Republican Sweep Bad News for Business Credibility
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Holmes Report

Republican Sweep Bad News for Business Credibility

The Republican sweep of Tuesday’s elections was clearly a disappointment for Democrats, but it could be a disaster for big business, struggling to regain lost credibility in the wake of a wave of corporate scandals.

Paul Holmes

The Republican sweep of Tuesday’s elections was clearly a disappointment for Democrats, but it could be a disaster for big business, struggling to regain lost credibility in the wake of a wave of corporate scandals.

Most corporate leaders won’t see it that way, of course. After all, the Republicans are the party of big business, and the Bush administration is dominated by refugees from corporate America—including many companies tainted by scandal. So it’s not surprising that corporate lobbyists are already lining up to “take advantage” of what is expected to be a “business friendly” government.

But the quotation marks around those phrases are quite deliberate. Because this business friendly government could end up undermining investor confidence even further. And lobbyists who think they are taking advantage could end up shooting their corporate clients in the foot.

While it goes against the grain, corporate leaders should be calling for more regulation, rather than less; for closer scrutiny, rather than a return to the laissez-faire attitude of the past. Contrary to the thinking of many on Wall Street, the intense public skepticism about the integrity of corporate America and its advisors in the financial community is not going to go evaporate overnight. In reality, it’s likely to get a lot worse before its gets better, especially if business interests appear to be resisting reform.

And there’s plenty of evidence to suggest that in the current circumstances, Democrats are better placed to help corporate interests than Republicans.

It’s interesting to note that historically, the economy has always fared better under Democrats than Republicans. Since 1900, the S&P 500 has produced a 12.3 percent annual total return under Democratic presidents, compared to an 8 percent return under Republicans. In 2000, the Stock Trader's Almanac, which monitors and analyzes Wall Street performance figures, reported very similar numbers—13.4 percent versus 8.1 percent—when measuring appreciation of the Dow.

Control of the White House is not the only factor. A Democratic Senate showed returns of 10.5 percent (versus 9.4 percent for a GOP-controlled Senate), and a Democratic House returned 10.9 percent versus 8.1 percent for the Republicans.

And while the stock market is not the only measure of economic performance, others show the same bias: Since 1930 (the first year for which reliable data is available), GDP growth was 5.4 percent for Democratic presidents and 1.6 percent for Republicans.

There are several possible explanations for the market’s preference: the Democrats are more likely to spread the wealth around through public spending on education and healthcare, which may stimulate the economy more broadly, while the GOP is more likely to favor tax cuts for the wealthy or higher defense spending, focusing their largesse more narrowly. But the most persuasive explanation is that the Democrats favor tighter regulation.

Corporate chief executives hate regulation. But the reality is that regulation begets confidence, and confidence begets performance.

Writing in The New York Times is July, Thomas L. Friedman explained the value of a vigilant regulatory culture: “What really distinguishes American capitalism… is not that we don’t have CEO crooks but others do, or that we never have bogus accounting, bribery, corruption or other greedy excesses but others do…. What distinguishes America is our system’s ability to consistently expose, punish, regulate and ultimately reform those excesses—better than any other.”

Friedman praises what he calls the “alphabet soup of regulatory agencies,” the SEC, the FAA, the FDA, the EPA, the IRS, for their integrity, and the credibility they deliver to the industries they oversee. President Bush, on the other hand, loves to denigrate these same agencies. After the EPA issued a report in June linking the use of fossil fuels to global warming, he dismissed it by telling reporters he had “read the report put out by the bureaucracy.”

So it’s not surprising that agencies that have traditionally served a watchdog role were turned over to individuals with close ties to the businesses they were supposed to be monitoring. For example, when the Bush administration was looking for someone to head the Securities & Exchange Commission, the government agency entrusted with serving as Wall Street’s watchdog, he turned to a man whose last job was as the accounting industry’s most influential lobbyist, a man who had been working full-time to reduce oversight of the accounting industry, a man who believed the SEC should step back and allow financial services firms to police themselves.

While Harvey Pitt made some headlines by prosecuting executives from Enron, WorldCom and Adelphia, he showed little enthusiasm for reforming the system—a reflection of the administration’s view that the scandals resulted from a few bad apples, not a rotten barrel.

