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"I didn't know" and "I was only doing my job": Has corporate governance careened out of control? A case study of Enron's information myopia
John Alan Cohan. Journal of Business Ethics. Dordrecht: Oct 2002. Vol. 40, Iss. 3; Part 2. pg. 275, 25 pgs
Abstract (Summary)

This paper discusses internal dynamics of the firm that contribute to the failure of knowledge conditions, using the Enron scandal as a case study. Imposing liability on directors for failure of oversight is extremely difficult to sustain in a court of law. Directors are likely to face much greater demands of accountability in the wake of Enron. Solutions to enhance flow of information include: 1. programs to encourage employees to expose wrongdoing without fear of retribution, 2. devising of communication system that enables important information to move upward to the proper decision-maker without getting distorted, 3. restructuring of audit committees, 4. providing adequate training for new directors, and 5. expanding the number of independent directors on the board. In the wake of Enron, corporations may simply have no choice but to meet increased demands by workers, shareholders, customers and the government for greater accountability. Appendix to the paper discusses the history of the corporation, moral dilemmas of the shareholder-centric model, and whether important social goods sometimes trump the notion of profit-maximization.

Full Text (17155  words)
Copyright Kluwer Academic Publishers Oct 2002

ABSTRACT. This paper discusses internal dynamics of the firm that contribute to the failure of knowledge conditions, using the Enron scandal as a case study. Ability of the board to effectively monitor conduct at operational levels includes various dynamics: senior management being isolated from those at operational levels; individuals pursuing subgoals that are contrary to overall corporate goals; information flow along a narrow linear channel that effectively forecloses adverse information from getting to senior management; a corporate culture of intimidation, discouraging open expressions of doubt or skepticism, resulting in reluctance to challenge senior officials, and pushing the limits of ethics and the law.

Elements of information blockage in the corporation include: the "law of diminishing control"; deliberate concealment of information by officers; motivation to report to the boss what one perceives the boss wants to hear; theory of "bounded rationality" that explains surprising role of irrationality in decisionmaking - unconscious emotions and motivations. Discussion of behavioralist studies of cognitive dissonance, belief perseverance, confirmatory bias,

entity effect, motivated reasoning, group cohesion or "groupthink," and the false consensus effect. Problem of overoptimism - tendency of many people to overrate their own abilities, contributions and talents - and tendency toward puffery and dismissal of risks in formulating disclosures and press releases.
Imposing liability on directors for failure of oversight is extremely difficult to sustain in a court of law. Directors are likely to face much greater demands of accountability in the wake of Enron. Solutions to enhance flow of information include programs to encourage employees to expose wrongdoing without fear of retribution; devising of communication system that enables important information to move upward to the proper decisionmaker without getting distorted; restructuring of audit committees, providing adequate training for new directors, expanding the number of independent directors on the board. In the wake of Enron, corporations may simply have no choice but to meet increased demands by workers, shareholders, customers and the government for greater accountability.

Appendix to paper discusses the history of the corporation, moral dilemmas of the shareholder-centric model, and whether important social goods sometimes trump the notion of profit-maximization.


We can understand the dissemination of information within a corporation only if we can understand the realities of behavior within. The focus of this paper will be on the internal dynamics of the corporation. I will address selected issues involving the failure of knowledge conditions that arose from the Enron implosion. The Enron scandal brought to light a recurring communication dysfunction within the organizational structure of the corporation itself. How does a corporation behave internally? Where does corporate accountability break down? Why is there a failure of knowledge conditions? What makes up a corporate culture of intimidation? What dynamics operate to lead individuals and units to pursue subgoals that are contrary to overall corporate goals?

In the past various scandals and business conspiracies have failed to uncover evidence of involvement by the senior management.1 What goes on in board rooms remains one of the best kept secrets of corporate America. The theme of "directors who do not direct" has received extensive commentary over the years.2 One theme is that the board is so isolated from managers at operational levels that it cannot effectively monitor or control the conduct of managers.3 That appears to be due to the decentralized nature of the corporate structure itself, the hierarchical chain of command that requires information to travel along a narrow linear channel, and a technical orientation of those at operational levels that makes them impervious to risky behavior.4 At times subordinates who may want to "blow the whistle" may be thwarted by an intimidating corporate culture, or simply because of the hierarchical structure that effectively forecloses adverse information from getting to senior management.5 In addition, the norm in large American corporations is to have multiple and autonomous divisions, each self-contained and headed by a divisional chief with full operational authority, thus fostering decisionmaking that is decentralized and prone to subgoals. It is as if there are several independent corporations within the larger structure.

What happened at Enron?

