It is becoming increasingly clear that many of the activities that got Enron in trouble are pervasive throughout corporate America. Consequently, some of the blame for its behavior must go to the business schools, management gurus, money managers and financial analysts. They not only turned a blind eye to unsound management practices, but implicitly encouraged them. In short, to prevent future Enrons will take more than making examples out of Ken Lay and other Enron executives.
Twenty-two years ago, two Harvard Business School professors, Robert Hayes and William Abernathy, wrote a highly influential article for the Harvard Business Review entitled, "Managing Our Way to Economic Decline." The gist of the article was that widely practiced management techniques were in part responsible for the decline of American industry.
In particular, Hayes and Abernathy criticized managers for having too short-term a focus. Companies were avoiding investments that might take years to pay off, in favor of those with a fast return. Moreover, there was an increasing emphasis on cash flow as the measure of success. These and other elements of managerial style at many large corporations were making them risk-averse, conservative and myopic.
Said Hayes and Abernathy, "We believe that during the past two decades American managers have increasingly relied on principles that prize analytical detachment and methodological elegance over insight, based on experience, into subtleties and complexities of strategic decisions. As a result, maximum short-term financial returns have become the overriding criteria for many companies."
The Hayes and Abernathy critique was sometimes converted into a criticism of the trend toward services and away from manufacturing in the U.S. economy. The problem, many said, was that the United States was no longer producing "things." This was not correct. First, Hayes and Abernathy never criticized the service sector or treated manufacturing as paramount; their criticism applied to all businesses. Second, although manufacturing employment had fallen, real output in the manufacturing sector as a share of the real economy was about the same in 1980 as in 1950.
A more valid criticism of Hayes and Abernathy was that they understated the way government policies helped bring about the bad behavior they observed. High inflation and tax rates, combined with growing federal regulation of business, encouraged companies to manage for the short-term. If they took risks and achieved "windfall" profits, they were denounced as greedy and their profits were taxed away. Under the circumstances, any manager who did not behave as Hayes and Abernathy described would have been foolish.
Thankfully, the election of Ronald Reagan changed the economic climate and the corporate culture in the United States. Tax rates were cut, inflation was sharply reduced, and risk-taking and entrepreneurship were celebrated. Within a short time, investors and managers discovered new and better ways of responding to market demands. Whole industries, like the auto industry, completely reinvented themselves, returning again to the top ranks of world businesses.
At the same time, innovations in finance, especially invention of the "junk" bond, made corporate takeovers easier. Although loudly denounced, so-called corporate "raiders" like T. Boone Pickens put the fear of God into complacent managers, forcing them to shape up or ship out. Suddenly, for the first time, shareholders had a way of disciplining corporate managers who failed to deliver profits. I believe that this was a major reason for the turnaround in American industry in the 1980s that established the foundation for growth in the 1990s.
Unfortunately, a backlash against corporate raiders set in. Michael Milken, inventor of the junk bond, was jailed for nothing more than making too much money too fast. As a result, hostile takeovers have largely become a thing of the past. Without the threat of a takeover, managers have been able to go back to ignoring shareholders, treating them like a nuisance, and giving themselves bloated salaries and perks, with little oversight from corporate boards.
Now insulated from shareholders once again, managers could engage in unsound practices with little fear of punishment for failure. Enron was exceptional in suborning its own accountants in order to keep financial analysts and money managers in the dark about what it was doing. Consequently, I believe that Arthur Andersen is, if anything, even more culpable than Enron. It failed its responsibility to protect Enron's owners and employees by keeping management honest.
It seems that we have come full circle, back again to the excessively short-term focus that Hayes and Abernathy decried 22 years ago. Clearly, Enron's obsessiveness with producing quarterly profits contributed to the unsound financial practices that got it in trouble. It remains to be seen whether financial markets will once again rise to the challenge and discover new methods of disciplining corporate managers the way hostile takeovers did in the 1980s.