by William K. Black, New Economic Perspectives
We continue to witness remarkable developments in the intersection of the related fields of economics, finance, ethics, law, and regulation. Each of 
these five fields ignores a sixth related field – white-collar criminology. The six fields share a renewed interest in trust. The key questions are why we trust (some) others, when that trust is well-placed, and when that trust is harmful. Only white-collar criminologists study and write extensively about the last question. The primary answer that the five fields give to the first question is reputation. The five fields almost invariably see reputation as positive and singular. This is dangerously naïve. Criminals often find it desirable to develop multiple, complex reputations and the best way for many CEOs to develop a sterling reputation is to lead a control fraud. Those are subjects for future columns. This column focuses on theoclassical economics’ use of reputation as “trump” to overcome what would otherwise be fatal flaws in their theories and policies. Frank Easterbrook and Daniel Fischel, the leading theoclassical “law and economics” theorists in corporate law, use reputation in this manner to explain why senior corporate officers’ conflicts of interest pose no material problem. The most dangerous believer in the trump, however, was Alan Greenspan. His standard commencement speech while Fed Chairman was an ode to reputation as the characteristic that made possible trust and free markets. I’ve drawn on excerpts from one example, his May 15, 2005 talk at Wharton.
“The principles governing business behavior are an essential support to voluntary exchange, the defining characteristic of free markets. Voluntary exchange, in turn, implies trust in the word of those with whom we do business. Trust as the necessary condition for commerce was particularly evident in freewheeling nineteenth-century America, where reputation became a valued asset. Throughout much of that century, laissez-faire reigned in the United States as elsewhere, and caveat emptor was the prevailing prescription for guarding against wide-open trading practices. In such an environment, a reputation for honest dealing, which many feared was in short supply, was particularly valued. Even those inclined to be less than scrupulous in their personal dealings had to adhere to a more ethical standard in their market transactions, or they risked being driven out of business. To be sure, the history of world business, then and now, is strewn with Fisks, Goulds, Ponzis and numerous others treading on, or over, the edge of legality. But, despite their prominence, they were a distinct minority. If the situation had been otherwise, late nineteenth- and early twentieth-century America would never have realized so high a standard of living. * * * Over the past half-century, societies have chosen to embrace the protections of myriad government financial regulations and implied certifications of integrity as a supplement to, if not a substitute for, business reputation. Most observers believe that the world is better off as a consequence of these governmental protections. Accordingly, the market value of trust, so prominent in the 1800s, seemed by the 1990s to have become less necessary. But recent corporate scandals in the United States and elsewhere have clearly shown that the plethora of laws and regulations of the past century have not eliminated the less-savory side of human behavior. We should not be surprised then to see a re-emergence of the value placed by markets on trust and personal reputation in business practice. After the revelations of recent corporate malfeasance, the market punished the stock and bond prices of those corporations whose behaviors had cast doubt on the reliability of their reputations. There may be no better antidote for business and financial transgression. But in the wake of the scandals, the Congress clearly signaled that more was needed. The Sarbanes-Oxley Act of 2002 appropriately places the explicit responsibility for certification of the soundness of accounting and disclosure procedures on the chief executive officer, who holds most of the decisionmaking power in the modern corporation. Merely certifying that generally accepted accounting principles were being followed is no longer enough. Even full adherence to those principles, given some of the imaginative accounting of recent years, has proved inadequate. I am surprised that the Sarbanes-Oxley Act, so rapidly developed and enacted, has functioned as well as it has. It will doubtless be fine-tuned as experience with the act’s details points the way. It seems clear that, if the CEO chooses, he or she can, by example and through oversight, induce corporate colleagues and outside auditors to behave ethically. Companies run by people with high ethical standards arguably do not need detailed rules on how to act in the long-run interest of shareholders and, presumably, themselves. But, regrettably, human beings come as we are–some with enviable standards, and others who continually seek to cut corners. I do not deny that many appear to have succeeded in a material way by cutting corners and manipulating associates, both in their professional and in their personal lives. But material success is possible in this world, and far more satisfying, when it comes without exploiting others. The true measure of a career is to be able to be content, even proud, that you succeeded through your own endeavors without leaving a trail of casualties in your wake. * * * Our system works fundamentally on trust and individual fair dealing. We need only look around today’s world to realize how valuable these traits are and the consequences of their absence. While we have achieved much as a nation in this regard, more remains to be done.” |
In an article I wrote in 2003 during the unfolding Enron-era frauds I called similar claims by prominent Texas politicians that Enron’s failure represented a triumph of capitalism “Texas triumphs.”
I distinguished Texas triumphs from Pyrrhic victories. The origin of that phrase comes from King Pyrrhus’ (of Epirus in Greece) victory over the Romans in 279 BC at the battle of Asculum in Apulia (on the Eastern side of the Italian peninsula). The Roman legions were elite and outnumbered Pyrrhus’ forces (which had many mercenaries). Nevertheless, he twice defeated the Roman forces, inflicting significantly greater casualties on them. After the battle of Asculum he responded to congratulations by remarking that one more such victory would undo him. He was a great commander who defeated highly competent opponents defending their own lands.
Only theoclassical economists could call the failure of our most elite firms that were looted by their CEOs a triumph of capitalism. I wrote:
Our family’s rule that it is impossible to compete with unintentional self-parody remains intact. A discipline (economics) that counts massive looting by the CEOs of elite control frauds as its greatest triumphs desperately needs an intervention. None of these control fraud failures (and that includes Fannie and Freddie) involves valiant efforts by economists to prevent the looting. The theoclassical failures to prevent control fraud did not occur because the economists strove to prevent the looting but were defeated by impossible odds. Theoclassical economists were the anti-regulatory architects of the criminogenic environments that produce our epidemics of control fraud. They are the elite frauds’ most valuable allies.
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About the Author
William K. Black is the author of The Best Way to Rob a Bank Is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Networkauthor page and at the blog New Economic Perspectives.
Follow him at: @WilliamKBlack
