Corporate scandals, past and present

David Skeel says the pressure to succeed sometimes pushes CEOs over the edge-and

David Skeel says the pressure to succeed sometimes pushes CEOs over the edge-and leads to fraud.

David Skeel remembers being asked the same two questions, over and over, in the wake of the corporate scandals that unhinged the business world in 2001 and 2002.

“I started getting a lot of calls, and people were asking, first, ‘Have we ever seen these kind of scandals before?’ said Skeel, a Penn Law professor and expert in corporate and bankruptcy law. “Then they were asking, ‘And do these scandals have anything in common?’”

Skeel knew the answer to the first question—scandal, he says, has a long, storied tradition among American business, and was certainly nothing new—but he wasn’t so sure about the second. So he set out to discover what, if anything, tied the modern-day blowups at Enron and WorldCom to those in the past. The result is his new book, “Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From.”

At the root of most large-scale business scandal, says Skeel, is pressure—and executives who may take unscrupulous risks to get ahead. “Risk-taking at some point can spill over into fraud, because of the competition, which in an odd way can reinforce the incentive to take risks,” Skeel says. “Companies that are very successful often can¹t maintain that success, and then the entrepreneur will take risks.”

Those pressures were uniquely powerful in the late 1990s, says Skeel. The stock market was exploding and earnings were high. Increased media attention to business news created the first generation of “celebrity CEOs”—executives praised as business saviors. Meanwhile, deregulation of the energy and communications markets created a “gold rush” mentality, and new federal regulations that capped CEO salaries and had the unintended consequence of making stock options—which were not capped—an increasingly common means of paying top executives. CEOs were put in an odd position: Given the business climate, they knew stockholders would demand success—in the form of earnings—and they knew that if they did succeed, they would benefit personally.

“The problem with the options, we’ve learned, is that they are all upside and no downside,” Skeel says. “If you can get that stock price up, you can make a lot of money.”

Combine all of those factors, Skeel says, and it’s easier to understand what led some CEOs astray. While some CEOs, such as General Electric’s Jack Welch, were able to function in that hectic environment, WorldCom’s Bernard Ebbers, among others, was not. Ebbers was recently found guilty of conspiracy to commit securities fraud and making false filings with federal regulators, and could face more than 25 years in prison. But how did Enron and WorldCom escape close scrutiny for so long? They used an old trick, Skeel says—they used the corporate structure to create a complex financial maze of subsidiaries and entities. “Looking at the Enron statements, there was a huge amount of money people could just not explain,” he says. “That—s one of the warnings signs that has historical precedent.”

Though Skeel says there are lessons to be learned from the recent spate of scandals—namely, investors should diversify their portfolios—he also says regulators must be careful about over-regulating big business. A balance must be struck, he says, that will allow businesses to innovate and grow, even while they do so responsibly.

“We don’t want executives to be afraid to take risks,” he says. “What makes our market go is executives willing to take risks.”

Originally published on March 31, 2005