August 23, 2017

Why CEOs and Companies Break the Law

Ben Horowitz, CEO of Opsware, offers an interesting essay on why so many bigshot CEOs seem to be in legal trouble. Why, he asks, would a rich and powerful executive risk going to prison? The easy answer, greed, is too simple because many of these guys were already tremendously rich and stood to gain little or nothing personally from the illegal acts. There must have been something else driving them.

One answer is pride. Exhibit A is WorldCom CEO Bernie Ebbers (now doing 25 years for fraud and conspiracy).

As WorldCom grew at a rapid pace, Bernie set expectations high. This led investors to give him advance credit, thus boosting his stock, which was the currency he used to build his company. When Bernie saw that WorldCom wasn’t going to meet those high expectations, and that thousands of shareholders to whom he had promised great performance would lose their money, and thousands of employees who he had hired would lose their jobs, he was willing to do anything to make things right. Even if it meant doing things that were wrong.

Like a killer committing his second murder, the decisions to commit fraud must have come easier as Bernie gained experience. In addition, the stakes continued to get higher. He continued to commit fraud, because if he hadn’t, there was a 100% chance that he would let everyone down who mattered to him and he would no longer be the person that he had worked so hard to become. He wouldn’t be Bernie Ebbers #11 in Time Magazine’s Cyber Elite; he’d be Bernie Ebbers, former milkman, bouncer, and disgraced CEO.

If this is right, Ebbers defined himself by the success of WorldCom. If the company failed, then his work – his contribution to society – would evaporate.

Even beyond pride, some executives see themselves as great benefactors, bringing happiness to employees, wealth to investors, and great products at low low prices to customers. If WorldCom’s growth was good for humanity, then it was worth taking risks to defend. And when the time came to take risks, the Great Man stepped forward.

While working on the Microsoft antitrust trial, I read Titan, Ron Chernow’s biography of John D. Rockefeller. Rockefeller saw most things clearly, but he had one blind spot: he honestly saw little distinction between the growth of Standard Oil and the advancement of humanity. Cheap, high quality oil would transform American life, and Standard Oil would be the agent of that transformation. America needed Standard Oil. Rockefeller had an uncommonly strong drive to do good in the world, a drive that was channeled into an intense need to win every business skirmish. His opponents, who were only trying to make money or run a business, were no match for a guy trying to save the world.

One gets the sense that WorldCom grew as big as it did, and the house of cards stood up for as long as it did, because Bernie Ebbers had a Rockefeller-like drive to make it so. He would do almost anything to keep WorldCom afloat, which is what made him dangerous to his employees and investors.

He was a danger, too, to his competitors.

Once WorldCom started committing accounting fraud to prop up their numbers, all of the other telecoms had to either (a) commit accounting fraud to keep pace with WorldCom’s blistering growth rate, or (b) be viewed as losers with severe consequences.

How severe were the consequences for not breaking the law? Well, like a baseball player who refuses to take steroids, CEO Mike Armstrong of AT&T did not keep pace with the cheaters. As a reward for his honesty and integrity, he was widely ridiculed in the press prior to being fired and AT&T, perhaps America’s most valuable brand, was acquired for cheap. Now you see why Barry Bonds needed something to help him keep pace with Mark McGwire.

The steroids analogy helps explain why corporate criminals must face serious punishment. It’s not enough for the average performer to know that the leaders probably aren’t cheating. Given the choice between believing that the other guy is cheating, and believing that he is honestly outperforming you, most people will go for the cheating theory. People need to know that nobody in their right mind would cheat – a lesson that Bernie Ebbers will be teaching us for the next twenty years or so.

Comments

  1. Obviously pride is part of the equation, but you can’t omit greed — one big chunk of the crimes Ebbers committed, for example, was a series of fraudulent loans that enriched him while taking resources from Worldcom. (Albeit if you buy the delusion about identity between Ebbers and his company, he was just taking what was his due.)

    There’s also pride in another sense: by the time someone gets to be CEO of a big company, they’re typically ensconced in a bubble completely insulated from reality as the rest of us know it. The people around them get promotions not merely by implementing the CEO’s ideas but by anticipating them and smoothing the way preemptively. (The CEO doesn’t have to fire people who have substantive disagreements, because the inner circle will make sure that the disagreements never reach the CEO’s ears.) There are exceptions to this kind of massive dysfunction, but they’re rare among the kind of egos that drive hyper-expanding companies.

