section will provide our readers with a number of
items by the authors that, for space reasons, did
not appear in The Naked Corporation.
We will publish these over the next few months, so
keep coming back for more!
Long Wave of Transparency
of the limits on transparency from principal-agent
problems, to the protection of trade secrets, to the
complexity that can overwhelm signals with noise, to
the war on openness are increasing or ineradicable.
So why do we claim transparency will increase in the
near and long term? A quick review of U.S. history suggests
that transparency always increases, albeit in a stutter
step, crisis-driven pattern.
Sages through the ages have linked knowledge, power,
and values. From Virgil, Of those who improved
life by knowledge, and those who are remembered for
their services: round the brows of these is a snow-white
band,(1) to Samuel Johnson,
Integrity without knowledge is weak and useless,
and knowledge without integrity is dangerous and dreadful,(2)
we have ever been urged that understanding permits wise
Yet those in power have not always encouraged the dissemination
of knowledge. History chronicles many battles over socially
and economically strategic information: a struggle for
transparency. Kings and viziers, apostles and priests,
sellers and buyers, socialists and capitalists, dictators
and democrats, bosses and workers all depend
on whatever information advantages they can muster.
Information monopolies, particularly when exploited
unfairly, inevitably lead to conflicts with rivals and
This chapter offers a potted history of transparency.
It begins with the emergence of transparency technologies
in the Western world and then focuses increasingly on
the rise of corporate transparency in the U.S.. This
book is about transparency for a variety of the firms
stakeholders employees, customers, b-web partners,
communities, and shareholders. The narrative that follows
focuses on the firms visibility to just one of
these shareholders. After all, if a company fails
to be accountable to its owners, how will care for the
interests of anyone else?
Before capitalism, transparency was inherently weak.
Tribes relied on cunning and myth. Church and state
were intertwined; by and large, they controlled commerce
and decreed the boundaries of the knowable and the known.
Until the Reformation, most cultural and social revolutions
were led or co-opted by rising waves of political-religious
Transparency depends on having a way to measure and
describe the world, and a medium by which to communicate.
The latter arose only some 500 years ago. Paper came
into Europe in the 13th century. It facilitated the
work of merchants, bureaucrats, preachers and writers.
But until Johannes Gutenberg invented the printing press
in the early 1450s, publishing was manual work: labor-intensive
and slow. Maintaining and disseminating knowledge depended
almost entirely on face-to-face interactions. Small
elite groups monopolized access to the written word,
and many texts were lost. Reference points that we take
for granted like standard maps did not
exist. As late as 1792, France alone had over 250,000
different systems of measurement.
By the turn of the 1500s, Renaissance thinkers had invented
investigative tools like the telescope. They also invented
the mechanical clock, which set predictable, constant
measures of time (though standard time had to wait centuries).
With such tools, Galileo, then Newton could discover
and publish laws of nature. The explosion in science
and mathematics was accompanied by applied technologies
such as musical notation, perspective painting, and
bookkeeping. These new technologies captured knowledge
as never before. Modern accounting at its core
double-entry bookkeeping originally invented
in the mid-1300s, was popularized in two books by Luca
Pacioli around 1500. Accounting was not essential to
doing business, but it let the budding capitalist visualize
and communicate the state of his business. Pacioli described
how transparency builds social capital; Frequent
accounting makes for lasting friendships.(3)
These developments helped stitch together a much broader
economy, more global and with more buyers
and sellers than ever before. Wide networks demand information,
increasing the need for transparency. A serf growing
grapes on a twelfth-century French baronial estate inhabited
a world where change was slow, prices stable, and relationships
highly structured. He could be exploited in several
ways, but he knew his boundaries of risk pretty well.
Six hundred years later, a pre-Revolutionary renter
working the same land in a more transparent world
faced more imponderables of prices and taxation,
but change was still fairly slow and markets relatively
local. Todays small-vineyard owner faces constant
price changes from volatile global markets, which unpredictably
change the rules from one season to the next and depend
on vagaries of geopolitics. Information and complexity
feed on each other. Todays grower knows a lot
more; he can instantly check prices and markets around
the world and immediately see reviews of his wines in
the international press. Yet he has a harder time planning
for each season because prices are volatile. Thus, transparency
increases over time, in tandem with growing volumes
of information, even when firms might wish otherwise.
the U.S. economy expanded rapidly from the late 1700s
through the 1840s, its tools and forms of business organization
were substantially the same as those of Renaissance
Europe.(4) Early America was
an agrarian society. Businesses were modest in size,
based on the family or, if larger, on partnerships.
They used double-entry bookkeeping, consignment sales,
and letters of credit. Joint stock companies also followed
During the latter half of the 19th century, science
and technology drove changes in industrial organization,
markets, finance and transparency. The core enabling
technologies were steam power and electricity, improvements
in machinery, new chemical industrial production methods,
and the emerging intellectual arts of invention and
technological innovation. Most pertinent to our story
were three inventions: the railway, the telegraph and
the telephone. We focus on the telegraph though much
of what we say applies to the other two.
The telegraph was the first, and in many ways archetypal,
communications medium of the industrial world. Like
the Internets founders, Samuel Morse tapped a
U.S. government grant to fund the first telegraph network
in 1844. This simple electric medium augured the wonders
of todays global web interactivity, any-to-any
communications, and the collapse of time and space.
Within a few decades, the telegraphs communication
and coordinating power allowed modern industries to
decimate local and itinerant firms. Financial and commodities
markets, transportation, retail industries, newspapers,
police work, and personal communications changed almost
Now and forever, information could move nearly instantaneously.
