The Emergence of Managerial Capitalism

The relationship between shareholders and managers is closely monitored by a government’s institutions of corporate governance. Both main forms of corporations are examined- the family, or closely held corporation, or the diffusely-owned corporation. Social democracies found mainly in Europe have been more concerned with the workers, than they have the managers or stockholders. In Germany, France and Italy, workers are found on the board of directors and the institutions created to watch corporation have needed to adjust to the power of the workers (Roe 18). These countries look after the welfare of their citizens much more so than the United States.
The United States has a much larger labor force that corporations are able to exploit and workers are not often seen on boards of directors. These factors have allowed corporate governance institutions to develop rather easily according to Mark Roe. These corporate governance institutions are created to ensure that corporations are acting within the confines of the laws and build stockholder trust in the corporation. No one would buy stock in a corporation if one did not feel that the corporation was acting lawfully or if they did not have confidence in the corporation’s ability to succeed.
The major corporate governance institutions within the United States are the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), and the most important piece of legislation, the Sarbanes-Oxley Act (SOA) which created the Public Company Accounting Oversight Board. These institutions were all created to monitor the trading of stock and the behavior of corporations. While there are numerous laws and institutions within Europe governing corporations, they are changing as the European Union continues to emerge.

However, one scandal, Parmalat, in Italy demands further inspection of Italy’s corporate governance structures as there was ongoing fraud. The Italian Parliament is currently in the process of enacting laws that, according to Carlotta Amaduzzi, would reorganize securities and financial regulators while instituting corporate governance changes that echo the U.S. Sarbanes-Oxley Act. Attention has focused mainly on the debate over redefining the supervisory roles of financial regulators. But other provisions of the bill, while less in the limelight, promise major reforms of Italian corporate governance.
Governments and institutions have at least taken swift action in response to these emerging scandals and are trying to rebuild public trust, while trying to reform the corporations. In recent years, institutions have been forced to probe deep within corporations or were created as a result of corporate scandals. The SOA was actually enacted in the wake of the Enron scandal. The government realized the extensive fraudulent activities of corporations needed to cease and for trust to be recreated in businesses. Investors and employees lost their retirement funds and pensions as a result of the creative accounting at Enron and other corporations, such as World Com and Parmalat.
These scandals would not have been as large or dramatic if there had been more stringent laws and rigorous inspections of financial statements. There were obvious lapses by the government and the institutions created to oversee corporations. Efforts are now being made to improve the transparency of corporations and to have much more in- depth inspections of financial disclosures. Stockholders and prospective investors should be able to evaluate the strength of a corporation based on the validity of its financial statements, not the creativity of its accountants.
Creative accounting was the base upon the Enron/Arthur Anderson debacle was created. Executives wished to “line their pockets” and they best way they felt was to overstate earnings and hide the increasing debt in partnerships and accounting schemes which would allow the stock price to inflate. These high level executives and managers had been given stock options- and acted in their own interests, not the corporations- the big pitfall of stock options. With the help of their auditors, Arthur Anderson, Enron created over 800 offshore tax havens and practiced illegal or highly questionable accounting and other business practices.
What is particularly shocking is that executives were exercising their stock options while the price was high and making money all the while knowing the company would collapse all and encouraging employees to buy Enron stock. The last people to know about the fraud would be the unassuming stockholders- they were just trying to save money for the future. It took one woman’s determination to cause the misdeeds of Enron officials to come to the forefront. Sherron Watkins, while working for the CFO Andrew Fastow, noticed that Enron was losing money on two of its equity investments, which harmed Enron as the investments were backed up by Enron stock. Her memos to other top executives detailed her concerns, and are now the basis for the ongoing investigation.
In the attempt to prosecute those responsible for the grievous deeds of the Enron officials, the government investigators are focusing upon the truly illegal activities. Michael Duffy, a Time columnist, notes, ” Enron avoided paying federal income tax for four out of the last five years and instead received millions of dollars in federal-tax refunds. For now, the House Energy and Commerce Committee and federal agents probing Enron’s fall are skipping over the accounting schemes and other questionable business practices–including a bizarre sex angle: a scheme to offer pornography via the Internet. The investigators instead have zeroed in on what officials from Enron and Andersen did and did not do once they realized that the debts were mounting, that the stock price was falling and that the last people to learn of the looming reckoning were going to be millions of Enron shareholders. Watkins’ two letters provide the road map for their inquiry.