How it is that Enron's directors failed to provide enough oversight to prevent the company's collapse, and the loss of billions of dollars of investors' money? An Enron executive, Sherron S. Watkins, told the House Energy and Commerce Committee that she believed Enron's former chairman, Kenneth L. Lay, was largely unaware of the severity of the company's troubles, that he "did not understand the gravity of the situation. . . "6 She submitted an anonymous memorandum detailing her revelations to Mr. Lay, and later met with him personally to discuss it.7 She said that even after she personally explained to him that the company appeared to have questionable accounting practices that hid huge losses, Mr. Lay still "didn't get it."8 Enron's former chief executive, Jeffrey K. Skilling portrayed himself as ignorant of the company's questionable practices in testimony before the same House committee.9 He said, "This was a very large corporation. It would be impossible to know everything going on."10 The practices under scrutiny were partnerships which investigators say were used to conceal debt and unprofitable investments from Enron's shareholders.11

Top Enron officials told employees that the company's stock price would continue rising at the same time other officials were raising serious questions about the stability of the company's finances.12 The optimism of the company's chairman, Mr. Lay, occurred even while Ms. Watkins, who was a senior Enron employee, explicitly warned him that several years of improper accounting practices threatened to bring down the company.13 This suggests that Mr. Lay was on notice about the company's accounting problems even while he was assuring employees and the investment public that Enron's stock would rebound. According to an economist at Enron Energy Services, "It was important for employees to believe the hype just as it was important for analysts and investors to believe it."14 Some in Congress claim that Wall Street analysts should have seen red flags as early as two years before Enron's implosion, based upon a string of warning signs in Enron's public securities filings.15 Instead, most analysts still rated Enron as a "buy" or "strong buy" on November 8, 2001, the same day Enron acknowledged it had overstated profits by almost $600 million.16 The problem may be that analysts who question the value of a popular company are branded as controversial, and "[i]f you want to move up the hierarchy of the Wall Street establishment, you don't rock the boat."17

Jeffrey McMahon, Enron's new president, told a congressional committee that Enron had a corporate climate in which anyone who tried to challenge questionable practices of Enron's former chief financial officer, Andrew S. Fastow, faced the prospect of being reassigned or losing a bonus.18 Ms. Watkins described a culture of intimidation in which there was widespread knowledge of the company's tenuous finances, but no one felt confident enough to confront Mr. Skilling or other senior officials, about it.19 Ms. Watkins was alarmed at the information she was receiving about Enron's manipulation of income, but was not comfortable confronting either Mr. Skilling or Mr. Fastow with her concerns. "To do so, I believe, would have been a job-terminating move. Frankly, I thought it would be fruitless, that nothing would happen. . . ."20 Ms. Watkins said she believed that Mr. Skilling and Mr. Fastow "did dupe Ken Lay and the board."21

Two trustees of Enron's 401(k) plan told Congress that they did little to protect employees in the plan as the company's stock plummeted to less than $1 a share from more than $90.(22) One trustee, Cindy Olson, disclosed that despite her knowledge of a memorandum that warned Mr. Lay that Enron could implode because of accounting irregularities, she did nothing to warn plan participants about the possible accounting problems and the damage they could do to Enron's share price. She said she did not warn anybody because she thought the assessment might be untrue.23

Further, Enron's board was faulted for failing to ask pertinent questions or to get involved in "any meaningful examination of the nature or terms of the dubious partnership transactions that moved debt off the company's sheet.24 And even when the board did ask questions, they were not given the right answers.25 By failing to delve more deeply, the board appears to have missed the opportunity to uncover fundamental flaws in the company's accounting practices.

William C. Powers, who became the chairman of a special committee on Enron's board that issued a report about Enron's shaky transactions that inflated its reported earnings, told a House committee that his inquiry had uncovered "a systematic and pervasive attempt by Enron's management to misrepresent the company's financial condition."26 The report concluded that numerous related-party transactions and accounting errors were the result of failures at many levels and by many people in the company. The report blamed numerous factors for these failings: "A flawed idea, self-enrichment by employees, inadequately designed controls, poor implementation, inattentive oversight, simple and not-so-simple accounting mistakes, and overreaching in a culture that appears to have encouraged pushing the limits."27

Enron is widely reputed to have had a "gogo" culture, in which senior officials cast aside traditional business controls.28 The corporate culture was such that top officers were unaware of financial details, and cast a relaxed attitude about conflicts of interest of executives.29 Joseph F Beradino, chief executive of Arthur Andersen, the former Enron auditor, testified that important information about Enron's finances had been withheld from his firm.30

Commentators are concerned that other bombs like Enron's may be ticking.31 The possibility exists that ignorance streams such as these are not confined to a small range of cases, but that the modern American corporation harbors millions of individuals who operate in a state of communication myopia throughout their careers.

