Management helping itself, says Galbraith

"The notion that management has its own set of priorities including among other things compensation for itself" has only recently come to the surface, Galbraith said. This compensation often amounts to "rewards that verge on larceny," Galbraith added.

The Toronto Star
March 28, 2004

Management helping itself, says Galbraith
Economist's new book tells how investors, directors grew passive. Into vacuum stepped management to take undeserved reward.
Christine Richard

CAMBRIDGE, Mass. — For John Kenneth Galbraith — the renowned Keynesian economist who has chronicled the economic scene for decades — the current era may well be remembered for its frauds.

The author of The Affluent Society, The New Industrial State and The Great Crash has just completed his latest book — The Economics of Innocent Fraud — in which he argues that fraud extends far beyond the scandalous behaviour of executives at a handful of companies such as Enron Corp., WorldCom Inc., and Tyco International Ltd..

Galbraith highlights in his book — set for publication in April — a series of frauds, from deep-seated structural problems with management powers and acquiescent board members who rubberstamp management decisions to an ill-fated belief in the all-powerful Federal Reserve.

And it's clear that he has no time for those who pretend to know what the future may hold for financial markets.

Galbraith expanded on his book at his home in Cambridge, Mass. The large Victorian is filled with books and mementos of his years in public service, including a posting as ambassador to India. It's situated just off the Harvard University campus, where he taught for more than 50 years.

Despite an illness which has left him largely confined to a chair, Galbraith's eagerness to take on the "conventional wisdom" — a phrase he coined in the 1950s — appears undiminished.

"The idea of the passage of power from the investors and the board of directors to the management is something that I have been working on for quite some time," said Galbraith, who at 95 speaks in a commanding voice about the subjects that have absorbed him for the better part of a century.

"The notion that management has its own set of priorities including among other things compensation for itself" has only recently come to the surface, Galbraith said. This compensation often amounts to "rewards that verge on larceny," Galbraith added.

While some executives have been convicted of crimes, much fraud committed by management can be labeled "innocent" because there's no well-established system of law dealing with management abuse of that power, Galbraith said. And it's likely investors haven't seen the last of it.

"The fact that there's been in the last couple of years a breakout of quite widespread effect is an indication that this is not a matter of ethics, it's a matter of structure," Galbraith said. "The situation goes much more deeply into the locus of authority."

The importance of this power shift needs to be fully recognized by the public, which means giving up the misperception that executives put the company's interest first. Without this recognition, reforms will remain inadequate.

"There must be surveillance of the reputable enterprise and general attention to managerial self-reward," Galbraith writes in the book. "No one should suppose that supervisory participation by directors and shareholders is sufficient."

"Given a fee and some food, the directors are routinely informed by management on what has been decided or is already known," Galbraith writes.

Shareholders — the real owners of U.S. corporations — can't be relied on to push the reform agenda forward either, despite recent signs of increased shareholder activity, particularly on the part of the large public pension funds.

The investing public "gave up because the management and direction of the modern large corporation is a very complex and specialized task," Galbraith said. "Somebody holding the stock, reading the annual report and attending the stockholders meeting has no real relationship to what happens in a large company."

While conventional wisdom underestimates the power of corporate management, it overestimates the power of the Federal Reserve, Galbraith said. Its ability to control boom and bust cycles is a major misperception of our era — or, as Galbraith would call it, a fraud.

"If you are in the investment business, you need to have some structure of belief, and nothing serves that so well as the bogus impression of Federal Reserve authority and action," said Galbraith. Businesses borrow to expand not because interest rates are low, but because expectations for turning a profit on investment are high, he said.

He disputed the widely-held view that the Federal Reserve's 13 rate cuts since 2001 — the fed funds rate has been at 1 per cent since mid-last year — helped stave off deeper recession in the wake of the bursting of the market bubble.

Falling interest rates have had a positive effect on the housing sector, but the impact on the broad economy is overstated. "You get a somewhat excited account of the possibilities (of Fed action) in the more vulnerable business journals," Galbraith said.

"The power of the Federal Reserve and the power of Alan Greenspan derives from the pleasure people have in thinking that because they understand the process and can speak of it, it must be important."

He also warns investors against heeding analysts' and economists' forecasts.
There's the well-known issue of conflict of interest to be considered, with financial advisers too often promoting firms in which they have an economic stake. But there's also the fraud of pretending it's possible to know the future.

"No one can tell with validity (the direction of the economy) — given the numerous factors that influence business conditions and different industries and given the number of things which cannot be predicted," Galbraith said. "All merge together in dictating and settling the investment prospects."

So, investors might do just as well to tune out Wall Street's many sibyls?

"One of the inescapeable features of financial markets is the enormous area of action responding basically to ignorance, to what nobody can for sure can know," he said.


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