Incompetence in the Boardroom

In a recent issue of The New Yorker, Jeffrey Toobin opined that Kenneth Lay and Jeffrey Skilling, the two men at the top of Enron during its career as Fortune Magazine's 'Most Innovative Company,' may never face serious criminal prosecution for their roles in the complete collapse - more like an evaporation than anything else - of the company under their command. The cases against them would be both too complex and too shaky to take before juries. This will be a depressing outcome, but I won't be surprised. Trial might reveal these men to be profoundly incompetent - not a crime for businessmen, who revel in their freedom from the shackles of professional standards. Their great enabler, Andrew Fastow, ought certainly to go to jail - he has been indicted, and his trial is set for next January - for the case against him couldn't be clearer. His violations of fiduciary duty, as Enron's Chief Financial Officer, won't require elaborate explication of securities or accounting laws. But even Mr Fastow nourishes a certain self-righteousness. After all, it was his financial legerdemain that permitted Enron to announce ever-greater earnings when, truth be told, they ought to have acknowledged some losses. As favors to shareholders go, this was negligible; it kept the game going for a few years longer than it would have had the accounting been honest. But what will put Mr Fastow in jail was his spectacularly inordinate, and apparently undisclosed enrichment at Enron's expense, not in the form of salaries and bonuses but as cream skimmed from the special-purpose entities that he established to warehouse Enron's turkeys. This was close enough to theft to pass for it.

That Enron's flock of turkeys - investments and business operations that lost money, cost too much, or simply didn't make sense - would have fed a small town's Thanksgivings if only they'd been convertible into fowl wasn't Andrew Fastow's doing. Whose then, was it? In the Epilogue to their riveting and intelligent account, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron, Bethany McLean and Peter Elkind (Portfolio/Penguin 2003) muse on the fact that no one will take responsibility for Enron's downfall. Everyone blames somebody else. In fact, everyone was partly, and only partly, to blame. No one person could have engineered the catastrophe. That's what's so disturbing about the Enron story. Like the sinking of the Titanic, Enron's bankruptcy stemmed from the collective and blinkered hubris of a small crowd; in both cases, the people in charge convinced themselves that old rules no longer applied - only to catapult into a disaster that underlined the urgency of the old rules. In many ways, Enron was simply the biggest of the dotcom fiascos, not because it had the hottest online trading network or because it threw billions into a half-baked broadband scheme, but because it was selling ether, the magical quintessence that would render more concrete assets trivial, if not positively obstructive. This ether was in fact a sort of science fiction, a vision of the world as it may indeed one day appear, but a vision not yet readily attainable. During the 90s, though, everyone of any eminence in business believed in the imminent delivery of plenty of ether. 

Thinking about this mass delusion, I've concluded that it was the wishful response of baby-boomers, guys, mostly, my age, who didn't understand computers as well as they thought they ought to - their kids were so much more adept! - to the onset of middle age. To the pumped-up but improbable expectations of computer geeks militating a new world order, they replied not with the caution that would have marked them (in their own eyes) as old, but with desperate enthusiasm. Like the sexagenarian who makes himself feel younger and more virile by attaching himself to a trophy wife, so these somewhat younger but still ageing enchiladas glommed on to visions of brickless and mortarless dotcom transformation. Unlike the elderly husband, however, they fooled most of the rest of the world into sharing their dream.

That they didn't know what they were doing, these sources of capital and institutional authority, has been expensively demonstrated - billions of dollars of shareholder value were created and destroyed within less than a decade. Jeffrey Skilling, a management consultant at McKinsey & Co., knew something about the oil and gas business before joining Enron - as the company formed by the merger of the InterNorth and Houston Natural Gas pipelines was christened ('Enron' was a last-minute substitute for 'Enteron,' the gastro-intestinal allusion of which ironically eluded the pipeline executives). But he had never worked in the industry, or, for that matter, anywhere but at McKinsey, when, in 1990, he was made president of Enron Finance, an Enron subsidiary whose operations he had masterminded while still an outside consultant. Where someone else might have seen a lack of experience, or even ignorance, Skilling (and the Enron executives whom he persuaded to see things his way) saw pure intellect, unhampered by the uncritically accumulated habits of mind that pile up in the minds of old-timers. If Skilling had, for example, no sense whatever of the danger that his insistence on mark-to-market accounting would pose for Enron, so much the better.

