Bush Overreacts to Enron


Enron Corp. declared bankruptcy on Dec. 2, after what appears to have been questionable dealings, and efforts to hide them. Enron’s market capitalization amounted to 0.2% of the capitalization of NYSE-listed companies only, and its debt did not reach 0.05% of total credit outstanding in the U.S. The demise of Enron should have made only a small ripple in the economy and in the judicial system.

Instead, present and former Enron executives were subpoenaed before a congressional kangaroo court, and grilled by ignorant, self-righteous politicians. Richard Burr, a Republican congressman from North Carolina, exclaimed, “At the center of this economic meltdown, we find a handful of economic terrorists.” On March 7, George Bush claimed that the faith of Americans in financial markets was shaken, and proposed his “10-point plan” to “get back to basic capitalism.” On March 14, the U.S. Department of Justice brought criminal obstruction-of-justice charges against Arthur Andersen, Enron’s auditors.

How did 19th-century capitalism—which was much more “basic” than today’s—worked, while there were no legislated standards of disclosure? How were investors able to evaluate corporations? According to Wharton professor Jeremy J. Siegel, the answer is simple: a firm signaled that its earnings were real by paying dividends. This signaling device doesn’t work anymore because of tax distortions: with dividends being taxed at higher rates than capital gains, shareholders prefer the latter. While the average dividend yield on stocks was 5.8% in the 19th century, it now stands at less than 2%. Add the fact that the tax system encourages debt financing as opposed to equity, and you have the recipe for Enron types of debacle.

Moreover, we need to question the simplistic idea that more disclosure of information is always better. Information is a good like any other, and is only worth producing as long as its marginal benefit is higher than its marginal cost. A related problem is that too much information might not be assimilated. General Electric said that it is willing to issue a disclosure statement the size of a phone book; yet, there is no guarantee that investors would read it.

How do we know if enough information is disclosed? There is no way to answer this question a priori, and regulatory agencies do not have the faintest idea. Each investor decides for himself, and the interaction of all investors with information providers—i.e., the market—will determine the optimal disclosure.

There is no reason why there should exist a single optimal level of information. Some corporations might, given their own circumstances, prefer to be more secretive and compensate investors with higher dividends for the supplementary risk. Such diversity would offer more choice to investors, more flexibility to corporations, and more chances of finding the optimal rules. There is no need for standardized norms that stifle diversity, experimentation, and discovery.

Bush’s Plan claims “[w]ithout proper disclosure, it is impossible for investors to make informed investment decisions . . .” Obviously, this is not true of all investors, because they otherwise would have their companies’ annual meetings impose new disclosure policies. The controlling shareholders must think that more disclosure would cost them more than they would benefit. Bush is, thus, taking sides against these investors, in favour of some other investors he thinks don’t get the information they want. This is just one illustration of the non-minimal state necessarily taking sides against some of its subjects.

Presumably, the state wants to favour small investors. Now, there is no God-given principle that dictates the participation of all potential small investors in financial markets, and if they do participate, it is at their own risk. Indeed, most people participate through intermediaries (mutual funds, pension funds, banks, etc.) whose role is to diversify, and manage, the risk. Paradoxically, by pretending to create a “level playing field,” the state has given unrealistic hopes to small investors, hopes that must be constantly shored up by further regulations.

In order to “make corporate officers more accountable,” George Bush’s plan wants the Securities and Exchange Commission “to ban individuals from serving as officers or directors of publicly-held corporations if they engage in serious misconduct.” “At present,” the government document adds, “the SEC needs to seek court approval in certain types of cases.”

A course in “basic capitalism” is not necessary to see that the power to forbid somebody from becoming an officer or director of any company that would freely choose him is completely antithetical to the free enterprise system. What is more remarkable is that such state power already exists, albeit in a restricted form. The SEC already imposes lifetime bans. According to a Wall Street Journal report, “[d]uring the fiscal year ended Sept. 30 [2001], the SEC took such action against just 33 officers and directors, though that was up from 14 during the prior fiscal year.” What the U.S. government now wants is to impose these lifetime bans without judicial review.

In most cases, the Bush proposals do not even require new legislation. In matters relating to disclosure, to corporate “accountability,” or to accounting and auditing rules, the SEC already had the legal power to intervene.

To sum up, the Enron craze has one function: to increase state power over nominally private corporations.

Pierre Lemieux is a Research Fellow at The Independent Institute in Oakland, California, and Associate Professor of Economics at the University of Quebec at Outaouais in Canada.