Overview of the board's oversight function and the business judgment rule

The failure of oversight by Enron's directors, many of whom were financially sophisticated, leaves one wondering what the purpose of a board is. Corporate law generally provides that the board of directors is responsible for managing the corporation, a function that is viewed as one of oversight.32 In carrying out their oversight responsibilities, directors owe fiduciary duties, including the duties of care and loyalty, to the corporation. As discussed in the Appendix, there is a tendentious divergence of opinion as to precisely what stakeholders are entitled to be beneficiaries of the board's fiduciary duties. But generally, officers and directors are expected to perform their duties "in good faith and with that degree of care that an ordinary prudent person in a like position would use under similar circumstances."33

The business judgment rule generally governs judicial interpretations of director decisions, and is an evidentiary presumption that directors, in making business decisions, act on an informed basis, in good faith and in the honest belief that their actions are in the best interest of the company.34 The business judgment rule requires directors to oversee the corporation only insofar as they should make inquiries where "suspicions are aroused, or should be aroused" by the existence of "red flags."35 In a leading case addressing the board's oversight responsibilities, the Delaware Supreme Court rejected a claim by shareholders that the board has an affirmative duty to install an internal system of monitoring, saying

it appears that directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on suspicion that something is wrong. If such occurs and goes unheeded, then liability of the directors might well follow, but absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.36

The standard of a board's oversight duty was expounded upon in In re Caremark International Inc. Derivative Litigation,37 involving the question of whether the directors breached their fiduciary duty of care by failing to monitor activities of the company's employees regarding corrective measures that may have prevented certain unlawful conduct. In discussing the liability of "inattentiveness" the court said that a director's obligation

includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards.38

Significantly, the court further noted that:

only a sustained or systematic failure of the board to exercise oversight - such as an utter failure to attempt to assure a reasonable information and reporting system exists - will establish the lack of good faith that is a necessary condition for liability.39

The court added that

absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf.40

Thus, imposing liability on directors for failure of oversight is extremely difficult to sustain in a court of law unless there is evidence tatamount to total abdication of responsibilities.41

In the wake of Enron, boards may scramble to review just how they go about monitoring in the corporate hierarchy. The right degree of monitoring can to some extent help workers know that violations of the law or of corporate policies will be detected and punished. But excessive monitoring of workers creates an atmosphere of distrust.42 Excessive monitoring gives the impression that people in the company cannot interact on an assumption of good faith, and this can backfire by eroding the level of commitment of workers throughout the company, and by shifting time and attention from doing "real work" to managing the impressions of the monitor. "[P]eople do not like to be monitored. They may well mistake monitoring and questioning for distrust. . . .."43 Another cost of distrust is that people are less healthy and less happy44

Elements that constitute information blockage in the corporation

Information blockage is a pervasive problem within large corporations.45 Enron is hardly the first company to have come under fire for holding back adverse financial news from the public until the last possible moment, leading to a rapid plunge in its stock price once the adverse information hit the news, followed by lawsuits from unhappy investors based on material misrepresentations by officers who kept an optimistic public face. Scores of cases decided by the courts each year under the antifraud provision of the SEC's regulations, Rule 10b-5,(46) fall into this category.47 The tendency to report information selectively, emphasizing the positive while omitting the negative, is characteristic of all bureaucratic organizations, from the Army to the Red Cross. The SEC and congressional reports have chronicled this alarming situation, dating back many years, in such corporate collapses as Penn Central and Stirling Homex.48 One commentator remarked that the board "was always the last group to hear of trouble in the great business catastrophes of the century."49 One economist put the problem this way: "[T]he larger and more authoritarian the organization, the better the chance that its top decision-makers will be operating in purely imaginary worlds."50

Information blockage can occur by deliberate concealment of information by officers to other board members, by the chief executive officer to the public, even in the face of direct inquiries by the press, by attorneys in rendering opinions to the board on sensitive transactions, and by outside accountants who may tolerate the falsification of corporate books and records without a fuss.51

The hallmarks of a successful company include flexibility and the ability to act and react quickly, but these are thwarted to the extent that information is blocked from the board.52 Supervisory executives, given they are a step or two removed from the nuts and bolts of a project, have a compromised ability to monitor the situation if they get no more than distorted information and have no alternative sources of data to examine.

Sociologist Robert Jackall describes the typical bureaucratic corporate structure this way:

Power is concentrated at the top in the person of the chief executive officer (CEO) and is simultaneously decentralized; that is, responsibility for decisions and profits is pushed as far down the organizational line as possible.

. . . [Pushing details down protects the privilege of authority to declare that a mistake has been made .... Moreover, pushing down details relieves superiors of the burden of too much knowledge, particularly guilty knowledge.

. . . .

. . .[Middle managers] become the "point men" of a given strategy and the potential "fall guys" when things go wrong.53

In many instances of corporate misdeeds the misconduct apparently occurs at a level well below that of senior management.54 Senior executives may often enough discover, albeit much to late, that the truth is indeed quite different from what they had been led to believe. With Enron, adverse information may not have reached the board until the crisis became unavoidable.