In June, meanwhile, the president nominated to the Commodities Future Trading Commission—the government agency that is supposed to be the watchdog over advanced “financial instruments” such as derivatives trading—two individuals who were responsible for drafting the regulations that let Enron run amok. Walter Lukken drafted a law passed in 2000 that gave Enron’s online trading arm the right to act without oversight, while Sharon Brown-Hruska helped create a regulatory exemption for Enron, and then resigned from the commission and joined the company’s board of directors.

But the most illuminating episode of recent months has to be the nomination of William Webster to head the new accounting oversight board. The accounting profession challenged the first candidate for the post, John Biggs of the investment plan TIAA-CREF, because it feared he would be “too aggressive.” (If that doesn’t strike you as odd, consider how you would feel if your town rejected a candidate for police chief because of fears that he would be too tough on crime.)

Webster, a former FBI chief and director of central intelligence, was then elected by a majority of he SEC commissioners despite the fact the he had led the audit committee of a company facing fraud accusations. Webster was on the board of a small publicly traded company, U.S. Technologies, which is nearly insolvent. He had told Pitt of his role there, but the now-former chairman of the SEC apparently did not consider it an obstacle to his appointment.

It’s no surprise, then, that under Pitt’s leadership, confidence in the SEC collapsed to an all-time low, according to a survey by RoperASW. Only 40 percent viewed the agency favorably—an 11 percentage-point drop from the last study, the sharpest in the history of the sale. The SEC now ranks last among 21 government agencies rated in the survey.

“The significant change in public attitude toward the SEC reflects concerns that the agency is understaffed, asleep at the switch or in bed with corporate insiders,” said Ed Keller, president and CEO of RoperASW. “Ordinary investors believe the agency helped companies reap huge profits at their expense.”

Some might take the resignation of the much-criticized Harvey Pitt—prompted in large part by his support of Webster—as a small victory, but it is unlikely to have any significant impact. There’s no reason to believe that Bush will replace Pitt with a zealous reformer who will advocate for tighter accounting regulations, or that the president will reverse course and give the SEC the full $750 million in funding proposed by Congress.

Indeed, the Bush team is likely to read—or persuade others to read—the sweeping Republican victory of November 5 as a mandate for its existing economic approach, which could best be characterized as extreme permissiveness.

If media reports are to be believed, financial services firms are already lining up to undermine efforts to restore integrity and credibility to the markets. A month ago, economist and New York Times columnist Paul Krugman reported that the mood among business lobbyists, according to a “jubilant” official at the Heritage Foundation, was one of “optimism, bordering on giddiness” at the thought that Republicans could control the White House and both chambers.

And The Washington Post reported on Friday—using a dazzling array of unidentified sources—that Wall Street now sees “a chance to put off reforms,” including the plan by New York attorney general Eliot Spitzer to create an independent research entity funded by brokerages but free from the influence of their investment banking businesses.

According to an executive at a large brokerage and banking firm, “My impression is that, with the election results and now with a new presumably less embattled SEC commissioner coming in, there is a desire among the firms to take a bit of a pause and examine exactly what it is we are agreeing to.” And in a speech to a securities industry trade conference, NASD chairman Robert Glauber expressed concern that reforms could be “unduly bureaucratic and impose “onerous” costs on the industry.

Many executives in the financial services sector—and corporate America in general—appear to be acting on the assumption that if they keep their heads down and continue to sell the fantasy that the recent scandals were the result of a “few bad apples,” then the media will lose interest in the story (especially if a war should conveniently come along) and the investing public will soon forget that it was defrauded out of billions of dollars.

That’s the kind of cynical attitude that got us into this mess in the first place, and it is undermined by a new survey from New York investor relations firm FD Morgen-Walke, which suggests the passage of the Sarbanes-Oxley Act in July has done little to ease concerns about the integrity of the market.

According to the survey of 240 portfolio managers and analysts, nearly three out of five (59 percent) say the situation has not changed during that period and 13 percent actually believe the crisis of confidence has worsened.

Nearly half of institutional investors (48 percent) say the Bush administration’s revised SEC budget will not be sufficient to support enforcement efforts, and more than three out of five investors (62 percent) do not regard William Webster as a good choice to serve as chairman of the new Public
Company Accounting Oversight Board. 

