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Why CEOs and Companies Break the Law

June 28, 2007 by

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.

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All the Interested Parties? Not Quite.

June 14, 2007 by

Here’s a quick quiz to detect whether you’re stuck in Washington groupthink.

There’s a patent reform bill under consideration in Congress. According to a blog entry by Andrew Noyes at the National Journal, a group of Republican senators sent a letter to Rep. Howard Berman, the chair of the relevant House subcommittee, asking that the patent bill be given more consideration before the committee votes on it. Senator Berman responded:

“There have been a number of hearings, briefings, and meetings about these issues over the past four years,” said Berman, who introduced a companion bill, H.R.1908. “We’ve heard from representatives of all the interested parties – from independent inventors, universities, bio-technology, pharmaceutical, software and financial services industries.”

Here’s the quiz: who did Rep. Berman leave off his list of “all the interested parties”?

Rep. Berman’s omission is a common one in Washington. Start listening for this omission, and you’ll be surprised how often you hear it.

I don’t mean to pick on Rep. Berman personally. Okay, maybe I do, just a tiny bit, given some of his past actions such as co-sponsoring the ill-advised Berman-Coble bill that would have legalized denial-of-service attacks against people suspected of sharing infringing content. If this was just one congressman, once, it wouldn’t be worth noting. But given the frequency of this mistake, I think it does reveal something about the standard Washington mindset.

In the case of patent reform, there are complex issues at stake. Changes to patent law can affect innovation and competition in subtle ways. That affects all of the parties Rep. Berman mentioned, as well as the one notable group he left out. Which is …

Ordinary citizens.

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Staying Off the Regulatory Radar

June 12, 2007 by

I just returned from a tech policy conference. It was off the record so I can’t tell you about what was said. But I can tell you that it got me thinking about what happens when a tech startup appears on policymakers’ radar screens.

Policymakers respond to what they see. Generally they don’t see startups, so startup products can do whatever makes sense from a technical and customer relations standpoint. Startups talk to lawyers, they try to avoid doing anything too risky, but they don’t spend their time trying to please policymakers.

But if a startup has enough success and attracts enough users, policymakers suddenly notice it and everything changes. To give just one example, YouTube is now on the radar screen and is facing takedown requests from national authorites in places like Thailand. (Thai authorities demanded takedown of an unflattering video about their king.) The cost of being on the policy radar screen can be high for online companies that have inherently global reach.

Some companies respond by changing their product strategy or by trying to outsource certain functions to other companies. We might even see the emergence of companies that specialize in coping with policymakers, making money by charging other tech-focused companies for managing certain parts of their technology.

Perhaps this is just another cost of scaling up a service that works well at smaller scale. But I can’t help wondering whether companies will change their behavior to try to stay off the radar screen longer. There’s an old strategy called “stealth mode” where a startup tries to avoid the attention of potential competitors by keeping secret its technology or even its very existence, to emerge in public at a strategically chosen time. I can think of several companies that wish for a new kind of stealth mode, where customers notice a company but policymakers don’t.

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Internet So Crowded, Nobody Goes There Anymore

April 24, 2007 by

Once again we’re seeing stories, like this one from Anick Jesdanun at AP, saying that the Internet is broken and needs to be redesigned.

The idea may seem unthinkable, even absurd, but many believe a “clean slate” approach is the only way to truly address security, mobility and other challenges that have cropped up since UCLA professor Leonard Kleinrock helped supervise the first exchange of meaningless test data between two machines on Sept. 2, 1969.

The Internet “works well in many situations but was designed for completely different assumptions,” said Dipankar Raychaudhuri, a Rutgers University professor overseeing three clean-slate projects. “It’s sort of a miracle that it continues to work well today.”

It’s absolutely worthwhile to ask what kind of Net we would design if we were starting over, knowing what we know now. But it’s folly to think we can or should actually scrap the Net and build a new one.

