But we also believe that it is impossible to run a fast-growth, high-investment economy without fairness and a level playing field for investors--and right now, it seems there is little of either. Each day brings to light yet another case of corporate falsehoods, misrepresentations, and manipulation of markets. Even blue-chip companies use aggressive accounting practices, while top managers grossly enrich themselves at the expense of shareholders.
Many business leaders act as if these problems are all going to blow over. They are keeping mum or supporting efforts by lobbying groups to derail or water down reforms. Meanwhile, executives such as CEO James F. Parker of Southwest Airlines Co. worry that the "misdeeds of a few" are undermining confidence in honest businesses.
There is too much at stake for CEOs to maintain this state of denial. Despite their optimistic pronouncements, the truth is that investor confidence and trust in Corporate America is fragile. As Henry M. Paulson Jr., CEO of Goldman, Sachs & Co., puts it: "In my lifetime, American business has never been under such scrutiny. To be blunt, much of it is deserved." The effect of the bad news is cumulative. Each revelation of corporate wrongdoing creates something like a small hole in a dike. At first, the leak is small, but the pressure increases until the wall collapses.HISTORY LESSONS. Fortunately, there is little evidence yet of a wholesale collapse of investor confidence. According to the BusinessWeek/Ipsos-Reid poll, taken June 7-9, only 18% of investors say they will reduce their investment in the market over the next six months. That number is slightly lower than in February, when BusinessWeek last asked that question.
History suggests, however, that the loss of confidence, when it comes, could happen very rapidly. The damage would be enormous. It would become far more difficult for companies to raise money, either at home or abroad. Moreover, the crisis would have the potential to imperil what business needs: a market-based economic system without excessive regulation, and strong financial markets with broad-based investor participation. Indeed, once investors lose confidence, other parts of the business agenda, such as free trade, are likely to come under attack as well.
What we need are institutional reforms that will restore trust in corporations and the markets before it erodes further. The effort must be broad-based, with the committed participation of Washington, Wall Street, and Corporate America.
First on the list is passage in Congress of accounting reform legislation. Right now, it looks like Senator Paul S. Sarbanes (D-Md.) has enough votes to move his accounting reform bill out of committee, but it still faces substantial opposition in the full Senate and the House of Representatives. Opponents of reform, such as Senator Phil Gramm (R-Tex.), who considers himself a free-market conservative, should recognize the threat caused by unreliable financial information from companies.OVERSIGHT WITH CLOUT. Equally essential is aggressive enforcement and regulation by the Securities & Exchange Commission. The SEC has stepped up its investigations of financial wrongdoing while pushing a strong agenda to tighten the disclosure rules for U.S. companies. On June 12, it proposed new guidelines that will triple the number of corporate developments--including such potential land mines as transactions with related parties, unusual financing deals, and waivers of ethics codes--that companies must report publicly. But the key question remains: whether the SEC will propose an accounting oversight board with true independence and clout.
The reform effort can't flow from Washington alone. Pressure also must come from Wall Street, in particular the institutional investors and pension plans that absorbed much of the losses from the string of corporate stock meltdowns. The latest proposal from the New York Stock Exchange to tighten governance standards and require more independent directors is a good first step. At the same time, pension plans and other big institutional investors are pushing shareholder resolutions. Another promising sign: the budding alliance among a group of major institutional investors representing almost 10% of the stock market--including Warren E. Buffett and John C. Bogle, founder of Vanguard Group Inc.--who want to force companies to worry about corporate governance and executive compensation, among other things.
Perhaps most important, top managers themselves have to step up and provide leadership during this crisis. So far, CEOs have held back, partly because they believe that the problems have been overblown by the media and partly because they may know that they played some games themselves with their earnings during the fat years. Still, the longer that leading executives stand on the sidelines, the greater their apparent complicity in a system that seems rigged against investors.
None of this will be easy. Congress and the Bush Administration are being lobbied to death by business groups demanding reduced reforms or none at all. Institutional investors are still tempted to sell their shares rather than fight for better governance. But everyone should remember that it's far easier to deal with a crisis of confidence before it gets out of control. The fire next time will be much worse.