Many telegraph lines used railway rights-of-way.(5)
They were also crucial to the growth and operation of
this revolutionary transportation network. Telegraph
messages enabled railways to run on time and to coordinate
people and materials.
Almost immediately, the new medium became a force for
change. The British military had for centuries wasted
soldiers lives and lost battles due to command
failures. In 1854, the Times (London) newspapers
telegraphed reports on the Crimean War described how
men perished on the battlefield from hunger and neglect
while the wounded languished without physicians or bandages.
The newspaper pointedly suggested that it rests
with the Government to make enquiries into the conduct
of those who must have so greatly neglected their duty.
The immediacy of this human interest story led Florence
Nightingale to go into nursing.(6)
She wrote to the war secretary proposing a plan for
a private nursing corps. Nightingale went to the Crimea
where she invented battlefield nursing. Then she created
the modern nursing profession, exposed the horrors of
the British home medical system, and laid the foundation
for the hospital and public health systems of the 20th
The telegraph added more than just immediacy to the
news. It spawned wire services, which fundamentally
changed the nature of reporting from the partisan,
idiosyncratic style of the local hack to a professional
approach that worked in papers of any style or stripe.
The new form was objective and spare: nothing but the
facts, at least in form if not always in content. Wire
services taught the public the structure and value of
The telegraph also spawned mythologies resurrected in
the early days of the Internet explosion, as in this
1858 U.S. paean: How potent a power, then, is
the telegraph destined to become in the civilization
of the world!
It is impossible that old prejudices
and hostilities should longer exist, while such an instrument
has been created for an exchange of thought between
all the nations of the earth.(8)
A British commentator took a more jaundiced view; It
may be doubted whether any more efficient means could
to consolidate British power and strengthen
British rule.(9) Indeed,
the telegraph quickly became crucial to the imperial
centers visibility and control over its colonial
representatives and investments. Perhaps empires could
be governable after all.
The telegraph combined with the railway to bring transparency
to markets. Before, markets were mostly local and independent
of one another. Prices varied from place to place. Middlemen
arbitraged these differences: their unique knowledge
enabled them to buy cheap in one place and sell dear
in another. The telegraph and railway quickly created
national commodity and securities markets. In the 1820s,
grain prices in Cincinnati lagged eastern markets by
two years. By 1840 the lag was four months, and it vanished
by the end of the next decade.
The result was profound: farmers locus of risk
shifted from local buyers to national commodity markets.
Futures markets replaced the arbitrage of pretelegraph
itinerant middlemen. These markets reduced price fluctuations
and enabled food supply chain participants to manage
resources with greater certainty. Space-based speculation
declined (arbitrage fails when all participants know
the current price), and time-based speculation took
off (futures bets work because no one can predict with
certainty, and time-value itself is salable).(10)
Futures contracts became tradable because reports on
weather and other conditions (such as capacity) reached
markets long before the goods. All these and
the financial derivatives that followed resulted
from the transparency of the telegraph and its successors.
As with present-day derivatives, the first futures markets
created new challenges to transparency. Such instruments
had the effect of creating an entirely new financial
marketplace with a life of its own. Speculators bought
and sold futures, receipts, and other instruments quite
independently of the goods to which they referred, and
also independently of their grit-fingered producers.
The vagaries of these self-contained commodities markets
ultimately translated into prices for producers and
purchasers, but these terms often bore only a passing
relationship to the hog farmers cost of production
or the consumers lust for bacon. As markets rose
and fell, some farmers got rich while others lost everything
all because of opaque forces that operated in
a mysterious and inaccessible realm.
Transparency breeds complexity, which creates new demands
for transparency. It is not a simple linear story of
progress but rather one of periodic crises, followed
by hard-won (and hard-to-preserve) breakthroughs.
the mid-nineteenth century, getting a charter to form
a corporation was still a privilege bestowed by the
state. The limited liability corporation was a new
kind of artifact, a gift to the new breed of entrepreneur.
Railway entrepreneurs in search of charters plied
politicians with money, shares, and free passes. Between
1850 and 1857 rail companies got 25 million acres
of public land for free, as well as millions of dollars
in loans from state legislatures. Railway stocks took
off, and then collapsed. In this nineteenth-century
bubble, many railways went bankrupt and defaulted
on their loans (capital expenses for laying track
and assembling rolling stock were huge).(11)
Most industries had dozens, even hundreds, of small
players and no rules. Competition was ruthless and
destructive, labor standards barbaric. The economy
swung erratically from boom to bust. Prices soared,
banks failed, and depositors were left in the lurch.
The telegraph and the press increased transparency,
but the world was not an open book for all.
The self-made steamship and railway baron Cornelius
Vanderbilt, a primary school dropout, kept his business
accounts in his head throughout his life. He trusted
no one and built his empire through market cornering
and bribery. At his death, reputedly worth $100 million,
he was the richest man in the country.
From its early days in the 19th century, the New York
Stock Exchange was the financial center of U.S. capitalism.
Backroom deals, gambling, fraud, and self-dealing
were rampant. Members enjoyed lower trading rates
than nonmembers. Share prices were rarely made known
to the public or the press. Until Dow-Jones founded
the Wall Street Journal in 1889 where the Dow-Jones
Index ran on a daily basis from 1896 most financial
newspapers were paid mouthpieces for stock promoters.
This practice ended only after the 1929 crash.
Meanwhile, there was neither meaningful financial
regulation nor a central bank. When the Knickerbocker
Trust failed in 1907 after a market panic, thousands
of depositors lost everything. The banks president,
Charles Barney, shot himself, and several depositors
followed suit. J. P. Morgan led a private sector bailout
of other wobbly trust institutions. This ad hoc system
functioned, but only at great risk and with meager
information available to ordinary investors.