A common phenomenon known as the "law of diminishing control," states: "The larger any organization becomes, the weaker is the control over its actions exercised by those at the top."55 That is why so many boards have limited impact in most forms of corporate decisionmaking. "Boards do not set policy, do not veto management, seldom intervene short of a major crisis, and do not even select their own successors or the next chief executive officer."56

The board of Enron, along with other modern corporations, appears to be analogous to the seventeenth century monarch - holding absolute power in theory, but cut off from access to information and thereby manipulated by the ministers who are its nominal servants. Occasionally, the board may erupt into forceful action, but in the long run its domination by its ministers seems inevitable.57

Blockage of information occurs in a variety of ways. For instance, in a hierarchical structure it is often the duty of middle managers to discern between the important and unimportant findings, and to limit the upward flow of information to relevant and unusual information.58 This deliberate filtering of information is compounded by a frustrating feature of human nature whereby messages simply get changed passing from one supervisor to the next in a hierarchy, with only a very diluted message ever reaching the top through regular lines of communication.59

It is probably safe to assume that most people prefer to be known as trustworthy rather than as untrustworthy, even if they are not. Collectively, managers have a natural incentive toward candor.60 The reputations of a company's executives are usually closely aligned with the ongoing interests of the firm as reflected in not only its share price, but in the firm's reputation for truthfulness. Concealment usually only delays the apprehension of the truth rather than permanently putting it out of public view, given the layers of outside scrutiny from professional analysts, accountants and lawyers. To have a reputation for trustworthiness means that people are likely to place their trust in you. Trusted managers in an organization are more easily able to persuade others to accept their decisions, and cooperation is facilitated if workers are able to readily accept the decisions of managers.61 Thus, given the obvious damage to one's reputation, to the trust reposed in people by the company, as well as legal consequences, it is puzzling why employees in the firm would deliberately conceal the truth.

Motivations to lie or deliberately conceal the truth in an organization

Corporate officers receive information from multiple, and sometimes conflicting, sources, that may well undergo distortion in transmission. With Enron, the "lies" came in a variety of forms. There was misrepresentation of hard data, that is, concealment of debt, lying about accounting results, as well as about the stream of earnings, and distortion of the company's future prospects.

For some, the motivation to lie is that disclosure of the truth may put the company into bankruptcy, with attendant group firings, and the loss of one's own job. There is also an emotional attachment to one's involvement in a project that motivates one to hold off transmitting information if it would flagrantly signal danger to the firm. Concealment can also buy time, as there is always the hope of some reversal of fortune after initial setbacks. Adverse situations are usually open-ended; that is, poor performance seldom can be established conclusively, and a turnaround is always possible. And one may just want to hold on to one's salary and perquisites for as long as possible. This can go on until a catastrophe presents an overwhelming case that requires the company to acknowledge that wrong decisions were made.

Disclosure of adverse information can be embarrassing to executives, leading to a drop in management morale. Also, disclosing a mistake means that one will have to "backpedal," which calls into question one's reputation for consistency, a highly valued asset in business organizations.62 Bad news can also affect overall optimism among workers as a whole and threaten continued external support from suppliers, customers, etc.63

A further motivation is that the promotion and termination protocols commonly found in corporations make it tempting to transmit information in a way that minimizes the potential for blaming oneself for bad news, and to convey as much good news as possible - consistent, of course, with a general desire to maintain a reputation for credibility with senior management. This was precisely what Sherron Watkins alluded to in telling a congressional committee that confronting senior management with her concerns "would have been a job-terminating move."64 Distortion or concealment can become a dominant strategy regardless of explicit injunctions of senior management to "give me accurate information," if workers fear the possibility of being fired or deadended in light of a candid portrayal of a situation.

Thus, subordinate managers have a pervasive interest in concealing bad news, and are tempted to vary the message to conform to their selfinterest.65 Doing so avoids or delays both personal embarrassment and the associated risk of being terminated, and the unpleasant and wealth-- reducing likelihood of a stock price drop. Some counterbalancing incentive to report bad news may be the need to foster an ongoing corporate reputation for credibility with outside suppliers, customers and lenders. But human nature - often in the form of self-deception - provides ample reason to believe that managers will often enough try to sweep the bad news under the rug, or give it an unrealistically positive spin.

There is also the motivation to report to the boss what one perceives the boss wants to hear.66 This is complicated by the fact that junior managers on the executive track moving from one role to another every couple of years, feel pressed to accentuate the positive and distort bad news or at least defer bad news that might tarnish one's chances for promotion until one has moved on to a higher position, thus leaving the problem for one's successor.

Based on the foregoing motivations, individual executives in Enron who made the decisions to hide the company's debts in dubious partnerships and through other means, feared an erosion of status within the organization if the company's expectations to increase income could not be delivered. Like most successful executives, they had a rather high regard for their abilities, and were unconsciously protective of both self- and external-image. In addition, officials who engage in misconduct may think they are doing so to benefit, not to injure, the corporation, because the results will, in theory at least, help maximize the company's profits.67

Information flow in a corporate hierarchy

Apart from lying and deliberate concealment, there are different features that contribute to a myopic information flow in an organization. First, people usually only have a small amount of data available to them in most situations - far short of that necessary to make inferences that meet anything resembling well-grounded empiricism. Thus, everybody must go about one's business on the basis of insufficient information. Through a variety of shortcuts, the mind fills in the gaps.

