Sometimes it's the little things that say it all.
The little thing that lingers in the case of Enron is the
story of its creation. The original plan was to call it
Enteron -- until somebody figured out this was Greek 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 the many gut-level issues that confront us: corporate
control of politics, executives getting rich while their
companies sink, 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 none are unique
to Enron. 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 Enron debacle comes down to two not unrelated truths:
1) The ideal of the unregulated free market is flawed, and
it's time we said goodbye to Adam Smith's "invisible hand." 2)
Managing a company solely for maximum share price can destroy
both share price and the entire company. These are
foundational flaws -- system design flaws -- in how we
conceive of markets and define business success.
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 (i.e. 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 has been exposed many times. Think of the Great
Depression, the savings and loan crisis or the collapse of
Asian economies in the late '90s. 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
Consider California's experiment with electricity
deregulation. At a Senate hearing on Enron, 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 energy bill 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 state duped by a magical belief
in 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 Securities and Exchange
Commission to grant it an exemption from the Public Utility
Holding Company Act, 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 (the utility act), I seriously doubt that the
types of transactions that brought this company down would
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
banking from investment banking. This allowed J. P. Morgan,
for 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 (who
recommended 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. That's what Glass-Steagall was
designed to prevent.
The list goes 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 -- a combination that 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 Enron train
What's most astonishing is not that this wreck occurred,
but that -- time and again -- we bought the deregulation myth
that led straight to it. We swallowed this absurd fairy tale
about some invisible hand that would sprinkle fairy dust on
us, making everything come out OK.
An earlier generation wasn't as credulous. Those who lived
through the Depression saw the absurdity of economic faith
healing. ("Believe in free markets and all ills shall be
They knew what, until recent rude reminders, we seem to
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." In
language that might get a business editor fired today, they
wrote: "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.
As though under mass hypnosis, we have denied what we know
in our gut: The theory of laissez-faire is 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
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 Chairman Kenneth Lay, CEO 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.
Free market mythology is a smoke screen 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 but with a veneer of legitimacy.
Which brings us to the second major 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 -- that no one asked questions.
Those who did, like whistle- blower Sherron Watkins in her
memo to Lay, were brushed aside. Why disturb the goose laying
so many golden eggs?
In the aftermath of Enron's collapse, 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 long range problems. What
could be wrong? The business is succeeding beyond anyone's
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
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 is 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 benefit
Nash's mathematics revolutionized "game theory" and is
central to "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 that of Adam Smith's
Viewed through the lens of Nash's theory, the Enron scandal
should 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. 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.
An even 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 to send 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, November
2001), from which portions of this are adapted.