Transparency would only happen as a result of aggressive
state intervention. No one knew how much J. P. Morgan
was at the center of the banking and commercial world
until the 1912 Pujo congressional investigation revealed
that he and a dozen partners held 72 interlocking
directorships in 47 major corporations. In total,
the officers of the Morgan and just three other banks
held 341 directorships in 112 corporations, with resources
of $22 billion (which exceeded the assessed value
of all property in the 22 states and territories west
of the Mississippi). In congressional testimony Morgan
denied knowledge of his own connections and dealings.
Until that moment of transparency and
even afterward, Morgan and his partners denied the
existence of a money trust.(12)
In an attempt to bring order to chaos and restore
public confidence, Woodrow Wilson formed the Federal
Reserve and the antimonopoly Federal Trade Commission.
This first great regulatory explosion was a response
to new, large-scale corporations and financial webs,
themselves made possible by the telephone and telegraph.
Yet they were insufficient to tame the business cycle.
It took the worst business collapse in modern history
the Great Depression to force transparency
into the underlying world of money and securities.
The Securities Act of 1933 was the first piece of
national securities legislation passed by Congress.(13)
During the previous two decades, some 20 states had
passed a patchwork of so-called blue-sky laws to regulate
the issuance of securities, but these were rife with
loopholes. U.S. financial markets, in both banking
and securities, operated pretty much free of regulation
and visibility until Franklin Roosevelt stepped in.
Arguably, the 1929 crash was just another 1800s style
panic in a bigger, more complex, and interdependent
20th century world. Wall Street machinations
many of which the Internet bubble of the 1990s revisited
caused the crash:
Stocks replaced bank savings for over a million
Bankers used deposits to lend money to stockbrokers
and accepted stocks as collateral.
The boom in banking and share prices drove
a false wealth effect along with inflation
and high interest rates.
The Depression had everything to do with transparency,
in several dimensions.
First was the collapse of investment-bank houses of
cards hundreds of interlinked holding companies
and investment trusts with little or no substance
Sachs, for example, floated the Shenandoah Corporation
in 1929. A third of Shenandoahs assets was
stock in another investment trust, Goldman Sachs
Trading Corporation. In due course, Goldman Sachs
created another and larger trust, the Blue Ridge
Corporation, and 80 percent of its capital was stock
in the Shenandoah Corporation. Such speculative
monuments of the New Era became its necropolis.
Their own stock was exposed as worthless when trade
banks were a second kind of house of cards; as they
collapsed, millions lost their personal savings. This
turned out to be another by-product of opacity. Some
bankers had used depositors money to personally
speculate on risky and fraudulent deals. Others simply
stole depositors money outright (this did not
apply to the major New York and Chicago banks, but was
widespread elsewhere). A vicious spiral ensued when
millions of depositors panicked and withdrew their money.
Then after the crash some bankers, notably Albert Wiggin
of Chase National, used their inside positions in Wall
Streets bailout attempt to make millions from
short selling. Wiggin used Canadian companies to hide
profits and avoid paying taxes. Word got out. This scandal
was among the main reasons why banks and stock markets
lost public support for a generation.(15)
All this contributed to mass fear that extended well
beyond 600,000 active investors to millions of families
who had fallen into debt for the first time in their
lives. A deflationary spiral ensued. Many closed their
wallets, pushing the prices of goods, services, and
shares down and unemployment up. Consumer spending dropped
by 10 percent in 1930.
the government stepped in and forced the United States
financial system to open itself to greater scrutiny
and regulation. Transparency was central to the first
piece of national securities legislation ever passed
by Congress. Franklin Delano Roosevelt submitted the
Securities Act of 1933 right after he took office,
Federal Government cannot and should not take any
action which might be construed as approving or
guaranteeing that newly issued securities are sound
in the sense that their value will be maintained
or that the properties which they represent will
earn a profit
There is however an obligation
upon us to insist that every issue to be sold in
interstate commerce shall be accompanied by full
publicity and information.(16)
act required sellers to register new securities
and supporting information with the Federal Trade
Commission. Issuers of foreign bonds (also the subject
of various fraudulent schemes) were required to do the
same. Wall Street dispatched John Foster Dulles (who
later became Dwight Eisenhowers secretary of state)
to fight the law, to no avail.
The Glass-Steagall Act went even further, dismantling
the structural basis of self-dealing in the Robber Baron
era. The act separated commercial from investment banking.
Every bank had to choose one or the other activity.
J. P. Morgan Company, the commercial bank, begrudgingly
spun out Morgan Stanley Company as a bond and stock
business. Now, bank depositors could trust that the
preservation of their accounts no longer depended on
Next Roosevelt decided to police the stock market itself.
The Securities Exchange Act of 1934 created the Securities
and Exchange Commission: for the first time, investment
bankers were accountable to a government agency. Again
transparency was central. Any company or investment
banker who made a false filing with the SEC would face
prosecution. All publicly traded companies would henceforth
be required to register and provide quarterly and annual
financial reports. To gain the right to register newly
issued shares of other companies, investment banks would
also have to provide financial information about themselves.
This was revolutionary, since most companies
from the house of Morgan on down had never published
annual reports. Joseph P. Kennedy, trusted by Wall Street,
was Roosevelts brilliant first choice as SEC chair.
Despite this choice, the SEC Act ended any prospect
for good relations between Roosevelt and the Street.
Roosevelt lost other battles. But his legal framework
established an enduring bridgehead for transparency
in U.S. capitalism. Although Wall Street and corporate
executives howled and skirted rules, the foundation
held. It changed the structure and day-to day operations
of industry, mostly for the better for all parties.
of Ownership from Control
Smith described the capitalism of the invisible hand:
individual entrepreneurs, pursuing their own self-interest,
create goods and services that meet the needs of customers
with growing efficiency, creating benefit for all.
