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March 15, 2009

The Barons of Bankruptcy Strike Again

By Jim Senter

CEOs taking extravagant bonuses while the corporations they run go bankrupt is not a new problem. This article explores the reasons why, and what we can do about it.


CEOs grab millions in bonuses on their way out the door, as their corporations crash around their ears and fall into bankruptcy. Billions of investors' dollars evaporate. Thousands lose their jobs and are left wondering where their next paycheck will come from. The public screams in impotent outrage at the unfairness of it.

What's this? A recount of January's announcement that Wall Street banks -the same ones that ran the world economy off the cliff-- paid $18 billion in bonuses for 2008?


You could be excused for forgetting it, given the heights of criminality we've scaled in the last eight years; but the reign of King George was ushered in on a wave of corporate bankruptcies the likes of which we've only recently seen again. At the dawn of the millennium, as the dot com bubble burst, scores of companies, like WorldCom and Enron, went under.

And their chief executives made out like bandits.

The Financial Times looked into this in 2002. What they found shocked the public and grabbed the attention of lawmakers for a time.  In the largest 25 corporate bankruptcies between 1999 and 2002, while hundreds of billions of dollars of investor wealth and over 100,000 jobs disappeared, the FT found the "barons of bankruptcy" made off with $3.3 billion.

Stunning reward for blazing mismanagement is nothing new, it appears.

How did the captains of finance build this "heads I win, tails I win again" machine? And how is it that we are here, six years on, watching incompetence being richly rewarded once again?

This isn't merely a story of greed run rampant. It's a story of greed that was enabled  to go wild by corporate structures, tax codes and the accounting standards by which corporations keep track of their money.  It demonstrates that, dull as they may be, such arcane regulations have immense influence on the daily lives of millions of people.

In response to the executive excesses of the Reagan era, in 1993 Congress capped at $1 million the amount of executive salary corporations could claim as tax deductions. At the same time, the Financial Accounting Standards Board (FASB), the accounting industry's self-regulation arm, considered requiring that stock options be recorded as corporate expenses.

Stock options give to the person receiving them the option to buy a certain amount of a company's stock at a set price. They are most often used as part of an executive compensation package, augmenting cash salaries. Not counting them as an expense exaggerates corporate profitability and gives a distorted market signal to investors. It dilutes the value of the already outstanding stock by increasing the number of shares the profit/dividend must be divided between. Because of these considerations, the FASB thought expensing stock options was a no-brainer.

Joseph Stiglitz, chairman of President Clinton's Council of Economic Advisors at the time, describes how wrong they were in his book, The Roaring Nineties. Corporate leaders started whining that expensing stock options would destroy entrepreneurship in the US. They lobbied Congress and administration officials. Treasury Secretary Bentsen and Commerce Secretary Brown wrote a letter denouncing the proposal. With industry encouragement, Senator Lieberman authored a non-binding resolution decrying the proposed standard, and spearheaded passage of a law stripping the FASB of authority to issue such standards, even though, as an independent, industry organization, the FASB was not subject to Congressional authority. The Securities and Exchange Commission (SEC) was dragged into the debate and threatened with a gutted budget if it allowed the FASB to enacted the standard. Under this intense pressure, the FASB adopted a watered down version.

After 1994, stock options remained hidden in the footnotes of corporate annual reports. And the foreseeable happened. With tax exemptions for cash salaries capped, the use of stock options exploded. In 1990 stock options for CEOs of publicly traded corporations amounted to approximately 5% of their total compensation. By 1999 this percentage rose to an estimated 60%. During that time, average compensation rose 150% with stock options accounting for most of this increase.

What this amounts to is a multi-million dollar incentive for corporate executives to use "aggressive accounting" to boost apparent profits and to increase the stock price in the short run.   For instance, when Enron signed a 20-year contract to provide natural gas to a utility company, the entire 20 years of profit was recorded on the day the contract was signed, before any gas was sold or money came in the door. And when deals went bad, those contracts were sold to to "special purpose entities" to get the losses off Enron's books.

These kinds of financial innovations are common, and they have turned US business into a shadow game, a house of cards waiting for the wind to blow. What developed out of this was a corporate culture in which the interests of CEOs and other managers diverged widely from those of other stockholders. (This conflict is as old as the stock company. Adam Smith commented on it in his 18th century classic, The Wealth of Nations. Stock options just put that conflict on steroids and multiply its destructiveness.)

Managers are in effect stock speculators, boosting short term stock price by any means necessary, regardless of its effect on the long term viability of the company. Investors that mean to hold onto the stock, on the other hand, are best served by building a stable enterprise. When it comes down to it, the interests of those who daily run the companies are the ones that are served.

The drive to maximize short-term stock price sent a rot throughout the economy. Auditors who were supposed to be independent, signed off on questionable accounting and bogus financial innovations for the sake of the consulting fees they got from the very companies they were auditing. Stock analysts used their buy recommendations to hype the stocks higher in exchange for the opportunity to be in the game. Campaign contributions flowed to Washington, assuring that when the public backlash occurred (which  it did), the legislative response would be half-hearted and focused on only the most obvious conflicts of interest (which it was).

The SEC watched its enforcement branch shrink with every appropriations bill.

Fifteen years on, we have a deeply entrenched corporate culture that holds that our captains of finance are entitled to vast compensation, regardless of the outcome of their management for stockholders, the company as a whole and society at large. Today, Wall Street investment bankers, acting on that entitlement, take their bailout checks to the bank and  the taxpayers to the cleaners.

If we are to avoid seeing the sorry spectacle of executives looting millions as the corporations they headed go bankrupt again, there are a few simple steps we could take to discourage it.

First, require that stock options be treated as an expense for bookkeeping purposes. No more hiding executive compensation in annual report footnotes.
Next, require that stock be held for at least six months after the option has been exercised and the stock bought, to prevent dump and run actions on the part of CEOs.

Then, give the Securities and Exchange Commission some legal and administrative muscle to go after corporate fraud. Give them the money to hire an army of forensic accountants to prosecute white collar crime. (How's THAT for a jobs program!?)

Finally, we can get rid of the idea that corporate executives are entitled to massive pay packages, regardless of the outcome of their management. They aren't that special. They are as human as you or I, subject to the same kinds of lapses in judgment, the same self-serving delusions. It's just with them, when they screw up, the world feels their pain. And they go to the bank.

Authors Bio:
Jim Senter is a freelance writer and photographer who lives in an intentional community/farm of 350 acres near Durham, North Carolina called Potluck Farm. The farm folk work towards energy and food self sufficiency. Jim is a member of the Southern Anti-Racist Network Executive Committee and is chair of his Democratic Party precinct committee. He is also active in local anti-nuclear and anti-coal power activities and is President of Potluck Power Company, which sells solar electricity through his local rural electric co-op.

His particular fields of study are:
the historical ecology of the Outer Banks of NC
the political economy and history of the Great Depression
the economic history of the utility industry in the USA
economic history as a way to cut through the lies of mainstream economic theory

Jim was born in New Orleans and has family still living in Katrinaville. He started college at the University of Colorado, Boulder and finished at College of the Atlantic, in Bar Harbor Maine, with a stint working with Japanese Buddhist monks in the effort to close the Rocky Flats Nuclear Weapons Plant outside of Denver in between.

He is also an auxiliary member of the United Steel Workers Union