Investors and all Americans want to see the officials of Enron prosecuted for their illegal activities. Investigators are particularly interested in the illegal deeds of both Enron and Anderson employees how may have had knowledge of the questionable practices and shredded documents. It would be highly illegal if documents were shredded after the investigations began and subpoenas issued.
The former chief outside auditor for Enron, David Duncan plead guilty in 2002 to an obstruction of justice, admitting that, He knew he had committed a crime when he instructed his colleagues at Arthur Andersen LLP to destroy documents as their energy client collapsed. “I obstructed justice,” testified Duncan, the government’s key witness in the trial of his former company. “I instructed people on the engagement team to follow a document-retention policy which I knew would result in the destruction of documents. (Johnson)
Recently several top Enron officials have pleaded guilty in plea agreements with former CEO Ken Lay currently facing a possible indictment. These executives were accused of mail fraud, wire fraud, money laundering, and various conspiracies. Steps are being taken to ensure that those responsible are paying for their actions and that a scandal of this magnitude could be averted. The Sarbanes-Oxley Act is an example of the action taken in the wake of Enron.
In addition to Enron, World Com has found itself in the midst of a scandal that has its former leaders on trial. World Com hid debts, understated costs and backdated contracts in a fraud of $ 11 billion dollars. The SEC filed a civil suit against the corporation and federal charges have been filed against several executives. Executives are charged with securities fraud, falsifying documents and statements to the SEC, and conspiracy (www.securitiesfraudfyi.com). World Com is currently seeking to emerge from bankruptcy protection, to rebuild trust in the company that is now known as MCI. Trust is being rebuilt by bringing in new leaders from outside the company with exemplary records, as well as a re-audit of the company’s financial statements from 1999 to 2002 and “while internal controls are being reviewed and strengthened” (Schlesinger).
While much attention has been placed upon the American corporations, European corporations were not exempt from these scandals. The Italian firm, Parmalat, exposed its ongoing fraud in late 2003. According to Gail Edmondson, a Business Week columnist the fraud began when, Parmalat defaulted on a $185 million bond payment in mid-November. That prompted auditors and banks to scrutinize company accounts.
Some 38% of Parmalat’s assets were supposedly held in a $4.9 billion Bank of America (BAC ) account of a Parmalat subsidiary in the Cayman Islands. But on Dec. 19, Bank of America reported that no such account existed. In the ensuing investigation, Italian prosecutors say they’ve discovered that managers simply invented assets to offset as much as $16.2 billion in liabilities and falsified accounts over a 15-year period, forcing the $9.2 billion company into bankruptcy on Dec.
Parmalat is controlled by the Tanzi family who owns 51% of the corporation. Several members of that family have been arrested and indicted on charges of fraud. Former CEO Calisto Tanzi is accused of diverting $990 million dollars from the corporation for his own personal use as well as fraud, false accounting, misleading investors and destruction of documents. Parmalat certainly used some creative accounting with the use of “derivatives and other complex financial transactions to shore up its balance sheet” (Edmondson). No one is sure where the missing money went, but Italian authorities want the punishment of Parmalat officials to be severe to possibly deter other corporations from committing similar acts of fraud.
The SEC is also investigating Parmalat as it has holdings within the United States- “the SEC has also charged Parmalat with fraudulently offering $100 million worth of unsecured notes to U.S. investors and inflating its assets by at least $5 billion. SEC regulators called this “one of the largest and most brazen corporate financial frauds in history”  (http://www.unobserver.com/layout5.php?id=1327&blz=1). This scandal will be unfolding as both Italian and American authorities continue their investigations.
The corruption was at the highest level at Enron, World Com and Parmalat suggesting flaws in the corporate governance structure of both of the diffusely- owned corporation and the closely owned corporation. Stockholders trying to get managers follow their wishes instead of siding with the workers have created this difficult situation by offering stock options. Many managers are choosing to create schemes to boost the short term outlook of the corporation to make themselves wealthier while harming the corporation in the long term. These managers must be reined in to prevent from scandals of these magnitudes from happening in the future. No form of governance will ever be perfect, but the stockholders and the boards of directors must pay greater attention to the actions of the managers and must not succumb to the temptations of wealth that corruption and creative accounting provide.
Works Consulted
Amaduzzi, Carlotta. “Italian Parliament Discusses Post-Parmalat Reforms.” http://www.issproxy.com/articles/2004archived/074.asp.
American Institute of Certified Public Accountants. www.aicpa.org/sarbanes/index.asp
Chandler, Alfred. “The Emergence of Managerial Capitalism.” The Sociology of Economic Life. Ed. Mark Granovetter and Richard Swedberg. Boulder: Westview Press, 1992.