This description was true enough in his time. But
by the New Deal, the invisible hand had given way
to an institutional model that was far more complex.
Instead of individual capitalists with modest businesses,
gigantic corporations dominated entire industries
and integrated a wide range of functions under a single
umbrella. And the shareholders of these businesses
were typically in the dark.
Consider one example. In 1881, James Bonsack patented
a machine which soon thereafter could produce 120,000
cigarettes per day. The most-skilled manual workers
produced 3,000 cigarettes a day; Bonsacks machine
reduced production costs by 85 percent. Fifteen such
machines would easily saturate the entire U.S. market.
James B. Duke was the first to put this machine to
work. He acted quickly to create a vertically integrated
purchasing, manufacturing, advertising, sales, and
distribution organization to capitalize on the machines
capability. Within a few years, his firm, the American
Tobacco Company, had all the core characteristics
of a managerial, multidepartment, twentieth-century
firm. Duke built a large-scale industrial corporation
from scratch, because he had no choice if he wanted
to capitalize on the potential of Bonsacks cigarette
machine. The choice was simple: grow fast or lose
out to competitors.
Duke and others like him did not personally have enough
capital to fund the growth of his business. Well in
advance of receiving product sales revenue that would
cover all his costs, he had to acquire land, build
facilities, hire and pay employees, buy equipment
and materials, advertise, distribute, and so on. Aspiring
capitalists raised money by selling shares of their
companies to others initially, perhaps, on
a private basis, then via public markets like Wall
These limited liability corporations,
made possible when the courts first allowed owners
and employees to be free of personal liability for
their firms actions, are central to modern capitalism
and unlike anything that Adam Smith imagined.
Since the corporation has a separate existence unto
itself, it is solely liable for its debts and obligations.
Its investors and shareholders stand to gain from
the firms success, but their personal risk is
limited to the amount of capital they have invested
(which in a worst case scenario such as bankruptcy,
they may lose).
Limited liability, granted by society, is a good deal
for investors. Arguably, in exchange for the privilege
of limited liability, firms as instruments of their
shareholders can or should be accountable to society
for their actions. In other words firms, should be
transparent, not cause harm, do good, and so on, as
consideration for the gift of limited
liability (not to mention other considerations such
as an education system that delivers skilled workers,
laws that facilitate commerce and the interests of
specific corporations and industries, financial assistance,
and so on). While a democratic state is the product
of the coming together of natural individual
citizens, the firm is an artifact that exists at the
pleasure of the state. As a minimum, since the firms
very existence and legal personhood depends
on the states laws and licenses, the state has
a right to regulate: to define the terms by which
the firm gains and continues in its right to exist.
A related big change from Adam Smiths theory
was the separation of ownership from control. This
began with the capitalization of railways in the nineteenth
century and became dominant across most industries
by the 1920s. Adolf A. Berle and Gardiner C. Means
first analyzed this change in 1933.(17)
As joint stock companies grew and investors traded
shares with one another, the stock market took on
a life of its own. Thousands, then hundreds of thousands
of individuals bought shares. By and large, no individual
owned even 1 percent of any one company. As a result,
shareholders as a class became weak, while managers
inside the firm took control. Berle and Means nailed
the resulting risk for shareholders: The controlling
can serve their own pockets better by
profiting at the expense of the company than by making
profits for it.(18)
Since few firms bothered to publish financial reports
before 1933, shareholders lacked the most basic information
about the companies they owned. Even Berle and Means,
after years of research, reported that due to the
difficulty of obtaining information on industrial
companies, they could not vouch for the accuracy of
their data on the ownership structures of the countrys
200 largest publicly traded corporations.(19)
Accurate information on most companies was just not
available: An outsider cannot estimate, and
the insider frequently does not know, which of the
various elements, if any, is dominant.(20)
New integrated multiunit firms like AT&T, General
Motors, and Standard Oil were exceedingly complex,
generating an ever-growing need for coordination,
well-defined organizational hierarchies, and professional
management.(21) Few of the
entrepreneurs who started companies knew how to run
them. Frederick Taylor and others promoted scientific
management, a complete mental revolution.
Managers and workers should push shoulder to
shoulder in the same direction to generate profits
so great that theres no quarrel over how to
divide them up. Exact scientific investigation
and knowledge ought to replace the individual
judgment and opinions of workers and bosses.(22)
Taylors exact scientific investigation
and knowledge founded the cult of management
science a mystique that sought to put managers
on a par with professionals like physicians, engineers,
and scientific researchers. Management has always
mixed art with science, yet the ideal of scientific
management reinforced the self-assigned right of executives
to run firms with minimal accountability toward shareholders
or, for that matter, other stakeholders (with the
occasional exception of customers). It also legitimized
opacity: like other scientific professionals,
managers purportedly have specialized knowledge that
is beyond the ken of the average layperson, not to
mention the average employee. On the positive side,
the cult of scientific management produced a mindset
of professionalism almost like a religious
calling. Integrity and modest personal gain were hallmarks
of the sincere post-World War II professional manager.
This system has prevailed ever since, though it is
now, in certain respects, in crisis. Top-down management
by the numbers is finally giving way, but not everywhere.
Peter Drucker dryly observed in 1954 that scientific
management may well be the most powerful as
well as the most lasting contribution America has
made to Western thought since the Federalist Papers.
Then he attacked its cardinal tenets, including assembly
line one-motion/one-job production and the divorce
of planning from doing. These practices, he
said, reflect a dubious and dangerous philosophical
concept of an elite which has a monopoly on esoteric
knowledge entitling it to manipulate the unwashed
recently has this message reached most business schools.)