    Once that kind of pride has been unleashed, it’s easy for someone to class objections of “that’s illegal” with “that acquisition is too big” and all the other pettifogging objections that would have derailed the company’s success story if they’d been listened to.

    And worldcom’s fraud wasn’t just dangerous to the company’s investors corporate competitors. Anyone in the industry who believed the company’s figures acquired a completely wrongheaded idea about what investment paths were profitable, leading to billions of dollars of misallocated investment. It’s quite probable that the computer and communications industries are still paying for those mistaken decisions.

    (Which explains not only why corporate cheating should be severely punished but also why real, thorough auditing is anecessary component of working financial markets.)

  2. Another Kevin says:

    Another motivation, seldom admitted, is guilt!

    Once the executive is aware that he’s stepped beyond the bounds of propriety (or, indeed, legality), there’s a tremendous pressure to continue, to try to cover up. The reasoning is, “if I win this one big bet, I’ll have enough money (or prestige, or whatever) to come clean, and all will be forgiven.” Each losing bet prompts the gambler to make even bigger bets, until, as Macbeth said:

    All causes shall give way : I am in blood
    Stepp’d in so far that, should I wade no more,
    Returning were as tedious as go o’er.

    Paradoxically, the heavy punishments meted out to Ebbers and his ilk may work to keep this vicious cycle turning. If those who confess peccadillos early face having their lives ruined, then those who commit minor indiscretions have a tremendous incentive to commit greater ones to cover the lesser, or at least to postpone the day of reckoning. “As well be hanged for a sheep as for a lamb.”

  3. ed_finnerty says:

    this ‘greshams law’ of assest aquisition was explained in the Economist when the auction for G3 licences in europe was going on about 8 years ago. The fact was that if you didn’t inflate your stock price you would be bought out by someone who did. see AOL and time warner or Mercedes and Chrysler for examples

  4. I am in the inflated ego camp when it comes to CEO’s breaking the law. My spin though is that law breaking actions of corporate executives is exacerbated by a lack of ethics.

    The law is really “shades of gray”, this gives those with power and a good legal team a lot of flexibility in defining how a corporation acts. CEOs with “good” ethics, I would hope, would try to act within the intent of the law. Those with “bad” ethics seek legal loopholes and innovative interpretations of the law to “justify” their questionable actions. I think the recent HP pretexting scandal is a clear example of ego defining the “law”.

    What also amazes me when a CEO is caught in this situation is their apparent lack of blame acceptance. First, this clearly demonstrates a lack of ethical behavior. Second, it also leaves me with this perpetual rhetorical question: If you are getting paid big bucks because you are the leader and you are the best at what you do, so how can you turn around and claim ignorance of the situation?

  5. Dave March says:

    I find it greatly amusing that no one saw it coming.

    Back in high school I was reading about WorldCom’s impending buy out of MCI, and how he was financing the purchase by pumping out more stock.

    It occurred to me that his company had already hit the break point, that he needed to keep buying up other companies in order to rob them of their assets in order to pay off his stockholders. That WorldCom was becoming a ravenous monster, and that anyone investing in the company was in for a nasty shock.

    It came as no surprise to me that he resorted to fraud near the end to keep the monster fed.

  6. Wow, what classic case. Moral or not, people are rarely irrational from their own perspective. Self defeating maybe, but rational in their own way, perhap “rationale” might be a better word..

    I just finished reading the Corporate Fraud Handbook by J. T. Wells that comes as part of the Certified Fraud Examiner (CFE) self study course. The opening chapter discusses Cressy’s Hypothesis: “In all cases of trust violation encountered, the violator considered that a financial problem which confronted him could not be shared with persons, who from a more objective point of view, probably could had aided in the solution.” The perception of nonsharable burden drives internal pressure which is one leg of the classic fraud triangle: pressure + opportunity + rationalization. Of course it could be co-incidence, but Cressy’s 60+ year old theory fits this one pretty closely.

    The pride that goeth before fall for the big time CEO leads to the twin sand and tar pits of status gaining and business reversals. The guy had too much pride regarding his appearance in the eyes of his peers; and could not admit to himself the delusional nature of his doomed businessman’s external optimism that things will get better tomorrow. [But most of us would have to leave IT if we admitted that last part!]

    BTW, Gesham’s law does not apply – the price going up did not make the price go up which would be exuberant positive feedback; the price went up because it was manipulated by fraudulent financial statements to go up. The guy was good at what he did, until the house of cards caved in.

