Accounting Fraud

Most investors are aware of the accounting fraud scandals that were uncovered in the wake of the Enron debacle. The lists of corporate accounting scandals collected by bbc, forbes and others reads like a rap sheet on Fortune 500 companies.

The damage caused by this fraud is well known. For example, Worldcom’s $11 billion in accounting fraud provoked the largest bankruptcy in U.S. history. Enron’s collapse left 21,000 jobless. Pensions and investments were lost. The wave of corruption shook the financial markets.

What is less well known is that most of these scandals were motivated by the greed of top corporate executives who sought to inflate the values of their stock holdings and options. In his 2002 testimony to Congress, Former Federal Reserve Chairman Alan Greenspan testified to this cause:

Why did corporate governance checks and balances that served us reasonably well in the past break down? … An infectious greed seemed to grip much of our business community. … Too many corporate executives sought ways to “harvest” some of those stock market gains. As a result, the highly desirable spread of shareholding and options among business managers perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising. … The incentives they created overcame the good judgment of too many corporate managers.

 Chairman Greenspan placed the ultimate blame for corporate fraud squarely on the desks of corporate CEO’s:

Manifestations of lax corporate governance, in my judgment, are largely a symptom of a failed CEO. … I recognize that I am saying that the state of corporate governance to a very large extent reflects the character of the CEO, and that this is a very difficult issue to address. (emphasis added)

 Greenspan warned that after memories of Enron faded, other corporate scandals would emerge. “[E]ven if the worst is over, history cautions us that memories fade. Thus, it is incumbent upon us to apply the lessons of this recent period to inhibit any recurrence in the future.”

He expressed his opinion that solutions to corporate fraud should lie in“strengthen[ing] the legal base of free market capitalism: the property rights of shareholders and other owners of capital. Fraud and deception are thefts of property.” (emphasis added).