In theory, the managers of the 1950s and 1960s cared
about shareholders; after all, they measured their
success in rising share prices. But the practicalities
of shareholder accountability were absent. Drucker,
again, was prescient this time in 1974. He
worried that boards have become a fiction.
They are either simply management committees
[i.e., controlled by inside directors], or they are
ineffectual.(24) He listed
three causes which ring true today: the dispersion
of share ownership (the fundamental cause), the separation
of ownership and control (the result), and the fact
that top management doesnt want a truly effective
effective board asks inconvenient questions. An
effective board demands top-management performance
and removes top executives who do not perform adequately
this is its duty. An effective board insists
on being informed before the event this is
its legal responsibility. An effective board will
not unquestioningly accept the recommendations of
top management but will want to know why
effective board, in other words, insists on being
effective. And this, to most top managements, appears
to be a restraint, a limitation, an interference
with management prerogatives, and altogether
who took issue with any of this could only vote
with their feet and sell their shares. Management
tightly choreographed annual meetings and shareholder
ballots. The typical shareholder didnt care, since
he (typically male at the time) was but one of millions
of unrelated small-holding speculators. He didnt
want to be bothered about corporate governance. As long
as his shares went up, he was happy. Opacity was A-OK.
rise of the baby boom generation in the 1960s, changes
in society, culture, and politics; and an accumulation
of shocks prepared the ground for a new assault on opacity
The Civil Rights movement challenged discrimination,
first in public services, then inevitably in the workplace.
As this tale unfolded, myths of equality and invisible
persecutions were stripped naked.
The Soviet Unions 1957 Sputnik, the first
space satellite, frightened the United States into wondering
whether the Soviet Union and its industrial technologies
might not prevail.
Executives of several large companies, such as
GE and Westinghouse, were found to have conspired to
raise prices. They had covered their tracks by meeting
in hunting lodges, using code names and making calls
from public telephone booths. Their CEOs claimed in
court they didnt know what their vice presidents
were doing. The VPs went to jail and business began
to operate under a cloud. Presidents Kennedy and Johnson
passed new regulations and staffed enforcement agencies
with business critics.
The 1963 Kennedy assassination tore away a patina
of civility; if the most dashing national leader of
the century was vulnerable, so was every other person
Vietnam divided the nation and weakened trust
In the 1970s, U.S. management practices were shaken
by stagflation and the stunning rise of Japanese competitors
(despite books on the Japanese way, it was
impossible for western firms to emulate Japans
complex webs of interrelationships, not least because
of their opacity). Their credibility again falling into
disarray, U.S. firms paid dearly for their lack of transparency
and accountability in the corporate raids of the 1980s
and the business reengineering craze at
the turn to the 1990s. Driving these events were two
additional structural shifts. First was a new industrial
revolution: a demanding, innovation-centric economy
made possible by information and communications technologies.
Second was the rise of investor capitalism: shareholders,
including institutional investors and market players
(such as the corporate raiders of the 1980s and the
venture capitalists of the 1990s), challenged the separation
of ownership and control.
Suddenly, anti-bureaucratic management, innovation,
and core-competency focus expressed and inspired
by books like In Search of Excellence began their
ascent.(26) One illustration:
analysts in the media and the computer industry worried
that data processing departments were losing control
over employees who were stealthily buying PCs with departmental
budgets. The PC revolution put a new kind of tool for
transparency in the hands of ordinary people, whether
they thought of themselves as shareholders, employees,
customers, community members, or all of these at once.
The merger and acquisition (M&A) boom of the 1980s
was a forced shakeout of the excess capacity and bureaucratic
inefficiencies in the old managerial capitalist order.
There were 35,000 M&A transactions between 1976
and 1990, with a total value of $2.6 trillion (1992
dollars).(27) Many described
the boom along with some huge payouts that went
with it as a greedy maneuver by corporate barbarians
who sucked innovation and investment out of the economy,
degraded the countrys competitiveness, and destroyed
the lives of hundreds of thousands of terminated employees.
Critics attacked exotic techniques like leveraged buyouts
and junk bonds, which eliminated size as a barrier against
takeover and let nonestablishment foxes into the corporate
chicken coop. Certainly, corporate raiders made tons
of money while loyal employees lost jobs, paying dearly
for a situation few of them created.
But underlying all the fire and fury, investors were
finally doing more than voting with their feet. Corporate
raiders and institutional investors reasserted the right
of shareholders to have a say in the fate of the firm.
Business visibility increased dramatically, as players
failings, inefficiencies, maneuvers, and self-dealings
were scrutinized as never before.
events changed the course of history for many companies
during the 1980s. Many analysts argue that the M&A
boom was a necessary purge. Excess capacity was eliminated,
corporations slimmed down, and companies that were trying
to do too many things at once got broken up into more-focused
units. On average, selling-firm shareholders in
all M&A transactions in the period 1976 to1990 were
paid premiums over market value of 41%, and total M&A
transactions generated $750 billion in gains to target
it appears that most
of these gains represent increases in efficiency,
reports Michael Jenson.(29)
But a new consensus urged that the continuous bloodletting
had to stop. It was, to put it mildly, too disruptive.
By the early 1990s the M&A boom was over. The corporate
and fiduciary communities reached a new consensus: accountability
to investors, and particularly long-term investors like
pension funds, would be better served through ongoing
oversight by management and directors within the firm
and by institutional investors outside the firm. Corporate
governance activities rather than battles over corporate
control would become the norm. But in the exuberance
of the dotcom boom, the expected oversight did not happen,
result: the 2002 corporate governance crisis.