Further, we all have limited cognitive capacities, so that even when people have abundant data, they might not be able to assimilate it because the mind lacks the capacity to process all that is available. Busy executives deal with information overload by processing the information, that is, by sifting through data and extracting what seems relevant.68 Given the finite time and mental capacity with which we live, people tend to adopt simplifying strategies such as reducing the number of factors considered or simply seeking some minimal threshold of satisfaction with a choice, foregoing any more careful consideration of it or other possibilities.

Second, many companies are informationbased, such as finance, software, media, health care, and other companies. Information in these companies is based on individual skills, insights, knowledge, and talent. Production in information-based firms does not proceed in linear, assembly line fashion - but interactively, with the creative input of individuals at a number of levels. For instance, with scientists working on a satellite, the creative flow of information is multidirectional, going from the development team to the software writer to an engineering committee, and then back again for refinement and perfection. Members of the production process must have sufficient understanding of the others' jobs in order to be able to communicate with them, to provide feedback, and to help refine the product. It's like the various members of a symphony orchestra, each one having specialized tasks but nonetheless needing to have some understanding of how one's colleagues' instruments work and interplay with their own sounds; and they must closely coordinate their work in order to make the whole piece come out right. The various members of a surgical team all have different specialized tasks, but each must have some understanding, even expert understanding, of the other members' functions.

Third, in large companies with numerous decentralized divisions, some economists have pointed out a kind of corporate schizophrenia called "subgoal pursuit,"69 by which managers at lower levels have a bias for the expansion and growth of their own division, and will therefore, tend to maximize the interests and autonomy of their own unit rather than the company's welfare as a whole.70 There may be a lack of congruence between the interests of the corporation and the career aspirations of executives in the corporate divisions. From this perspective, the problem of information blockage is not a technical failure but is instead part of a deliberate and predictable strategy rationally employed by lower echelons to protect their own interests from both senior management and the board alike. When subgoal pursuits are at risk, there is a motivation to "decouple" topmost management from crucial information.

Irrationality and cognitive biases in corporate governance: the formation and persistence of initial beliefs

Corporate governance operates on the premise that workers are autonomous and rational beings. But legal and economics scholars now acknowledge that the neoclassical assumption of rationality often fails as a descriptive model of economic actors and their behavior. In other words, individuals are not rational all of the time. Innumerable studies by behavioralists show that human beings display a remarkable ineptitude for understanding causal relations and probability.71

Members of boards are human beings and, as such, they are unlike the classical economic actor who "can perfectly process available information about alternative courses of action, and can rank possible outcomes in order of expected utility."72

Irrationality plays a surprisingly important role in human decisionmaking. By "irrationality" I mean such things as unconscious emotions and motivations. In many ways our lives are governed and even sustained by unknown, and sometimes unknowable, motivations and feelings. Maternal love, friendship, romance, artistic creativity, faith in an afterlife, and heroic greatness are examples of the life-affirming power of the irrational in our lives. We recognize in our own behavior, something essentially absurd in irrational acts, for which no explanation can be given. People failing to abide by the rules of logic is something behavioralists claim is a consistent and persistent human trait.73 In other words, irrational tendencies in human cognition are systematic and predictable.74

Psychoanalysis takes seriously the important place unconscious motivations and feelings have in human conduct, and suggests that irrationality is at the center rather than the periphery of human experience. Today, cognitive psychologists claim that perception as well as mental processes such as memory, judgment, and attention take place below the level of conscious awareness -- and includes instincts, emotions, fantasies, desires, and conflicts. The behavioral economist Herbert Simon once observed that "we cannot, of course, rule out the possibility that the unconscious is a better decision-maker than the conscious."75

Neuroscientists also claim that much of what happens in the brain goes on outside of conscious awareness.76 Neuroscientists who have studied unconscious processing of information claim that most decisions are made subconsciously, with many gradations of awareness.77 These findings, which are gaining wide acceptance, challenge the notion that people always make conscious choices about what they want and how to obtain it.

Cognitive psychology has developed the concept of bounded rationality, now popular in the economic literature, to help explain irrational behavior.78 The theory of bounded rationality identifies systematic, and somewhat predictable, deviations from rational and somewhat predictable, deviations from rational behavior. The theory focuses on cognitive biases, heuristics, and limitations that lead individuals to depart from outcomes otherwise predicted by the neoclassical rational choice model.

Behavioralists have extensively studied and documented several kinds of cognitive phenomena that demonstrate how we form initial beliefs or hypotheses outside of rational or logical norms, and how we then maintain a bias for the persistence of these beliefs even when we are confronted with thoroughly discrediting evidence. An examination of these cognitive biases is helpful to understand how individuals in a corporate hierarchy are susceptible to irrational decisionmaking in processing, giving or receiving information to and from others in the organization.

We start from the premise that managers become committed to a company's agreed upon course, and they cannot easily step away from it, even if signs of trouble become prounounced. There is likely to be distortion in the flow of information if various cognitive biases are in operation, and hence, fewer danger signs will be reported up the hierarchy as "relevant," while those who do report danger signs to senior managers will tend to give negative information a positive spin. Should serious problems arise, there is a high degree of commitment to support the prevailing beliefs, that is, a strong motivation to preserve the status quo.