Mark-to-market accounting, common in the securities industry, where high liquidity assures readily discernible valuations, differs from the historical-cost accounting that most other industries use in almost every way. It would turn out to be bad for Enron because the kinds of assets that Enron traded could not be valued with anything like stock-market certainty. Worse, although most of these assets were long-term contracts, either to sell gas or to create a broadband network, mark-to-market accounting allows the full value of a deal to be booked long before the first dollar is paid. While all accounting involves some conjecture, accounting for Enron's contracts on a mark-to-market basis was perilously subjective, and the temptation to abuse the system in order to inflate profits was great from the start. And if Skilling himself appears to have been a straight-shooter - at least at the beginning - it is obvious in retrospect that his zeal for mark-to-market accounting expressed an almost pathological impatience. A brilliant debater, Skilling had skyrocketed to the top of his class at the 'B' School and then risen almost as speedily at McKinsey. He was, by the time he got to Enron, habituated to quick success, promptly followed by fresh goals. And his early successes at Enron Finance quickly habituated the company to hefty growth increases. By 1996, when Skilling became the Chief Operating Officer of Enron itself, everyone expected the company to grow by 15% annually. This was no more sustainable than most dotcoms were profitable.

Enron didn't have to grow so fast. It had to maintain an investment-grade credit rating, but it was certainly entitled to one when Skilling took over the running of Enron. It did not, yet, have to maintain certain stock levels, but its stock price had followed its earnings and soared above trigger figures. A more perspicacious CEO than Ken Lay would have realized that the early 90s were a one-off period for Enron, an anomaly that would be corrected when Enron's trading partners caught up with its originator's advantage. But Ken Lay paid Enron hardly any attention at all. I've no doubt that he tells the truth when he claims that he didn't understand what was really going on at Enron. Too fond of schmoozing in Washington, leading Houston's charitable elite, and charming his board of directors to spend much time going over balance sheets, Lay was like one of the kings of old who delegated all the hard work of government to trusted lieutenants. Worse, he was too lazy or detached to make sure that his lieutenants could be trusted. And so Enron was propelled to its doom by an impatient tyro whose ruling passion came to be the growth of Enron's share price. Jeff Skilling would do anything to convince Wall Street that Enron was underpriced. And when there was nothing for him to do, he stayed out of the way and let someone else do the convincing.

This someone was Andrew Fastow. I am not going to try to summarize the fundamentally fraudulent financial vehicles that he designed in order to maintain Enron's accelerating pulse. While The Smartest Guys in the Room would have benefited from diagrams like the ones that the New York Times ran in its coverage of the Enron collapse, Ms McLean and Mr Elkind do a fine job of reducing Fastow's chicaneries to intelligible prose. They ask, early in the book, when it was that Enron crossed the line between legitimate and dishonest ways of doing business, only to answer that no single event marks such a moment. I disagree. In November 1997, Arthur Andersen, Enron's accounting firm, signed off on a deal whereby Enron 'sold' certain assets to an entity called Chewco. The accountants ought to have known that the risk element in the Chewco deal was sham, thereby disqualifying Enron from utilizing an accounting treatment essential to its quarterly earnings pretensions. By going along with Chewco, Andersen permitted Enron to do something not just iffy or sleazy but wrong, and from now on there would be no going back, but on the contrary a steady pushing of the envelope. Enron would push the envelope too far, eventually attracting the attentions of people who had nothing to lose, and possibly something to gain, by Enron's decline, and by then Enron would be as hooked as any crack addict, hopelessly unable to come clean despite repeated, if ever less credible, assurances that this time it was telling the truth. But in 1997 the only people who knew what was going on had every reason to look the other way. Chewco put money - in some cases, a lot of money - in everybody's pocket.

Enron's collapse may not have been instantaneous, but it was very fast. It began when Enron's banks balked at lending the company much-needed cash at the end of October, and ended with a bankruptcy filing on 2 December. The richness and variety of delusion exhibited by Ken Lay and Jeff Skilling - both retired heads of Enron - during this period was truly pathetic. They were like captains who could no longer tell stem from stern, or convinced themselves that steel will float on water no matter how it's configured. The deer-in-the-headlights (or deer-in-denial) character of their maneuvers make one wonder how they ever occupied leadership positions. The answer to this is that they tasted success early in life and believed in themselves completely.  Neither was a young man when Enron went into bankruptcy, but each remained, alarmingly in retrospect, a callow and naive golden boy. They learned nothing in later life because nobody presumed to teach them. Achievement and self-assurance are assets in any constitution, but the tendency of American businessmen to treat them as collateral is unhealthy. The future is not the past - certainly not when a Jeff Skilling or a Ken Lay is pontificating about throwing out old ways of doing things and replacing them with new. Men for whom the discovery of successive new worlds is the highest form of success will probably inevitably land in alien territory that doesn't support life as they know it.

Writing about business isn't easy, and in my library I have only two or three books that equal The Smartest Guys in the Room as literate and authoritative business histories. Ms McLean and Mr Elkind infuse their prose with just enough vernacular to sharpen the more incredible points of their tale, but they avoid business jargon altogether and write long, comprehensive paragraphs made up of immediately comprehensible sentences. The book is extraordinarily well organized, each chapter taking Enron closer to disaster. The eleventh, 'Everybody Loves Enron,' demonstrates how appallingly deep was the phalanx of Enron's defenders; from gushing reporters to hesitant rating agencies, everyone in the financial world seems to have let investors down. If the book has any weakness, it is the shortchanging of things that Enron did well; throughout the company's existence, its pipelines chugged along reliably and profitably, and presumably Enron was good at a few other things, too. The 'Cast of Characters' at the beginning would have been more useful presented in organizational form, showing who reported to whom at key moments. And company's directors, who failed to do their job as completely as any other players, get off too easily. These are minor quibbles. The Smartest Guys in the Room is an important, if depressing, book, an auspicious beginning to this chapter in the history of mercantile catastrophe.