But first in the early 1990s came business reengineering,
fueled by another recession. Whether inspired or traumatized
by popular management theory and the corporate raiders,
executives in effect raided their own companies. They
delayered middle management, downsized the
front lines, and reengineered business processes (many
of which had never been engineered in the
In a spirit of better late than never, boards of directors
moved in on some serious executive failures. GMs
board fired CEO Robert Stempel in 1992 after the company
reported losses of $6.2 billion in 1990 and 1991. IBM
replaced John Akers with Lou Gerstner after $2.8 billion
in losses in 1991 and more red ink in 1992. Eastman
Kodak followed suit. In these and other cases the problems
had been visible for years in GMs case
for over 20, in IBMs for over 10. Transparency
means more than making things visible; it also means
taking action on what you see.
The Internet bubble, for all its folly, permanently
regeared the economy. Most important for our story (as
described in Chapter 1), the Internet is a transparency
medium without peer in human history. The bubble also
bounced the world out of recession, shocked companies
out of their process-reengineering narcissism, brought
globalization to life, and launched a productivity boom
that has no end in sight.
Steel provides an example of how the game changed.
Founded by Andrew Carnegie and taken public by J.P.
Morgan, U.S. Steel was a crown jewel of U.S. industrial
capitalism. By the 1980s it was under assault from
efficient Japanese steel manufacturers. It had too
many plants, and too many inefficient plans. Sensing
that the company was vulnerable, CEO David roderick
diversified by buying Marathon Oil in 1981. Nevertheless,
by mid decade U.S. Steel's shares had fallen below
its breakup value (the price its indivitual components
would fetch if they were sold separately), well
below what it had paid for Marathon.(28)
1984 Roderick used a proxy statement to push through
anti-takeover resolutions, including staggered board
elections and a rule that any takeover required
approval by two-thirds of the shareholders. This
is a perfect example of a maneuver designed to preserve
the separation between ownership and control. Such
measures strenthen the hands of management against
the interests of shareholders who might make money
from the sale of the company. Note that, if owning
share in a company is an investment in its future
value, a sale is one great way to enjoy this benefit.
Tying the company upby requiring a two-thirds majority,
as Roderick did, is bad for shareholders who stand
to gain from a sale.
following year Roderick announced plans to buy another
oil company, Texas Oil and Gas. He planned to achieve
this by issuing 133 million new shares, which would
more than double the number to 255 million. As a
result, several institutional investors - pension
and retirement funds holding several million U.S.
Steel shares - rose up in arms. Roderick managed
to push the deal through, at an excessive price,
just as natural gas prices peaked and just before
1986, slumping energy prices drove U.S. Steel's
oil and gas profits down to $42 million (from $1.6
billion in 1985). The new Texas Oil and Gas subsidiary
posted a $31 million loss. Corporate raider Carl
Icahn decided to acquire the company and sell off
its assets one by one. He started buying now-cheap
USX (as U.S Steel had renamed itself) stock. He
soon amassed 9.8 percent of the company's equity
and made an offer on the rest of it. Roderick threw
up a series of defenses and managed to stave Icahn
off. In 1989 Icahn returned. Brandishing 13.1 percent
of USX shares, he went after the new CEO, Charles
Corry. Icahn forced a shareholder vote on a motion
to break the company into two "pure plays,"
steel and energy, artguing that they had greater
market value separately than together. Several big
institutional investors supported him; new style
activists lined up against USX's industrial age
management. Corry fought back and defeated Icahn's
motion. Then a year later hne presented a resolution
of his own to split the company's shares into separate
steel and energy trading stocks. with Icahn's endorsement
it passed by a large margin. USX had finally bowed
to the wishes of its owners.
Corporate Governance Crisis of 2002
Internet bubble lubricated the corporate governance
crisis of 2002, most visibly in the case of Enron, by
diverting attention from old-fashioned standards of
profitability and governance amid hype about new
rules for a new economy. But crooked dealings
at accounting firms, multibillion dollar writedowns
at over 150 companies, and conflicts of interest at
securities firms cant be blamed on the Internet.
In April 2003, ten Wall Street firms agreed to split
penalties totaling $1.4 billion, a relatively painless
outcome considering how they vaporized the integrity
of core processes at the heart of market capitalism.
For corrupt practices like publishing falsely favorable
analyst reports, sending clients advance copies of analyst
reports, and using shares of hot initial public offerings
to virtually bribe CEOs of client firms, the brokerages
avoided admissions of guilt while their executives escaped
criminal prosecution. Some forth percent of the fines
were mitigated by tax deductibility or insurance. And,
as The Economist observed, the entire amount is equivalent
to a few days collective profits and a tiny percentage
of what the firms earned during the boom.(30)
The two entities that should have been policing these
firms the New York Stock Exchange and the National
Association of Securities Dealers also escaped
censure. Investors civil suits are now bound to
Ultimately, the bubble merely exacerbated the perennial
principal-agent problem, that is, the separation of
ownership from control. When there is personal gain
at stake, many agents (corporate executives)
tune their values to rationalize malfeasance.
Weve seen such problems before, most spectacularly
in the events surrounding the 1929 crash houses
of cards; misstatements of financials; self dealing
by overpaid executives; stock promoters with conflicts
of interest; boards of directors that fail to blow the
whistle whether due to cronyism, conflicts of interest,
or sheer laziness; and all in the atmosphere of an overheated
market where expectations outpaced reality.
But there were some encouraging differences. At no time
was the integrity of the banking system questioned or
at risk. Even the brokerage industry, with a proven
industry-wide conflict of interest between research
and underwriting, was not fundamentally undermined:
it lost more to the overall decline of the stock market
and the rise of online trading (another Internet-based
transparency phenomenon) than to the conflict of interest
Also, transparency proved to be a constructive force.
