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Ethics for a Post-Enron America1

John R. Boatright

The high profile scandals at Enron, WorldCom, Global Crossing and Tyco,
among others, combined with the spectacular dissolution of the accounting
firm Arthur Andersen, are more than business failures. Voluminous news
reports have revealed egregious failures by top executives and their advisers –
including accountants, investment bankers and lawyers – to fulfil their basic
fiduciary duties to serve the interests of shareholders and the public.
Executives are pledged to serve the interests of shareholders, for example.
Yet some have manipulated earnings, hidden debts and falsified accounting
records, all in order to exercise their lavish stock options at their shareholders’
expense. Accountants who perform audits for the benefit of the investing
public have permitted many instances of so-called ‘aggressive accounting’
and approved financial statements that subsequently proved false. Investment
bankers have helped executives to develop complex financial transactions
that generate phantom earnings or remove unwanted debts from the balance
sheet.
All the while, the banks’ analysts, who were supposed to be objective, were
giving favourable evaluations of the securities of companies with which the
banks were doing deals, and the banks’ brokers were filling their customers’
portfolios with these same securities, even as they denigrated them in internal
communications. And the lawyers who blessed many of these accounting
and financial shenanigans were acting as though their clients were the
executives who hired them, and not the shareholders, who were ultimately
paying for their services.
In each of these cases, the moral wrong is simple: a failure to fulfil a fidu-
ciary duty, generally because of serious conflicts of interest. That this kind of
behaviour is immoral, and often illegal, is clear, but what challenge does it
pose beyond recognising that it is wrong and attempting to prevent it? Some
argue that existing laws and the force of the marketplace are sufficient, and
nothing more needs to be done. Indeed, many of the wrongs in the recent
scandals are slowly being rectified. Congress has mandated new rules to
ensure that directors and auditors are ‘independent’, which is another way

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© Palgrave Macmillan, a division of Macmillan Publishers Limited 2006
 John R. Boatright 227

of saying ‘free of conflicting interests’. Among the many provisions of the

Sarbanes-Oxley Act, for example, are the requirements that audit commit-
tees be composed entirely of independent directors with no ties to manage-
ment, and that accounting firms doing audits refrain from performing
certain non-audit services that could bias an audit. Similarly, Eliot Spitzer,
the New York State attorney general, has forced some major investment
banks to increase the independence of analysts in order to reduce the risk
that their ratings of stocks will be influenced by the banks’ deal-makers.
Although these efforts to reinforce fiduciary duties by removing conflicts
of interest and restoring objectivity may produce some improvements, they
do not address the most important challenge posed by the recent scandals.
The effectiveness of fiduciary duties as a regulator of business conduct has
been undermined seriously since the 1980s by several developments in the
American business system. In particular, executive compensation tied to per-
formance, the combining of auditing and consulting by accounting firms,
and consolidation in the financial services industry have produced powerful
new incentives that have been major factors in recent scandals. Restoring
the traditional fiduciary duties in the face of these developments will be a
difficult, if not impossible, task.
There are alternatives, however. Imposing fiduciary duties is one form of
regulation that relies heavily on moral force, but market-based regulation
that seeks to alter the incentives is another form. The challenge in this post-
Enron era, then, is to determine which form of regulation, or what combina-
tion of these forms, can best secure the kind of ethical business environment
in which future ‘Enrons’ will not occur.

What went wrong?

We cannot propose reforms to prevent another Enron, much less understand
the post-Enron world, without a firm grasp of why the recent scandals
occurred. The stories are complex, and each one is different, but they all
share some common features. Each case involves a business strategy gone
awry, executives determined to boost short-term stock price by any means,
directors who failed to detect warning signs, accountants who acquiesced in
aggressive accounting, investment bankers who structured questionable
financial deals, and lawyers who showed how to achieve the desired results
with a plausible legal veneer.
A major factor in the scandals of 2001 is an increased focus on share price.
This began in the early 1980s, during a period of hostile takeovers when a
high price was the best defence. The impetus for high executive compensa-
tion tied to performance came originally from companies taken over that
needed to raise share price quickly. Institutional investors encouraged this
trend because it seemed to promote good corporate governance by aligning
executives’ interests more closely with those of shareholders. Finance