to plummet, the economy has continued to recover from last year's recession. In June, consumer spending was up a remarkable 1.1%, and industrial production rose 0.8%, its sixth straight gain. And although consumer-confidence surveys show that all the bad news on Wall Street is affecting the way people feel, it's not having much impact on the way they're acting.
This may seem surprising, but it fits well with economic reality. Although we heard much during the 1990s about America as a shareholder nation and the advent of "people's capitalism", no more than 50% of Americans own any stock and, as of 1998, the median stockholder's portfolio was worth just $25,000. What happens on Wall Street, then, has only an indirect effect on the day-to-day lives of most Americans, for whom jobs and prices remain the key determinants of how much they feel like spending. The amount of wealth wiped out in the stock market in just the past six months has been, of course, remarkable. But the "victims" of that decline are disproportionately the wealthy.
In the long run, of course, a bear market is not good for anyone's mood. But in concrete terms, the most important things about the US economy right now are the unemployment rate - which, at 5.9%, is still low by the standards of the past two decades - and inflation, which is nonexistent. That helps explain the most curious thing about what's happening on Wall Street, which is that it feels simultaneously like a huge story - front-page news every day - and yet a contained one.
Of course, consumers are not the only players in the economy, and there's no doubt that the stock market's decline, the rise in investor distrust, and the skittishness of corporate executives has slowed the recovery substantially. Here too, though, the major impact is psychological. The stock market is not the chief way that companies raise money for future investment, and in any case it's not exactly clear how cutting back on spending - which is what businesses are doing - is a rational response to fears about corporate corruption. It's more likely that what we're seeing are executives who have been so burned, personally, by the steep drop in stock prices that they feel the need to hunker down until the storm has passed.
The biggest question, of course, is whether the genuine anger and revulsion that many Americans feel toward people such as Jeff Skilling and Bernie Ebbers will translate into anything bigger than accounting reform and a new attitude toward stock options. In other words, will connections between corruption in the executive suite and corruption in the executive branch be made, and the place of corporations in the polity as a whole be rethought? That, after all, is very much what happened in the wake of the scandals of the gilded age, which prompted an era of reform that transformed the role of the American state, leading to everything from the Sherman Antitrust Act to the Pure Food Act to the first serious regulation of Wall Street.
It may be too early to answer that question, but at the moment the rebirth of Progressivism does not appear to be upon us. In part, that may be because most Americans have yet to feel too much pain as a result of the scandals, while the legacy of the boom years in the form of higher wages and low prices is still with us. But in part it's also because these scandals ultimately seem to have more to do with the internal workings of corporations - that is, the division of power between shareholders and managers - than with the effect of corporations on the outside world.
The historian Richard McCormick famously argued that Progressivism was the product of "the discovery that business corrupts politics". But what we seem to have discovered in the past year is simply that business corrupts business. It may be an obvious lesson, but apparently it has to be learned over and over again.
· James Surowiecki is a staff writer for the New Yorker.