Micheline Maynard's The End of Detroit: How the Big Three Lost Their Grip on the American Car Market (Currency/Doubleday 2003) belongs to another, more familiar chapter; to be sure, it's more forecast than history. GM and Ford are still very much with us, and Chrysler manages to play both sides of the domestic/import fence. But if Ms Maynard's prediction comes true, and 'Detroit' no longer means, in 2010, what it means today, she'll have, at least by means of the present volume, contributed almost nothing in the way of an explanation. The book would have been more aptly titled The Rise of the Imports. The overwhelming bulk of the text describes, in prose that is almost enthusiastic enough to pass for gush, the little-train-that-could incursions of Japanese, Korean, and German auto manufacturers into the formidable American market, with profiles of their visionary executives and tantalizing glimpses of future lineups. Living without an automobile of my own in Manhattan, where all vehicles that aren't obviously buses, vans, delivery trucks, taxis or limousines fall under the blanket rubric, 'car,' I know little of the Camry and the Lexus, and I have to work to imagine what someone in the market for a new car has in mind. So most of The End of Detroit was less than compelling reading for me. I went through it all anyway, lured by the title of the penultimate chapter, which is the same as that of the book. There, I thought, the trouble with Detroit would be spelled out. But I had fallen for a mirage. The chapter in question simply catalogues what the author expects will be an unsuccessful attempt on the part of GM and Ford to recapture market share from the imports in the next few years.

To give an example of what I was looking for, let me quote from the Chrysler portion of the chapter.

The Chrysler Pacifica, introduced in spring 2003, was the company's first entry in the crossover category. ... Pacifica's design seemed like a combination of a Chrysler minivan and the PT Cruiser, as big as the first and with the retro influences of the second. What people primarily noticed, however, was its price: $32,000, more than many vehicles in the Chrysler lineup, and in the same strata as some luxury vehicles. While Pacifica initially received favorable reviews, some journalists who drove it felt it was underpowered and noted that it lacked the sophisticated, five-speed transmission that buyers of cars in that price rage had come to expect. By summer, Chrysler was offering lease deals on the Pacifica and talking about how it could save the bungled launch.

Assuming that Ms Maynard is right and that Detroit, or Chrysler, has failed again, I still want to know why. If, as she asserts, the failure of the Big Three to survive the current decade will constitute a regrettable development for American business - if, that is, this story matters - then surely it's important to know something about the decision-making process at Chrysler. Who was responsible for the Pacifica? Had it been an import, Ms Maynard would have supplied the names of one or more key executives behind the automobile's development, and, indeed, when she talks about the future of Detroit, Ms Maynard is careful to note that it will be shaped by Robert Lutz of GM and Trevor Creed of DaimlerChrysler. But Detroit's past appears as a monolith: 'Detroit.' If buyers in the $32,000 price range expect sophisticated, five-speed transmission, how can this have been a mystery to 'Chrysler'? To whom at Chrysler? Was it a case of design being overruled by bean-counters - a favorite theory of what's wrong with 'Detroit'? I want to know. 'Detroit' gets worse: 

[DaimlerChrysler COO Wolfgang Bernhard] was distressed upon coming to Detroit to see the shoddiness of the components the company was buying from some of the same suppliers that Mercedes dealt with in Europe. Digging for answers, Bernhard found that Chrysler, in many cases, simply wasn't expecting enough. Without a knowledge of what suppliers were doing in other parts of the world, it simply accepted the parts that it was sold, not realizing it could ask for better materials and get them for the same price.

Really? Were the Chrysler people such genuine clucks? Or is Bernhard's explanation just what you'd expect from new management? Without more to go on, my curiosity remains unsatisfied. Reflecting so adversely on the competence of an important American enterprise, the shoddiness of Chrysler's parts needs to be explained with more rigor than this. If I suspect that ill-advised contracts, negotiated at less than arm's length by automotive cronies with no particular loyalty to any corporation, had something to do with the case, that's only because The Smartest Guys in the Room overflows with so many examples of low-grade corruption that sweetheart deals begin to look like the American way of doing things. It makes more sense, or is at any rate less terrifying, than the portrayal of Chrysler's parts buyers as outright morons.

Yet the corporate culture of bigness that is so inherent in Detroit and, indeed in the American business world in general, does not lend itself to the belief that these companies will shrink. Voluntarily slimming down to a realistic and manageable size just isn't part of the way Detroit does things.

Such generalizations ought really to be backed up with details or omitted.

But as I say, I'm probably not Ms Maynard's ideal reader. (November 2003)

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