“Professional investors clearly do not believe that actions taken in Washington in response to corporate accounting scandals have yet improved the environment for investing,” said Gordon McCoun, senior managing director of FD Morgen-Walke. “This survey demonstrates that investors view enforcement as critical to restoring confidence in corporate America and the financial markets.”

Meanwhile, a poll conducted by Washington public affairs firm Widmeyer Communications found that executives in the financial services sector have replaced lawyers as the nation’s least trusted professionals. Asked which professionals they regarded as most trustworthy, 32 percent chose lawyers, 28 percent chose investment bankers and analysts, 20 percent chose accountants, and just 15 percent chose business executives.

“In all the time I’ve done polling, I can’t remember a time I’ve seen lawyers be perceived as more trustworthy than accountants,” says Marty McGough, vice president of research at Widmeyer. “This is really a clarion call to American business. If they want to rebuild trust in the institution, and faith in the economy, they need to develop a clear strategy for communicating positive and convincing messages to the public.”

Many financial executives appear to want a friend of the industry in the top spot at the SEC to counterbalance Spitzer. What they don’t seem to realize is that Pitt’s extreme disinterest in reform created the leadership vacuum into which Spitzer stepped. And if Wall Street firms oppose Spitzer’s independent research consortium, as some are now planning to do, there is little doubt he can find more suits to bring against them, dragging out the reputational damage over several quarters and providing a constant reminder of why investors should be skeptical of market advice.

If any group of people in corporate America ought to recognize this wishful thinking for the folly it is, it’s public relations professionals. In theory, at least, public relations professionals recognize the value of trust, and understand how it is earned: through the endorsement of credible third parties, including independent regulators. They understand that corporations can only gain credibility by surrendering some degree of control, however painful that might be.

They might point out what happens when stakeholders don’t trust the regulators who are supposedly looking out for their interests, it’s worth recapping recent events in Europe, including the health scare involving Coca-Cola products in Belgium three years ago, or the problems experience by Monsanto and food producers as they attempt to secure acceptance for genetically modified products. In both cases, the company could have avoided significant friction—and expense—had consumers trusted what regulators were telling them.

Public relations people might also point to companies that have recovered from crises—companies like Foodmaker (parent of the Jack in the Box restaurant chain) or oil giant Shell—not by fighting regulation, but by making a point of going further than regulations demand, by demonstrating that their commitment to the public interest is a strong as their commitment to quarterly profits.

Unfortunately, public relations professionals appear to have gone into hiding in reaction to the current crisis of confidence. It’s hard to escape the conclusion that the corporate agenda is being driven by accountants and lawyers, who tend to reject the idea of increased regulation reflexively. In too many companies, public relations people are not being invited to discussions about restoring corporate credibility, nor are they volunteering their counsel—especially if it conflicts with that of professionals who have more perceived authority.

Receiving a award from the Institute for Public Relations this week, Ketchum chairman David Drobis raised this very issue, asking the assembled audience: “Where have we been in the last 12 months of business turmoil as the lawyers, particularly, have taken over creating debacles out of Arthur Andersen, Enron, Martha Stewart, WorldCom? Why haven’t we worked to find a united voice to talk to the public and, frankly, help build public confidence? Isn’t it time we take some responsibility?”

According to Drobis, “We have an important role to play here. Because more than anyone in business today we have a total view of an organization, all of its publics, and how they interact…. Perhaps it is time for us to stick our necks out, to take some leadership.”

But the most powerful voices have leadership have come not from the public relations industry but from mainstream business journalists. 

“No one in business likes regulation,” Business Week writers Mike McNamee and Paula Dwyer acknowledged this week. “But investors are still awaiting proof that the seamy underside of the markets, so vividly exposed over the last year, has really been cleaned up.” The magazine’s editorial writers were even more forthright: “The administration should support a broad-based equity culture over the narrow and corrupt crony capitalism that has done so much harm. To do that, it should fully implement the reform measures passed in recent months.”

Robert Shiller, author of Irrational Exuberance, agrees. “In the long run, business people are better off if we have good strong regulations in place to prevent shenanigans from happening,” he says. “If people are getting upset, we need to take measures that have some teeth. The mood is souring; we need to do something.”

It’s time for public relations people to make the same case, however unpopular it might be, to their CEOs and to their clients.

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