In general, the various kinds of bias are based on the longstanding theory of cognitive dissonance, holding that the human mind has an innate drive to maintain consistency between its preexisting attitudes and the information it receives.79 Behavioralists say that cognitive dissonance is the tendency to reject or downplay information that contradicts other, more favorable views, about oneself or one's state of affairs. This explains why executives are often overoptimistic. (See discussion below.) With cognitive dissonance, the mind filters out tmuch information that is inconsistent with one's prior attitudes. Hence, people unconsciously focus on and relay only the information that reinforces their preexisting attitudes, and filter out conflicting information.

For instance, once a project is set into motion, there is a heavy commitment for the project to succedd. Those invlved with it recognize the reality that the project can still be killed. Once a commitment is made to a particular course of action, adverse information that arises subsequently is unlikely to be evaluated with the same objectivity as it would for managers assessin ga proposal to which they have no prior commitment. Cognitive dissonance suggests that managers will systematically underestimate external threats to their projects. Those who receive risk-related information may sense the need to give it a positive spin or to use other defense mechanisms. After all, it is still early in the project, so that any risks shown by early data may be speculative and thus can be discounted.

Revising plans based on discomfirming information can be both bothersome and anxietyprovoking. Bias induces people to simply ignore information pertaining to risks that seem to be remote or highly contingent. Only a fairly vivid or flagrant threat will be sufficient to prompt revision. A manageable and stress free way to handle information that might contradict decisions that have already been set into motion is to rationalize it away or ignore it, simply not report it and forget about it, or communicate it upward in a way that sanitizes it.80 It thus becomes easy to preserve an aura of optimism. Senior management is then unlikely to sense serious cause for concern. "Troubling bits of information are subject to dismissal or rationalization, without much conscious deliberation. . . ."81

Cognitive dissonance manifests in various types of bias that impact the flow of information in corporate hierarchies:

1. One cognitive phenomenon is called confirmatory bias, which involves misreading of evidence that contradicts one's initial beliefs.82 The strategy is to construe information and events in such a way as to confirm prior attitudes, beliefs, and impressions.83 People will tend to reduce the complexity of evidence by focusing on the portion of evidence that supports one's initial belief, and when faced with disconfirming evidence, formulate "alternative interpretations" to help explain away the evidence.84 This is exacerbated if the evidence is ambiguous or complex. Confirmatory bias also involves the tendency to exaggerate or imagine a correlation when doing so confirms one's belief that such a correlation "should" exist, and to underestimate a correlation that might go against one's belief.85 That is, people often perceive correlations between variables based on their preconceived biases.

Confirmatory bias helps bolster one's chosen course of action by construing information in such a way as to confirm one's beliefs and impressions, resisting taking in disconforming information, at least subconsciously. This may help explain why Enron's lawyers failed to rule any feathers in their investigation of the claims of accounting abuses voiced by Sharron S. Watkins.86 People who commit to a company's course of action, such as lawyers, may find it difficult to appreciate evidence of client wrongdoing, making them less than fully competent gatekeepers.87

2. Another cognitive phenomenon is called belief perseverance, which is the tendency of people to construct "theories" to account for events or circumstances, and then to disregard evidence that contradicts their first impressions.88 Belief perseverance tends to cause managers to misperceive events and risks, inducing them in their good faith to perpetuate an unrealistic set of beliefs.89 In doing so people may have a kind of bias against revision, relying, somewhat unconsciously, on stock understandings and preconceived beliefs about people and situations.

There is a significant tenacity in belief perseverance: "[I]nitial beliefs may persevere in the face of a subsequent invalidation of the evidence on which they are based," even when the initial evidence is itself weak and inconclusive.90

3. Another cognitive phenomena is called the entity effect, whereby peoples' hypotheses often take on a life of their own, so that people will continue to believe something they initially held to be true even after it is thoroughly and completely discredited.91

4. Another phenomenon is called motivated reasoning, which refers to the tendency of people to utilize a biased set of cognitive strategies to arrive at a belief they privately already desired to obtain.92 People in organizations often need to make decisions about the future in a context that is ambiguous is highly stressful, and to reduce the anxiety, people unconsciously impose an order on their environment, a set of causal explanations that lead to an artificial, but a more comfortable sense of predictability.93 This tendency influences how people evaluate evidence, to wit, by picking and choosing from evidence so as to make it fit into one's preconceived hypothesis. One commentator states that "the practice of motivated reasoning appears to be a universal and, perhaps, immutable characteristic of human nature."94

5. Another cognitive phenomenon involves group cohesion. Once a group commits to an idea or a course of action, there is a strong motivation to resist evidence that it was the wrong move. This group cohesion phenomenon functions as a stress reduction mechanism, and has been dubbed "groupthink."95 The possibility of a mistake means that the group will have to reverse its position. Members risk exclusion from the group if they introduce stressful dissonant information into the group setting.96 Thus, groups tend to edit out negative information in order to maintain cohesion. "This, in turn, leads to the suppression of information and ideas and cognitive conformity. . . ."97 Ambiguous information tends to be dismissed as unmanageable.98 The group cohesion tendency works so that if one member brings up some information that suggests that the group has failed to consider something troubling, a certain sense of stress arises, and members tend to dismiss or rationalize away the danger signals.99 Each member of the group tends to have a strong bias toward the status quo, and will subconsciously seek to rationalize away or dismiss any dissonant information, only bringing it to the group's attention if it is difficult or impossible to avoid.100 This not only aids in reducing stress, but also helps increase the group's focus, concentration and persistence. It also increases a sense of group confidence and trust among members.