For one thing, the Net is working very nicely already. Sure, there are problems, but they mostly stem from the fact that the Net is full of human beings – which is exactly what makes the Net so great. The Net has succeeded brilliantly at lowering the cost of communication and opening the tools of mass communication to many more people. That’s why most members of the redesign-the-Net brigade spend hours everyday online.

Let’s stop to think about what would happen if we really were going to redesign the Net. Law enforcement would show up with their requests. Copyright owners would want consideration. ISPs would want some concessions, and broadcasters. The FCC would show up with an anti-indecency strategy. We’d see an endless parade of lawyers and lobbyists. Would the engineers even be allowed in the room?

The original design of the Internet escaped this fate because nobody thought it mattered. The engineers were left alone while everyone else argued about things that seemed more important. That’s a lucky break that won’t be repeated.

The good news is that despite the rhetoric, hardly anybody believes the Internet will be rebuilt, so these research efforts have a chance of avoiding political entanglements. The redesign will be a useful intellectual exercise, and maybe we’ll learn some tricks useful for the future. But for better or worse, we’re stuck with the Internet we have.

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Cablevision and Anti-Efficiency Policy

April 18, 2007 by

I wrote recently about the Cablevision decision, in which a judge appeared to draw a line between two kinds of Digital Video Recorder (DVR) technologies. (DVRs let home viewers record TV shows and play them later.) The judge found unlawful a Remote Storage DVR (RS-DVR) in which recorded shows are captured and stored in the cable TV company’s data center, but he apparently would have allowed a Set-Top Storage DVR (STS-DVR) in which shows are recorded on a device kept in the customer’s home.

Why should the law prefer that recorded shows be stored in the customer’s home? The judge’s reasoning was that the cable company is more involved in an activity if that activity happens in its data center. This appears to follow from the judge’s reasoning even if the alternative in-home STS-DVR is owned and controlled by the cable TV company. But I’m not asking what the law says; I’m asking instead what it should say. Why should the law prefer STS-DVRs over RS-DVRs?

If the goal of the law is to protect copyrighted material – and remember that this was a copyright case – then you might expect it to favor solutions that are more controllable or more resistant to content ripping. But the court got the opposite result: Cablevision was liable because it had more control. The result will be more customer control, which is a benefit for many law-abiding customers.

The court’s ruling also has implications for technical efficiency. Central storage is arguably more efficient than set-top storage in the customer’s home, because of economies of scale in managing a central facility. The court’s decision pushes companies toward set-top storage, even though it is probably less efficient and offers virtually the same functionality as central storage.

It might seem at first glance that public policy should never try to increase the cost of a lawful activity, but in fact there are exceptions. It can sometimes make sense for policy to raise the cost of an activity, if that activity has benefits but can harm nonparticipants. Raising costs rather than banning the activity outright can prevent marginal uses while allowing those uses that provide greater benefit. Of course, if you want to argue that raising the cost of DVRs is good policy, you’ll have to make several assumptions about the costs and benefits of DVRs – assumptions that are very likely untrue.

Even before the suit was brought, Cablevision was already reducing the efficiency of its system in the hope of improving its legal position. For example, their storage facility had a separate storage area for each customer, even though it would have been much more efficient to use a single shared pool of storage. If 5000 customers asked to record last week’s episode of Lost, Cablevision would store 5000 identical copies of that episode, one in each customer’s areas. It would have been easy, and much more efficient, to store a single copy. The only sensible reason to keep redundant copies is that a system with individual storage areas might look to a judge more like a set-top DVR system, thereby bolstering the argument that the system is just like a (presumably lawful) STS-DVR. In other words, even before the recent ruling, legal factors were pushing Cablevision toward a less efficient implementation.

For the companies who filed the suit, the goal was not to serve the public but to maximize their own economic advantage. What they cared about, most likely, was simply establishing that one had better come to them for approval before doing anything new. By that standard, they must see the suit as a big success.

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