Whistleblowers came forward against Enron, Andersen,
WorldCom, and others. The media delivered the story.
Institutional investors like CalPERS pressured Congress
to act and tightened up their own operating guidelines.
Investors pulled out of the market; this resulted in
a massive value collapse and sent a clear signal that
visible change was a matter of urgency. Many companies
began to rethink and revise their governance.
As in the 1930s, the government stepped in with new
laws (though we are not convinced it will follow through).
The Sarbanes-Oxley Act moved quickly through Congress
and came into effect July 30, 2002. Like Roosevelts
1933 Securities Act, the focus of Sarbanes-Oxley is
to strengthen transparency. Key provisions among the
acts many new rules are:
A firms CEO and chief financial officer
must both sign written statements certifying that their
companys quarterly and annual financial reports
meet reporting rules and fairly present, in all material
respects, its financial condition and the results of
A new board will set and enforce the quality
and ethics standards of audits, with the authority to
impose stiff financial penalties.
Accountants are prohibited from providing nonaudit
services to audit clients.
Board committees of independent directors rather
than company executives will appoint external auditors.
The Securities and Exchange Commission is mandated
to address securities analyst conflicts of interest.
The kind of evidence destruction that Andersen
did at Enron can lead to a prison sentence of up to
20 years, and defrauding shareholders 25 years.
Employees who blow the whistle on securities
violations gain protection.
Institutional investors demanded new kinds of transparency
in this crisis and they also found ways for transparency
to contribute to their portfolio growth. The crisis
in corporate governance drove them to adopt a much more
In 2002 the California Public Employees' Retirement
System (CalPERS), the $143 billion benefits fund for
state workers and other public sector employees and
the largest of its kind, moved into the headlines. It
had been badly stung by a distinct lack of transparency:
Pacific Corporate Group, which advised CalPERS to put
more than $750 million into Enron, also was getting
rich fees from the Texas energy trader for snagging
investors. CalPERS moved to eliminate such conflicts
of interest by requiring its financial advisers to disclose
financial ties with the firms whose securities they
recommended. And, in late 2002, CalPERS invested $200
million to become a partner in a turnaround fund that
targets underperforming Japanese companies. The fund
is forecasting a 30 percent rate of return by acquiring
sclerotic conglomerates, selling off their parts, and
improving their corporate governance a strategy
that hearkens back to the glory days of 1980s M&A.
CalPERS was also instrumental to the passage of the
proxy voting rules for mutual funds that we described
in Chapter 1 a critical piece of the puzzle for
improving corporate accountability to shareholders.
Role of Regulation
strengthens market forces, theoretically reducing the
need for regulatory enforcement. But the history of the
past century shows that the transparency-driven surge
of powerful market forces is not sufficient to change
corporate behavior. As a matter of economic necessity,
many firms may embrace norms of candor and integrity that
exceed minimum legal requirements. But free riders will
take advantage of the system as long as the legal umbrella
protects them; and many, as weve seen, are quite
willing to break the law.
Thus, free markets depend on strong governments. Public
interests are greater than the sum of all private interests.
And open market economies depend on clear rules, rigorously
Well-performing capital markets capture the wisdom of
millions of investors, but this only works when investors
have complete and accurate information on each firms
financial health. This begins with trustworthy audited
financial reports. External auditors were among the measures
the U.S. government put in place after the 1929 stock
market crash. But even then questions arose as to whether
external accounting firms could be trusted. In 1933 a
member of Congress asked Col. A. H. Carter, senior partner
of Deloitte Haskins & Sells: who will audit the accountants?
"Our conscience," Colonel Carter replied.(31)
More than sixty-five years later, this premise sent Arthur
Andersen up in smoke.
The protections in Sarbanes-Oxley are long overdue; if
anything, they dont go far enough. Some business
groups fought even these mild measures. U.S. Chamber of
Commerce president Thomas Donohue published a letter that
accused Senator Paul Sarbanes of a "knee-jerk, politically
charged reaction" to the Enron scandal and claimed
that accounting reforms were a threat to "informed
market decision-making." Not all groups were equally
shortsighted. The Business Roundtable called for Sarbanes-Oxleys
swift implementation, saying the legislation will
help investors, employees and companies by restoring investor
Rules also help a market economy by preventing unethical
companies from externalizing costs onto other market participants.
Example: the Prestige oil tanker sank off the Spanish
coast November 2002, resulting in a human and economic
disaster beyond that caused by the Exxon Valdez. The Prestige
immediately disgorged 20,000 tons of fuel oil (half the
amount spilled by the Valdez) and sank with another 60,000
tons still on board. Oil from the tanker contaminated
beaches and shut down a $1.5 billion fishing industry
that employed 120,000 people along the Spanish Galician
coast. The oil then moved east to the Asturian and Cantabrian
coasts. Oil stains were reported in the Basque province
of Guipuzcoa. By early January 2003, cowpie-size globs
began washing up on the shores of southwestern France,
closing the area's famed oyster beds and tourist beaches.
With a massive store of oil still in the sunken tanker,
no one knows when this disaster will end.(32)
The Prestige was a regulatory basket case. It was, like
the Valdez, a single-hulled tanker, a construction well
known to create far greater risk of spill than a two-hulled
ship; the U.S. banned single hulled tankers from its waters
after the Valdez spill, but the European Union had failed
to follow suit. The boat was chartered by the Swiss-based
subsidiary of a Russian conglomerate registered in the
Bahamas, owned by a Greek through Liberia, and given a
certificate of seaworthiness by the U.S.. When the ship
refueled, it stood off the port of Gibraltar to avoid
the risk of inspection. Every aspect of its operations
was calculated to avoid tax, ownership obligations and
Such examples explain why societal expectations for improved
corporate behavior result in pressures to regulate. The
post-Enron environment has increased support for legislation
in the U.S.: in July 2002, two thirds of Americans agreed
that the free market economy works best when strongly
Government regulation can also create a level playing
field for competition: many industries depend on patent
laws to reward innovation and discourage free riders.
