Home > Articles > Business & Management > Finance & Investing

The Importance of Investor Confidence

Take an in-depth look at the crisis in investor confidence that is affecting corporate America. You will see how this lack of confidence could seriously damage the economy and how the crisis can be reversed before too much damage is done.
This chapter is from the book

One scandal rocks investors after another. The problems with Enron, Arthur Andersen, Rite Aid, WorldCom, Adelphia, Global Crossing, Martha Stewart, Merck, etc., have been blamed on greedy accountants, analysts, executives, and directors. The intense media frenzy and investor attention has allowed many people to grab the limelight, and much grandstanding has occurred. Regulators have gone after high-profile companies for fraud. Politicians have suggested and enacted new regulations and laws. Prosecutors have indicted individuals at these scandal-ridden firms. Yet the actions and proposals do not seem to be enough to satisfy investors.

In order to reverse the crisis in investor confidence, investors need to believe that two things will happen. First, those individuals in the corporate system that have misbehaved will be punished. The tough rhetoric from regulators, prosecutors, and politicians makes punishment seem very likely. Second, investors need to see changes in the system that will preclude bad behavior in the future. In general, there are two ways to change behavior—the carrot and the stick. The U.S. government is good with the stick—that is, deterring misbehavior through a fear of legal punishment. The government can make the stick thicker, harder, and more accurate. Indeed, nearly all the proposals have dealt with more laws, better laws, and more regulation. Such measures can change some behavior, but if you really want to change behavior, offer the carrot. In fact, a well-designed incentive system can be a far more powerful motivator than regulation. In a nutshell, this idea has been the triumph of capitalism over socialism. The U.S. government, however, is terrible at offering solutions with the carrot.

When corporate scandals are viewed from an understanding of the corporate system, then solutions can be designed that enhance the system, not drag it down. For example, many view the recent corporate failures as a problem with accountants and auditors. However, the accountants in a firm are operating in an environment created by the company's management in which the accounting department is directed to act like a profit center. Instead of a tracking and evaluation function, accounting departments have also been assigned the task of smoothing earnings and even generating profits. Managers do this to boost the stock price and cash in millions of dollars of stock options. These incentive packages are offered to top managers by the firm's board of directors—the stockholders elect this board of directors. Sure, the accounting profession must share some of the blame for the recent financial meltdowns. But blame can also be shared by managers, the stock option incentive, boards of directors, analysts, and even shareholders. Trying to fix the system by looking at only one piece of it in isolation is a doomed approach. A failure to examine the entire corporate system will only lead to temporary patches and not long-term solutions.

The purpose of this book is to examine the entire corporate system, identify the problems, and propose remedies that both fix the problems and enhance the system without creating more layers of costly government bureaucracy.

Asleep at the Wheel

To gain some perspective, it should be noted that these scandals originated from the excesses of the late 1990s. Indeed, there were strong signals in the late 1990s of forthcoming scandals. However, investors did not seem to care. As long as the stock market was going up, investors did not want to ask too many questions about the behavior of the corporate system that was earning them profits.

Consider SEC Chairman Arthur Levitt's speech to CPAs, lawyers, and academics in New York. The chairman attacked accounting chicanery and earnings management practices, and promised that the agency would go on the offensive. Although the speech was given in 1998, it is reminiscent of the post-Enron environment of 2001 and 2002. In the couple of years after the speech was given, the SEC took actions against many firms for accounting manipulation and fraud. Some firms were mega firms like Bankers Trust, Cendant, Sunbeam, Waste Management, and McKesson HBOC. Other well-known firms with accounting problems included Boston Chicken, Mercury Finance, Telxon, and Oxford Health.1 But were investors upset about these corporate misdeeds? Were Congressional inquiries made? For the most part, no.

Even the largest two firms (in market value) have been under suspicion—General Electric (GE) and Cisco. The media expressed concerns about the earnings management practices of GE, and, while the company is notorious for producing increased profits every year, Money magazine claimed that earnings would have been down in 1997 and flat in 1999 had it not been for some accounting maneuvering.2 Barron's questioned the long-term viability of Cisco's practice of financial engineering.3 The article specifically questioned the accounting used in Cisco's endless string of acquisitions. Indeed, the article went so far as to call Cisco a “modern house of cards.” Again, investors did not seem too concerned about the accounting problems. After all, investors had made a lot of money investing in Cisco and GE.

However, the stock market declined (along with the economy) in 2000 and 2001. Then came the failures and collapse at Enron in the fall of 2001. Enron's managers, accountants, analysts, and board of directors all failed the investors and employees of Enron. Investors became angry at the enormous fraud at Enron and at the other firms that have subsequently announced problems. However, the problems have been brewing for a while. It has only been since the Enron debacle that investors, the media, regulators, and politicians have taken notice and demanded accountability.

The outcry against corporate greed and fraud is a manifestation of the failing confidence of investors in the corporate system, which, in turn, is partially caused by the decline in the stock market. The following sections illustrate this crisis in investor confidence and how it affects the stock market. Eventually, the lack of confidence can become a drag on the economy. The crisis needs to be reversed before too much damage is done.

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.

Overview


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information


To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.

Surveys

Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.

Newsletters

If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information


Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.

Security


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.

Children


This site is not directed to children under the age of 13.

Marketing


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information


If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.

Choice/Opt-out


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information


Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents


California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure


Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.

Links


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact


Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice


We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020