What It Takes to Restore Trust
What’s still wrong with American business? Start with pervasive conflicts of interest and the limits of enforcement.
The crisis in American business has spawned tales of colorful characters who will surely live on in folk memory, quipped Harvard Business School professor D. Quinn Mills: the ignorant CEO; the creative accountants; the big-spending dot-com kid. Dark humor aside, though, underlying fault lines in American business are plainly visible for the whole world to see, Mills warned. Repairing the infrastructure is critically important to restore trust in American business, and tinkering with the rulebook is not enough.
The process of instilling confidence in American business is also going to be much more difficult than anyone would wish. According to Mills, who offered the closing comments at the Restoring Confidence in American Business conference held at Harvard Business School on April 21, which drew about 350 attendees, it is clear that regulation and reform of regulation can only go so far.
The American capital markets are a key element of the economic system, and "when they function well, they are a wonder of the world," he said.
But the American capital markets require four qualities from those who participate in them, he observed: honesty, disclosure, transparency, and professionalism. Those are missing now, and those are exactly the qualities that are needed before we'll see any significant change in the prevailing lack of trust, he said.
Our securities industry is broken. It's in terrible shape.
— D. Quinn Mills
"What's broken in our system? Not our economy. It's not in great shape, but it isn't doing too badly, and measured by the standards of the rest of the world it is a marvel and it's doing quite well," he observed. The financial sector is not perfect, either, but banks are also in "pretty good" shape.
"But our securities industry is broken. It's in terrible shape. We're here [at the conference] because we know it; we're here because the public knows it, and we are concerned about the fact that they know it," he said.
According to Mills, the 1990s lured new, unsuspecting investors in record numbers. In 1983, 19 percent of American households owned equities in some form or another. By 2002, the figure for households had rocketed to 49.5 percent. Among single people in 1983, 42 percent held equities, while in 2002, 84 percent did.
"This was a great triumph of American capitalism and was well recognized as such at the time. We had become a nation of equity owners. We were all in the markets; we were all sharing in the benefits of our system. And then what happened? Many were wiped out. Almost all were disillusioned." It is a systemic problem, not just a matter of a few bad apples, he said.
Fixing the system
What hasn't changed? The temptation of standard options, among other bait. Standard options remain the dominant pay pattern in American businesses today, he said. Most academics have never favored standard options and regard them as a danger, he said, because in a volatile market they allow top executives "to get rich no matter what happens to the shareholders."
Options should be indexed options. These options pay for performance, not for volatility in the markets.
Pervasive conflicts of interest are other key reasons for the lack of confidence in American business. According to Mills, these conflicts of interest include the well-publicized conflicts between chief executives and their shareholders; banks and customers' investments; and auditors and boards of directors and their shareholders. Less talked about are these:
- Venture capitalists versus the long-term health of the companies that they back. "Their interest [is] in getting the thing out quickly, getting it public, cashing in, and getting out before the whole thing collapses," Mills said.
- Politicians versus the public. Politicians have to raise money "from these same people who have done so well by defrauding investors."
- Nonprofit organizations "like our own universities, museums, churches—whose leaders should be talking about this, and talking about it more than they are, who should be providing some of the ethical [discussions], but who are out there with their tin cups raising money from the very people that they would otherwise be called upon to criticize and condemn," Mills concluded.
While he praised the breadth and depth of the conference sessions—which covered topics from enforcement to auditing—he reminded the audience that no individual that day had raised the issue of restitution for investors who had been defrauded and subjected to misrepresentations.
"We have apparently decided that the issues of restitution ... should primarily be left to the trial lawyers of the United States." Lawyers are now preparing to tackle restitution "on a massive scale," he warned.
"I don't think many of us think this is a very good system if this is a good way to handle it, to hand it over to trial lawyers. But that is apparently what we are going to do."
The Restoring Confidence in American Business conference was co-sponsored by the Harvard Business School Association of Boston and the Boston Security Analysts Society.