  7. That quote about Bernie Ebbers is disgusting. His only motivation was to “make things right”? He just wanted to prevent stockholders from losing money and employees from losing their jobs? He was completely altrusitic and simply didn’t want to “let everyone down”?

    That’s complete BS. In fact, it’s dangerous BS, because it suggests that he and others like him really didn’t do anything wrong, or if they did they should be forgiven.

    Ebbers was no altruist. He wasn’t trying to help anybody, except himself. His motivations were greed, power, fame, and self-aggrandizement. When you want to help people, you don’t commit massive fraud, you don’t destroy companies, you don’t destroy jobs, you don’t destroy billions of dollars in assets, you don’t destroy peoples careers, you don’t wreak havoc with peoples lives, you don’t wreck a major industry. To suggest otherwise is outrageous.

  8. Steve Nordqui__ says:

    Great find! But your punishment junk is wretched:
    “The steroids analogy [noncheaters are expected to lose in the market] helps explain why corporate criminals must face serious punishment.”

    Ebbers was working on (an ebilluent flavor of; and secured (disingenuously; though quite per legis) with employees-experience-hours) personal credit lines pretty deep into that bubble, and barely got his snorkel close enough to the surface to taste or buy any innovation or talent.
    His board is behooved to unanimously move the risk to the company’s aegis. His virtual VCs are behooved to lather rinse and repeat with a studied variation dictated by the wait policy chosen as oversight. Worse, the board followed with a demand that Ebbers (and Anyone who threw down like him in telecom without having other interests. Which is asking for a voodoo straw WorldCom;) explain how he was going to an All-Night Open Chocolate Bar and have 30kg of lean and well-employed muscle the next morning. The correct answer is of course that his lean will still be there but the chocolate’s running on gas. What correction would you order yourself as a reasonable person (even of rangy weight?) Bonus: You are being featured in your nations’ and industries’ WEF/Davos forecasts. Academia is not communicating ‘no’ well when told the bubbles are extra.

    Had Ebbers a very serious staff, all under 18, to decide what capabilities in agility and market strength were being developed, they would inevitably find a muscular swim bladder made of the legal structure preventing creation of 3-year puts in telecom. In Congress, Boards, whistleblower and FASB accounting review; everyone but Network Operation Centers was ordering lids on innovation and more of the cool running double-digit CAGR. NOCs got the call-center treatment.

    Now, Craig Venter could keep a lid on what he was doing for the most part; he did not have to keep a phone on show, and makes a good point of not being motivated by anyone else’s fears. If on the upside coral makes a comeback and disease vectors lean regressive, it is not to please a DA.

    In conclusion, if it is decided you will win and cheat then the charade is begun; you and your investors should care about having a diverse shop with some open trade elements and a compelling practice. I regret this says nothing about whether it is cool to be Halliburton.

    Rob could use to read a bit more widely in The Economist before calling it a decision from a shallow sample of allies too, I think; a moody market and its cash managers will buy 6 of those Macbeths (each) before they book 5 hours at a hotel the same night.

    *cite it yourself; trivial. Except for Rob. Sorry Rob.

  9. Steve Nordqui__ says:

    Humility that stands too close to laws claiming you have to restate your investment structure and those of affected businesses (for error X) is ironically far from respect for craft. I now get to look up a citation of Venter’s in AAAS Notes/News for who first suggested an exercise in craft to rematch the opportunity costs in question….

  10. Steve Nordqui, that sounds like it was supposed to make sense, even though it didn’t. Can you hook me up with your drug supplier please?

  11. I keep trying to read “Steve Nordqui” as an anagram of “Mark V. Shaney.”

  12. Who the hell is Mark V. Shaney?

  13. Well?

  14. I heard this rumor from a salesman who used to work for WorldCom’s generator supplier. He said the reason WorldCom went bankrupt is this:

    An engineer who used to work for the generator suppler didn’t provide the various sites with backup power quickly enough. The sites couldn’t be operational and pass traffic as planned until they had backup power, so WorldCom couldn’t generate sufficient revenue. WorldCom was their biggest customer.

    • I think I know who you’re talking about…I met this engineer at a site in CA. Project was delayed months because of him.

  15. I used to work for WorldCom, and MCI WorldCom before that. Mr. Ebbers was a good and decent man who has been vilified by the media. A real shame what was done to him.