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Contributed by W. Steve Albrecht, Associate Dean of the Marriott School of Management and Arthur Anderson Professor at Brigham Young University Dr. Albrecht joined Red Hat's board of directors in May 2003. The following article is extracted from an article to the graduating class of the Marriott School of Business and used by permission.
Symptom: The Expensive Preschool
Jack Grubman is a telecom analyst for Citigroup's Salomon Smith Barney. He is also the father of twins whom he wanted to enroll in Manhattan's 92nd Street Y, home of a prestigious nursery school that is supposedly harder to get into than Harvard. In 1999, Grubman, who wasn't particularly excited about AT&T as an investment, had rated the company's stock as "neutral." However, in early 1999, Sanford Weill, chairman of Citigroup, asked Grubman to take a "fresh look" at AT&T. Grubman began a review but also stated in an e-mail that was titled "AT&T and the 92nd Street Y" that he'd love Weill's help in getting his twins in to the Y's preschool. Shortly after the memo was written, Grubman upgraded AT&T's stock to "buy." Not long after the upgrade, Salomon won some lucrative AT&T business. At about the same time, Citigoup gave $1 million, spread over five years, to the 92nd Street Y, and the Grubman twins were admitted to the preschool.
Kinds of Abuses
Whether or not Jack Grubman did anything wrong, Citigroup's $1 million donation to the school and the Grubman twins's admittance have been characterized in the press as a symbol of the ethical abuses that occurred in the United States during the past two years. During 2000 and 2001, there were numerous revelations of corporate wrongdoing that created a crisis of confidence in the capital market system. Some of the most notable of these abuses included:
Misstated financial statements and "cooking the books": Examples include Qwest, Enron, Global Crossing, WorldCom, Xerox, etc. Some of these frauds involved 20 or more people helping to create fictitious financial results and mislead the public.
Inappropriate executive loans and corporate looting: Examples include John Rigas (Adelphia), Dennis Kozlowski (Tyco), Bernie Ebbers (WorldCom), etc.
Insider trading scandals: The most notable example is Martha Stewart and Sam Waksal of ImClone.
Initial Public Offering (IPO) favoritism, including spinning and laddering: Spinning involves giving IPO opportunities to those who arrange quid pro quo opportunities. Laddering involves giving IPO opportunities to those who promise to buy additional shares when prices increase. Examples include Bernie Ebbers of WorldCom and Jeff Skilling of Enron.
Excessive CEO retirement perks: Companies including Delta, PepsiCo, AOL Time Warner, Ford, GE, IBM have been highly criticized for endowing huge, costly perks and benefits, such as expensive consulting contracts, use of corporate planes, executive apartments, maids, etc., to retiring executives.
Exorbitant stock options for executives: In 1997, for example, Bernie Ebbers of WorldCom had a salary of $935,000 but received stock options worth approximately $46 million.
Loans for trading fees and other quid pro quo transactions: Financial institutions such as Citibank and JP Morgan Chase, for example, provided favorable term loans to companies such as Enron in return for the opportunity to make hundreds of millions of dollars in derivatives transactions and other fees.
Bankruptcies and excessive debt: Because of these and other problems, six of the ten largest corporate bankruptcies in history occurred in 2002 and four of these firms experienced financial statement frauds.
Massive fraud by employees: While not in the news nearly as much as financial statement frauds, there has been a tremendous increase in fraud against organizations and some of these frauds have been as high as $2 to $3 billion dollars.
Why Ethical Problems Occur
Ethical problems such as these usually occur when three factors come together: (1) some kind of pressure, (2) a perceived opportunity, and (3) some way to rationalize the act as appropriate, given one's personal code of conduct. People who have analyzed these abuses have argued that such pressures include:
Executive incentives to provide favorable earnings reports to meet Wall Street's earnings forecasts for their firms.
The need to report increasing earnings to maintain high stock prices so that endowed stock options can be exercised
High rewards for short-term profitability at the expense of long-term growth
Large amounts of debt and leverage
Greed by CEOs, investment and commercial bankers, investors and others
Most business analysts believe the opportunities that led to these abuses included:
A good economy during the '90s that masked many problems
Rule-based accounting standards that made it difficult for auditors to argue against aggressive accounting practices
Inappropriate behavior of CPA firms, especially some partners that were more concerned about building their practices than maintaining independence
Educator failures to teach ethics, fraud and analytical skills to students
Moral development researchers maintain that one develops honesty through a combination of proper modeling (example) and labeling (teaching and training.) They also argue that when either of these is absent or when inappropriate modeling or labeling is present, people will be less honest. Unfortunately, bad modeling makes up most of the news we read and watch on television. Families that used to provide most of the honesty labeling are spending less and less time together. The result is that many people working in business have developed situational rather than absolute ethics. Situational ethics, combined with pressures and opportunities like those described above, made it easy for many people to rationalize participating in these abuses. In some cases, as many as 20 to 25 different people cooperated in the same fraud. In one case of financial statement fraud, for example, the CFO instructed the chief accountant to artificially increase earnings by $105 million so the company could meet Wall Street's earnings forecast. Although the chief accountant was skeptical about the purpose of these instructions, he did not challenge them. The mechanics were left to the chief accountant to carry out. The chief accountant created a spreadsheet containing seven pages of improper journal entries, 105 in total, that he determined were necessary to carry out the CFO's instructions. In total, between 25 and 30 individuals in the company were involved in making misleading financial entries.
This case does not represent an isolated instance of acquiescence to inappropriate requests. As an example of how widespread these types of problems were, consider the results of a poll that was taken of attendees at the April, 1998 Business Week Forum of Chief Financial Officers. At that forum, participants were queried about whether or not they had ever been asked to "misrepresent corporate results." Of the attendees, 67% of all CFO respondents said they had fought off other executives' requests to misrepresent corporate results. Of those who had been asked, 12% admitted they had "yielded to the requests" while 55% said they had "fought off requests" to cook the books.
Expectations for Marriott School Graduates
Honesty lies at the core of any decent and just society. Wherever we are or whatever job we are entrusted to perform, we must stand for principles of honesty and integrity. The model we provide will send strong messages to our coworkers and our family members. We cannot afford to be involved in even passive participation in or observance of dishonest behavior. No amount of material wealth is worth having a guilty conscience or compromising our integrity. Our challenge is to boldly stand against dishonest behavior.
The words of Karl G. Measer, an early president of BYU, about honor and integrity provide a great example for us to follow:
"I have been asked what I mean by my word of honor. I will tell you. Place me behind prison walls -- walls of stone ever so high, ever so thick, reaching ever so far into the ground -- there is the possibility that in some way or another I may escape; but stand me on the floor and draw a chalk line around me and have me give my word of honor never to cross it. Can I get out of the circle? No. Never! I'd die first!" --
Practices to Avoid
As deans of the Marriott School, we strongly recommend that you provide a positive model in everything you do and that you avoid participating the following:
Any transaction or behavior that, if discovered or printed on the front page of a newspaper, would be embarrassing (not of "good report") or has the potential to harm other people. You should walk away from involvement in anything that you would not be proud to report to your mother.
Any quid pro quo transaction that causes you to comprise your principles to provide an advantage to you personally, to your firm or to anyone else.
Any activity that causes you to extend yourself too far financially or become too indebted. High amounts of debt and leverage motivated many of the corporate problems described above.