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The Tipping Point: How Good Companies Go Bad and Executives Become Rogues

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By now, we've all been inundated with the news of financial scandal and executive misbehavior. In the past few years, a veritable flood of reports have come in regarding crooked executives. Just what makes an executive go bad? Find out in this sample chapter.
This chapter is from the book

Through the 1990s, most Americans grew accustomed to good financial news. We enjoyed one of the highest standards of living in the world, a product of the dynamism of our business system. Keen competition combined with the driving force of good management efficiently provided a constant flow of new and better products and services. Our free enterprise, management styles, education, and executives were all being copied—the envy of the world. Americans felt proud of the unusual degree of peace and prosperity free market capitalism had provided.

Pride so easily tips into arrogance and prosperity into greed. With the new millennium came startling revelations of destructive cracks in our much-heralded enterprise systems. In the years following, large numbers of Americans began to lose faith in the integrity of business and its leaders. A small cadre of executives were exploiting their positions to "hog" corporate profits with unconscionable pay packages and breaking the law in the bargain.

Business scandals are just another part of the stream of daily news that is full of scandal. The wars in the Middle East bring stories of prisoner-of-war torture and war profiteering. Our all-American pastime, baseball, is scandalized by revelations of steroid use. America’s Catholic Church sex scandal has been in the news off and on for several years. The media confesses to its own scandals, inflated circulation numbers, made up stories, and shilling for politicians. School administrators and teachers are caught helping students cheat on proficiency tests and fudging their books to make dropout rates appear lower.

Americans are still learning about new and troublesome examples of self-aggrandizing executives and misconduct in American business a full five years after the first publicized revelations that all was not well in corporate America. Even as these stories continue breaking, the financial news suggests that senior executive compensation is still increasing, often providing eight-figure annual earnings.

It is no longer just the risky dotcoms and their high-tech brethren who get in trouble. The diversity and prestige of corporations in the news suggest there are some underlying forces affecting a broad swath of business. Americans should be concerned that many executives are still tempted to engage in or encourage actions that show this new, troubled face of free enterprise.

We have sought to step back from the headlines and salacious details. Our studies disclose a number of destructive distortions in the components of our business system that together over the past decade have conspired to produce the distressing headlines about accounting irregularities, fraud, and the tales of exorbitant executive compensation. Understanding what has been going wrong and how it can be checked and reversed requires going behind the bad guy stories to a view of how the parts fit together and play off of each other.

Remember, America in the 1990s was pulsing with the easy profits of a new gold rush. Investors shoved to get in on the ground floor of new industries and new marketing ploys—just before they tanked into a subbasement. As shareholders and employees began experiencing enormous losses, CEO celebrities became villains.

At first, it was easy to assume that the Enron implosion and the uncounted number of dotcom failures were anomalies. They represented an inflammatory mixture of some truly rotten apples combined with wild shareholder exuberance and investment analyst and entrepreneurial excess. The half a decade following proved this view too optimistic. As we tip into the last half of the first decade of a new millennium, we look for signs of real change. (One hopes that the popularity of Donald Trump’s television show, The Apprentice, is not a reflection of reality or being mistaken for a model to emulate.)

In the extraordinarily tough global economy, America can’t afford economic vulnerabilities and weakness. We are no longer the unchallenged market leader in many industries, and competition gets tougher by the day. Manufacturing is fast becoming an endangered species in the U.S., and even our mainstay, financial services, is outsourcing some functions overseas.

We expect that free enterprise capitalism combines the self-regulation of the marketplace with powerful motivations for ambitious entrepreneurs and talented executives. Enormous energy and creativity is released in a free capitalist society. Overpriced or poor quality goods or services, outdated technologies, defective business plans, and ineffectual managements and companies—all get rejected (in time) by market forces.

As in much of life, there are "snakes" in the garden. Embedded in this marvelous, self-managing, self-cleansing motivational engine that generates innovation and growth is the potential for exploitation and cheating. We’ve known this. The real work has always been in keeping the proportion of such incidents low.

In the past, some American business tycoons sought to "beat the system" by anti-competitive maneuverings in the marketplace. Many presumably free markets became manipulated markets. While business executives universally professed allegiance to free enterprise, it was often expedient for some corporations to engage in collusive price fixing and dividing up the market with like-minded competitors. These market-manipulating executives always professed more loyalty to free enterprise than to free markets. Monopolies provide easier and greater profitability. Our effective anti-trust legislation, when enforced, is a testament to the strength of these lurking temptations and the need for some government intervention.

Today, the Inner Dynamics of Business Are the Culprits

Today’s threats to American capitalism are primarily internal to the corporation, very different from efforts to monopolize external markets.

Management has been changing, not always for the better. The change started with modest deviations from accepted good accounting practice, pushing the limits, such as not expensing stock options. When no resistance was forthcoming, sophisticated number games and executive self-serving became a ground swell of malfeasance. Modest dithering with the accounting tipped over into flagrant fraud. For example, technically, Enron had been bankrupt for years before its bankruptcy filing in December 2001. As we shall see, many other companies were running on fumes generated by financial engineering.

When chief financial officers privately asked the head of the Security and Exchange Commission (SEC) to make rules harder so it would be easier for them to resist the orders of their CEOs, it became obvious that some things needed to change in the 1990s.1 They didn’t, and Americans paid a heavy price.

Concurrently, executive compensation became obscene, scandalizing Europeans who saw their executives adopting American values. Top management can be earning 1,000 times the average worker’s pay versus 50 or 100 times not so long ago, if American trends are followed. More extraordinary and more troubling, executive pay is taking a significant bite out of the net earnings of many companies—10% of the shareholder’s stake in one study!2

It appeared that the system had been rigged to favor the very few on top. They had become the beneficiaries of corporate largess, reflecting what appeared to be soaring profitability or shareholder value. We learned too late that many executive performance measures were hollow successes, highly rewarding to executives and short-lived for employees and investors. For many companies, reported earnings were more myth than reality.

These changes in executive values and decision making have consequences more serious than the loss of investor confidence and portfolio profits. What has emerged threatens the future vitality and global competitiveness of their companies. Chapters to follow look closely at the major players in this flight from excellence. Included, of course, are senior executives, corporate boards, auditors, investment bankers, and the investor community. It is also important to understand why business journalists were so slow to spot corporate deception and executive fraud, and business academics and consultants so slow to spot the failure of theories.

The following is a preview of the major forces that led to the misshaping of executive decision making and many high cost failures—to employees and investors, not executives.

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