In addition, promotion patterns place a premium on "team players" - those able to conform their attitudes to the immediate needs of the team, typically as articulated by senior managers - and as a result the organization develops a collective egocentric bias.

6. In boards there may also be a tendency for people to engage in what psychologists call the false consensus effect, a tendency to think that others share one's own attitudes, beliefs and inferences."' The false consensus effect distorts decisionmaking because believing that others are in alignment with you creates the hazard of acting on the false premise that others will agree in advance with your choices. The false consensus effect manifests, often enough, by one person holding back information because of the misperception that other people on the board, for instance, are "on the same page," when in fact they might not be.

These various types of cognitive bias show that attitudes and beliefs do not change easily, and indeed can persist even though not justified by probative evidence. From the board's perspective, cognitive bias may easily manifest itself by holding onto and promoting originally formed beliefs so that adverse bits of information are, first of all, slow to come in, and second, that the information may be rationalized away and forgotten, however sanitized it may be at that point.

Even less committed outsiders, such as lawyers and accountants, may find it difficult to introduce any dissonant information that would threaten a company's status quo because they, too, can be susceptible to cognitive biases. A lawyer who authorizes certain dubious partnership transactions becomes committed to a certain scheme from that point on.

Overconfidence and overoptimism in the firm

As we have seen, much of what people believe is based on insufficient empirical data, and often is inaccurate. Their level of confidence in those beliefs is often enough based on irrational cognitive processes. Many people, in other words, confidently hold beliefs that are illusions or myths. Confidence and optimism are closely related, and both are viewed as genetically favored in behavioral studies in economics,102 and in biology.103 The reason is simple. Doubt and uncertainty produce inaction, while confidence is associated with initiative and persistence. Confidence is energizing, and lack of confidence debilitating. If I strongly believe that I understand what is going on, I can feel more confident in my prediction about where things will end up. In group settings the opinions of those who display confidence will often be deferred to by others.104

An excessively optimistic "face" of the firm appears to have become the norm in external press releases of American corporations.105 Corporate press releases tend to be in a style that creates a strong image of confidence and control, and this prescription creates a certain pressure on firms surrounding corporate publicity.106 Failure to comply with the norms surrounding the public's expectation of press releases may result in the tainting of the organization's image and the hampering of the flow of support from public markets. Thus, any company that is not careful to adhere to this norm and instead is entirely candid risks signaling weakness, setting off negative reactions, disengagement of relationships, rumors, and reputational loss.

Enron appears to have a generic story in common with Apple Computer,107 TimeWarner,"108 Polaroid,109 and other cases in which shareholders relied upon statements of "false optimism," only later to claim that these statements constituted fraud. In most of these cases, the board undertook a course of action with respect to some product or strategy and was later faulted for concealing some bits of adverse information later found to be material.

Optimism is an important feature for success. The most successful person, on average, tends not to be the realist, but rather the optimist.110 Part of the leadership role of a senior executive is to communicate confidence and optimism about the company. Optimism is attractive to others, enhancing the ability to influence and persuade. Optimism is probably a virtue insofar as it functions as an energy source in a business. Optimism is important for business leaders, because decisiveness and aggressiveness are considered indicators of a successful manager.

A proper dose of optimism and confidence are not only good internal motivators, but they also influence others. Exhibitions of confidence and optimism make people more persuasive and influential. Managers who are optimistic can help motivate workers, and create the expectation of future growth and profitability that leads individuals to invest their human capital in the firm more willingly and to defer present consumption in favor of future rewards. Firms with "can-do" cultures generate higher levels of internal effort and, by projecting self-confidence, can be more successful in attracting external resources.111 "High levels of optimism and confidence are not only good internal motivators, but they can also influence others; exhibitions of confidence and optimism make people more persuasive and influential."112 The risk of failure is reduced if managers project a strong sense of optimism about the long-term growth of the company.

