01 Feb 2003 A Transparent Free Market is Our Best Corporate Cop

On the back of a dollar bill appears a reproduction of the Great Seal of the United States. Upon it rests the motto “Annuit Coeptis” – meaning, “God favors our undertakings.”

The phrase refers to the hand of Providence in the founding and success of our nation. On the dollar bill, a second message is implied: adherence to the laws of God brings prosperity.

If you are among the skeptical, compare the stock price of companies with a reputation for keeping honest books with the stock prices of firms that don’t.

Honesty pays. The market penalizes the dishonest.

In July, following Congressional action in the wake of the Enron scandal, President Bush signed legislation purportedly designed to reduce corporate accounting fraud. By the time he did, the stock market had already done more to reward honest corporations and penalize crooks than any piece of legislation ever could.

The end for Enron came when word spread of a Securities and Exchange Commission investigation of its practices and Enron admitted it had overstated profits over the previous five years. Investors asked more questions. They didn’t like what they heard; the stock price continued to fall. Enron’s worth went from $30 billion to nearly zero. It desperately needed capital to survive, but couldn’t get it – its lack of honesty had scared off investors.

The Enron House of Cards fell hard before passage of recent legislation against corporate scandals. The free market cleaned up its own mess, acting far faster than Congress.

Even after Congress’ new anti-fraud measures were imposed this summer, when corporations scrambled to prove their honesty, it mostly wasn’t law enforcement they were worried about, but investors.

Law enforcement, at its most severe, can jail executives and level fines. The market can crush a dishonest firm in short order: smash its stock price and starve it of capital before a Grand Jury even has time to hear evidence.

Not every company that has suffered scandal recently has fallen as far as Enron. Those that suffered scandal but didn’t fall as far had one overriding goal: to get rid of the bad apples in their corporate hierarchies and prove to the investing public that their books are honestly kept and their accounting methods can be trusted. These firms aren’t worrying about Congress nearly so much as they are worrying about investors.

There are, however, things elected officials can usefully do:

Remind the public that investing is a risk, that portfolios should be diversified, and that the goal of investing is long-term, not overnight, gains. In business, as in all professions, there always will be bad apples, but most companies are run by honest executives.

Lead by example – try harder to weed out government fraud. Little noted, yet huge ongoing accounting frauds within the U.S. government make Enron’s books seem honest by comparison.

Recognize that sometimes the laws we already have are good enough. New laws should only be approved when they are truly needed, not merely because passage makes congressmen look good.

A transparent marketplace of informed investors, not an increasingly complicated web of federal laws and regulations imposed by government officials motivated by a desire for publicity, is the way to keep Wall Street clean and our nation prosperous.

A transparent free market is our best policeman.

Amy Ridenour is President of The National Center for Public Policy Research, a Washington, D.C. think tank.