State of the Union January/February 2006

Executive Privilege

The CEOs of too many public companies enjoy the power and rewards of ownership without the risks. Corporate values have deteriorated as a result
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W arren Buffett, one of the most successful investors the world has ever seen, is also the epitome of a particular style of business leadership—the supreme practitioner of, and spokesman for, old-fashioned virtues in American capitalism. Berkshire Hathaway, the diversified conglomerate he built and still runs, has for years represented prudence, patience, steady calculation, and a zealous advocacy of owners'—that is, stockholders'—interests over those of managers. This old-time, values-driven philosophy, expounded in plain English each year in Buffett's letter to shareholders, stands in deliberate contrast to Wall Street's "greed is good" ethos. Still living and working in Nebraska, munching his hamburgers and sipping his Cherry Coke, the Oracle of Omaha is affectedly unglamorous. But, reassuringly, he seems to know something the fast-buck speculators don't: as Berkshire's principal shareholder he is worth around $40 billion.

Last year AIG (American International Group), an insurance giant, came under investigation for accounting irregularities stretching back years—yet another in a long list of recent corporate scandals. The company's boss, Hank Greenberg, was forced to resign. Among the transactions that attracted regulators' attention was a deal the company had done with a subsidiary of Berkshire Hathaway. Last April, Buffett gave evidence to investigators about the transaction. Soon afterward he praised Greenberg as a great insurance pioneer, the "number-one man" in the business. In May, New York's attorney general, Eliot Spitzer, prosecuting his high-profile campaign to stop corporate abuse, filed suit against Greenberg, alleging that among other things, he had designed sham transactions to make the company appear sounder than it was.

Buffett is held in such high esteem that almost nobody believed he had behaved improperly—least of all, it seems, Spitzer, who was careful to say that Buffett was not under suspicion. "Warren Buffett is an icon," said the grand corporate inquisitor. "He has succeeded the right way. He stands for smart, long-term investing, transparency, accountability—all those things we value and support." (Quite whom he meant by "we" is unclear.) Still, had things come to this? That a man of Buffett's matchless reputation might have so much as brushed up against improper business conduct was shocking. All that talk of a crisis of values in American business must be true.

Enron, WorldCom, Adelphia, Tyco—not to mention Martha Stewart, accused of insider trading and jailed for lying to investigators: the tally of actual and alleged corporate sinners is long. It includes companies and executives once famed not just for their spirit of innovation and their shining business prospects but also in many cases for their drive, their integrity, and their values. Kenneth Lay, the head of Enron, spent last year awaiting trial on multiple charges of fraud and other crimes. He was a self-made man—the son of a part-time preacher, raised in poverty, who went on to become an acclaimed business innovator, a plutocrat-philanthropist, a model boss, Houston's hometown hero, and a good friend of the first President Bush.

Lay and others were not sleazy small-timers. That is why they raise doubts about the overarching integrity of America's business culture. Capitalism is underpinned not just by law but by trust, which can be legislated only so far. Parties to contracts need to trust each other. Investors in companies—increasingly at a distance from their assets—need to trust the managers whose salaries, ultimately, they are paying. In the broadest sense, citizens need to trust the system itself, to believe that it has their interests at heart—or at least that it serves their interests, even if it has no heart. The people who benefit most conspicuously from capitalism are parties to a social contract with the rest of us. The question is, are they in breach?

Put it this way: the terms of the contract are coming under strain. Outright fraud is just one manifestation of the problem, and a narrow one at that. The ostentatious greed of many (law-abiding) CEOs, and their broader lack of accountability to shareholders, are at least as significant.

The division of capitalism's spoils has become more lopsided in recent years. Many workers have seen their wages frozen and their benefits cut. And lately even owners haven't done well: returns to stock-market investments have been poor since 2000. The group that has continued to profit, sometimes spectacularly so, is high-end professional managers—the very group from which corporate criminals are drawn. Over the past ten years the gap in pay between top executives and their subordinates (not to mention workers at the bottom of the scale) has widened a lot, and the trend shows no sign of slowing. In many cases pay schemes that rewarded chief executives generously when share prices were soaring continued to do so as prices tanked. CEOs fired for incompetence, leaving injured companies and distressed investors behind them, sometimes walked away with multimillion-dollar payments. If it isn't fraud and false accounting, one might be forgiven for thinking, it is rapacious salaries, unexpensed options, golden parachutes, and post-retirement use of the corporate jet. Not every kind of compensation is being driven down by global competition.

Unseemly executive behavior has outlasted the stock-market boom of the late 1990s, but it nonetheless has roots within that boom. Both the prevailing corporate culture and—just as important—investors' expectations shifted significantly during that time, and neither has shifted back entirely.

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