Regulation can itself be a double-edged sword. Disclosure
rules could protect firms that externalize environmental
costs. Business and social critic Amy Cortese notes: With
their confidence shaken in corporate bookkeeping and the
market's omniscience, investors are starting to look for
other possible off balance sheet land mines,
including the hidden risks that could be associated with
global climate change
. (and) company officers could
be held accountable for failing to protect their companies
from climate-related risk.(34)
Rules for disclosing such risks could, by implicitly factoring
them into the stock price, keep these shareholder lawsuits
But all this only proves that mandating disclosure is
not enough; it may also be necessary to regulate behavior.
Laws like the Environmental Protection Act dont
just expose they restrict polluters behavior.
Regulation alone wont produce open enterprises that
always do the right thing. And legal compliance is merely
the lowest common denominator. What really counts is leadership
with integrity, beyond compliance.
sea change is finally happening in corporate governance
in the relationship between ownership and control. Shareholders
are steadily acquiring the ability to scrutinize the
ompanies whose share they hold, and the governmetn is
helping to ensure that third-party overseers - auditors
and regulatory agencies - are themselves held accountable.
In short, the crisis helped to bring about an increase
in transparency. Nevrtheless, after a century and a
half of shareholder capitalism, the jury is still out
on the theory that investor oversight can work.
stakeholders expect a new kind of integrity.
Virgil, The Aenid of Virgil (19 BC)
Samuel Johnson, The History of Rasselas, Prince of
(3) Alfred W. Crosby, The Measure of Reality: Quantification
of Western Europe, 1250 1600 (Cambridge: Cambridge
University Press, 1997), 216.
(4) Dr. Alfred Dupont Chandler Jr., The Visible Hand:
The Managerial Revolution in American Business (Cambridge,
MA: Belknap, Harvard University Press, 1977).
(5) As the telegraph moved information faster than a
messenger, the railway moved people and goods faster
than a horse or a boat. Both, of course, were also cheaper
than what they replaced. Another footnote: telegraph
operators, of course, chattered personal messages to
one another in the unheralded origin of instant messaging.
(6) Marshall McLuhan, Understanding Media: The Extensions
of Man (New York: McGraw-Hill, 1964), 223.
(7) James W. Carey, Communication As Culture: Essays
on Media and Society (Winchester, MA: Unwin Hyman, 1989),
(8) Charles S. Briggs and Augustus Maverick, The Story
of the Telegraph and a History of the Great Atlantic
Cable (Rudd & Carleton, 1858), cited in Carey, 208.
(9) William P. Andrews, Memoirs on the Euphrates Valley
Route (William Allen, 1857), cited in Carey, 209
(10) Market insiders seek to protect and extend their
arbitrage opportunities. For example, in 1894 the New
York Stock Exchange banned telephones on the trading
floor to create a 30-second time advantage over Boston
(11) Howard Zinn, Peoples History of the United
States: 1492 Present (20th Anniversary Edition)
(New York: Harper Perennial, 1999), 220.
(12) Charles R. Geisst, Wall Street: A History (New
York: Oxford University Press, 1997), 131.
(13) Ibid, 228.
(14) Harold Evans, The American Century (New York: Alfred
A. Knopf, 1998), 223.
(15) Geisst, 192.
(16) Ibid, 228.
(17) Adolf A. Berle and Gardiner C. Means, The Modern
Corporation and Private Property (New York: MacMillan
(18) Ibid, 114.
(19) Ibid, 48
(20) Ibid, 84
(21) Chandler, The Visible Hand, 6-9.
(22) Excerpted in Michael T. Matteson and John M. Ivanevich
(eds.), Management Classics, 2nd ed. (Santa Monica,
CA: Goodyear Publishing Company, 1981), 6-8.
(23) Peter F. Drucker, The Practice of Management (New
York: Harper & Row, 1954), 284.
(24) Peter F. Drucker, Management: Tasks, Responsibilities,
Practices (New York, Harper & Row, 1973), 628.
(25) Ibid, 629.
(26) Thomas J. Peters & Robert H. Waterman Jr, In
Search of Excellence: Lessons from America's Best-Run
Companies (New York: Harper Collins, 1982)
Michael C. Jensen, A Theory of the Firm: Goernance,
Residual Claims, and Organizational Forms (Boston: Harvard
University Press, 2001), 21.
Nitin Nohria, David Dyer, and Frederick Dalzell, Changing
Fortunes: Remaking the Industrial Corporation (New York:
John Wiley & Sons, 2002), 172-175
(29) Jensen, A Theory of the Firm, 22.
(30) Unsettling, The Economist, May 3, 2003.
(31) Clay Feet: Could Capitalists Actually Bring
Down Capitalism? New York Times, June 30, 2002
(32) Spanish Coast Seethes at Incessant Tide of
Oil, USA Today, January 13, 2001.
(33) Comment: Capitalism Must Put Its House In
Order: The Prestige Disaster is Yet Another Example
of How Unregulated Business Practices Can have a Calamitous
Effect, The Observer, November 24, 2002.
(34) Amy Cortese, As the Earth Warms, Will Companies
Pay? New York Times, August 18, 2002
December 3, 2003)