3: Crimes Against the Information Age

In this era, the price of bad data can be disaster. When a company lies or inflates its numbers, everyone suffers: Investors, the financial markets, and even competitors

Here's a simple observation: Many of the leading figures in today's corporate scandals, such as Kenneth Lay and Jeffrey Skilling of Enron, Bernard Ebbers of WorldCom, and Gary Winnick of Global Crossing, may never be convicted of a single crime. They got approval from their boards of directors and accountants for most of their actions. And while their financing and accounting techniques were aggressive to an extreme, they may not rise to the level needed to put the executives in jail.

But that's no solace to investors, who discovered all too late that those companies and a slew of others were far weaker than they believed: Debt levels were higher, true revenues were lower, and prospects for future growth far less optimistic than the executives had made them seem at the time.

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It may turn out that these executives were not guilty legally. Nevertheless, they committed serious offenses against today's Information Economy. Just as a plane can't fly without fuel, this economy simply can't perform well without accurate data. By misleading investors and concealing important facts, these executives have caused pervasive harm. The result: wasted resources and a long-term drag on the economy.

The damage is especially deep because of the rapid pace of change over the last few years. Investors need something rigorous to go by if they're going to shift their money quickly to the best-performing companies and sectors. Managers have to have accurate data about their competitors, so they can identify and emulate the most successful ones. And companies depend on truthful reports about their own performance, so that they know when major restructuring and personnel changes are essential.

Start with the financial markets, which lie at the heart of the U.S. economy. The trend over the last 20 years has been to rely increasingly on the equity and debt markets, rather than on banks or the government, to allocate capital. When the financial markets are working well, the U.S. has a big competitive edge over Europe and Asia. U.S. capital markets can funnel money rapidly to new technologies, and then adjust quickly if new ventures don't pan out.

Misrepresentations by top executives can jeopardize the efficiency of the financial markets. In particular, the accounting misrepresentations at companies such as WorldCom and Qwest Communications (Q ) kept far too much capital flowing for too long into the telecom sector--perhaps as much as $30 billion, much of that in bonds which will never be paid back. That's money that could have been used much more profitably and productively elsewhere.

The financial markets are not the only ones to suffer when a company provides bad information. Competitors in the same industry are hurt, too. They're keenly aware of how their rivals are doing, especially in a sector with rapid technological change. If one company seems to be faring exceptionally well, everyone else tries to figure out why and copy it. That's how innovations diffuse through an economy.

That process doesn't work right if one company is lying about its performance. When Enron Corp. reported revenue growth of 70% annually from 1997 to 2000, and operating profit growth of 35% a year, that drew other electric and gas utility companies into energy trading. The fact that Enron achieved much of its gains by moving debt off the books and using other accounting tricks was not obvious at the time. Similarly, in 1999 and 2000 WorldCom Inc. reported operating profits equal to 21.4% of sales, compared to 15.4% at Sprint (FON ) and 11.8% at AT&T (T ), its two main competitors. If WorldCom's profits were in part bogus, that meant Sprint and AT&T were getting the wrong signals: They weren't doing as badly compared to WorldCom as it appeared.

Finally, companies that provide bad information to outsiders end up hurting themselves. Internal financial reports are supposed to help executives determine which parts of their company need improvement. But the accounting at companies like Enron and WorldCom hid rather than illuminated, and these troubled companies didn't make the changes they needed to survive. The result: two major bankruptcies, leading to economy-wide disruptions.

Nobody would seriously consider instituting a new class of felony consisting of "crimes against the economy." But the damage that these executives have done is measured in billions--and we are all going to pay.

By Michael J. Mandel

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