The anti-capitalist mentality has, predictably, reared its ugly head once again in the wake of the recent scandals involving Enron, Global Crossing, WorldCom and several other multi-billion dollar corporations. The usual suspect is, of course, greed and the usual accusers are trotting out the usual solution: less unfetterred capitalism.
A case in point: the article “The greed cycle” by John Cassidy that appeared in the September 23, 2002 edition of the New Yorker. Executive stock options, we are told, tempt executives to use questionable accounting practises to fake revenue, hide debt and increase non-existing revenues. These manipulations result, in the short term, in a better bottom-line on profit-loss statements which, in turn, drive up the price of their companies’ stock so that options can be cashed out at the highest possible value. The solution proposed? The “selfishness of senior executives”, Cassidy writes, and their “greed and self-dealing undermine the public consent on which they ultimately depend.” Therefore, in order to “save capitalism from the capitalists” we must get rid of stock options.
I suggest that the solution is not to get rid of the stock option system because it works just fine. Indeed, the greed on the part of both company executives and stock holders was, is and will continue to serve investors and America well. The solution, of course, is to allow the marketplace to create the solution.
Not surprisingly, the marketplace already has.
In fact, the solution is inadvertently provided in the very same New Yorker piece. Citing the litany of wrong-doing the evil corporate executives have committed , the author quotes the observations of several economic experts. In order to establish the credibility of one such expert, Cassidy provides the resume of Howard Schilit, a professor of accounting, who founded The Center for Financial Research and Analysis in 1994. And what does the Center do? Why, it “monitors corporate financial statements and issues warnings to…investors”. And, sure enough, the piece goes on to explain that the Center did precisely that with most of the failures portrayed in the article well before their highly publicized collapses. In other words: this information was already available to those investors who chose to take the time and care to research their holdings.
Another case in point is the story of investor James Chanos, a tale that didn’t get nearly enough attention in the national media. As told in the November 5th, 2001 edition of the Wall Street Journal, Chanos made a killing off of Enron’s collapse…and he did it the old fashioned way: by rolling up his sleeves and doing his homework. Chanos poked his head out of the ether of irrational exuberance, read the small print in Enron’s annual reports, realized that the numbers didn’t add up, concluded that disaster was imminent, and then sold short. "Enron's books may have been hard to figure out, but Mr. Chanos spotted enough to believe that the then high-flying stock ultimately should tumble," the Journal tells us.
Stock analysis is a commodity. As in any market in which the quality of the commodity offered for sale is sub-par or flawed, entrepreneurs enter the scene with a better product. Why? Because better quality products can be sold for more money and more units get sold, resulting in more profit for the producer of the commodity. In this case, the producers of the commodity in question are monitoring firms such as the Center for Financial Research and Analysis whose successful predictions of failing companies provides improved quality of the commodity. The Center’s success will attract more paying subscribers which, in turn, will make them more profitable. This will attract more suppliers to enter the marketplace offering the same and better warnings of future Global Crossing-lke shenanigans. Those investors who do their homework will discover that their stock holdings are worth less than the market value and will sell. This, in turn, will bring the price of the stock down to a level more reflective of its actual worth and the executive will be denied the opportunity to cash out his option at a highly-inflated value.
The solution to the problem of allegedly self-serving executives is not to try to reign in their greed. That’s like trying to catch the wind and bottle it; you can’t stop the wind from blowing. What you can do is let the wind continue to blow and, instead, harness the wind in order to solve your problem.
This is what free-marketers do.
October 8, 2002