On the other hand, many studies show that people develop higher levels of confidence in the accuracy of their beliefs than is warranted by the facts. This is the famous "overconfidence effect,"113 observed especially among American males. Asked to estimate their confidence in the accuracy of their judgments, people usually estimate too high. The tendency towards distorting reality by overconfidence and overoptimism are commonplace among skilled, professional people.114 People want to see themselves as good and reasonable, and they may rationalize facts to bolster or maintain a positive self-image, or subconsciously distort evidence.115 "One tells stories to oneself that inflate feelings of efficacy and control, establishing a sense of identity less susceptible to the threats of the everyday world. That is why egos are so prickly, people so averse to criticism."16 People will often tend to buffer anxiety by maintaining an illusion of normalcy, that is, by interpreting new data as consistent with the status quo rather than seeing red flags that suggest danger.117 This strategy helps people feel that their world is more "understandable, predictable and controllable than it really is."118

Behavioralists refer to the term illusion of control119 as the human tendency to "treat chance events as if they involve skill and hence, are controllable."120 Even when confidence is illusory or irrational, it has an action-guiding function. A story from World War II told by Albert Szent-Gyorti captures this perfectly.121 A platoon of soldiers got lost in the Alps. They became gripped with fear and despair, and they did little until an officer found a map. They then felt energized, rallied around the map, and finally found their way to safety. Only later did they learn that the map was of the Pyrenees, not the Alps, and hence, was totally useless.

This story is a metaphor for what goes on in corporate hierarchies. The map metaphor fits well because in corporate hierarchies the consequences of our actions rarely become evident immediately. And there often can be a range of plausible explanations as to why things turned out a particular way. In the face of ambiguity, executives may easily develop excessive confidence in their explanations of situations and events. Executives who are confident enough in their beliefs and want to sustain them, whether true or false, can operate according to these beliefs for long periods of time particularly when they have sufficiently vague and delayed feedback from their decisions.122

There is a systematic tendency of many people to overrate their own abilities, contributions and talents. People dwell on successes and attribute them to skill and diligence. Failures are more likely to be dismissed based on external or unforeseeable causes.123 This finds expression in excessive optimism and overconfidence, and a sense of omnipotence regarding one's ability to control events.124 People tend to claim that positive events are due to their skill, and that negative situations are caused by outside circumstances. Groupthink can increase optimistic biases, fueling a tendency to place unwarranted confidence in one's decisions.125 The excessive confidence of senior officials in an organization only works to solidify the phenomenon of groupthink.

Excessive optimism is not a virtue, but is essentially a subconscious tendency to distort reality in a positive direction.126 The phenomenon of excessive optimism can trickle down in a corporate culture, with the persistent belief that one's own company is superior to competitors, or that one's company is on a winning streak that has no end. This can induce a tendency toward puffery and dismissal of risks in formulating disclosures and press releases.127 An optimistic culture can blind managers so that, faced with risk or trouble, they will more likely persist in normal, functional activity than take appropriate corrective action, or not see risks clearly or construe them unrealistically.

The dark side of optimism is that it justifies the preservation of the status quo, and hence can result in an entrenchment of denial and lead to ultimate failure.128 Many supervisors, consciously or not, do not want to know precisely how their subordinates achieve their results. As long as the bottom line is profitable, there is little incentive to discover how those results were achieved. Focusing on the bottom line also facilitates the denial of either moral or legal complicity should severe problems be uncovered.129

Corporate "culture" and its influence on information flow

The corporation is said to be a cooperative association.130 "Cooperative association" is a term that implies that the participants in the enterprise subscribe to a set of common goals, and they accept the centrality of the common goals or purposes of that enterprise.131 Each firm has a particular "culture." Studies of organizational behavior show that institutions develop belief systems - shared ways of interpreting a company's environment, its past, and its future prospects. These belief systems are important because they color the interaction and communication between managers and employees. An organization's culture - the norms, routines, and shared understandings and expectations of those who work in a firm - impacts how information flows through the hierarchy. The interpretation of a given bit of information in a company as a whole depends upon the social processes, the patterns - the overall institutional culture, that one learns as one becomes a member of that firm.

There are pre-given social mechanisms in a corporate culture that determine the context and the content of individual decisionmaking and choices. For instance, many corporate cultures discourage open expressions of doubt or skepticism, which stifles the flow of information.132 Or, if a company's CEO promulgates a culture of trust, transparency of communication, direct lines of communications despite decentralized management - stressing honest behavior, honoring the spirit as well as the letter of the law, putting safety before profits, encouraging kind acts and respect to all employees, and frowning on backbiting and internal politicking - this company will have a markedly different culture than one that emphasizes profit-maximization at all costs, and that cheating is okay if you can get away with it. We can find one decent and the other reprehensible.

Senior officials in a company often develop large egos, bolstered by the repeated promotions and increasing responsibility they have accrued, and they are likely to exhibit considerable confidence in their own managerial and decisionmaking abilities. Ego in organizational settings can reverberate by inducing subordinates to conform their presentations to what they think their boss wants to hear, even when the boss emphasizes the need for accuracy and accountability.133 Many a CEO is strong-willed, imperious and dominating, and seldom confides in or relies upon the board.134 Robert Jackall once said that middle management is guided first and foremost by the maxim, "When [the CEO] sneezes, we all catch colds."135

Senior officials might impart the sense that the board would rather not be put on formal notice as to the ugly "facts of life" of illegal or improper activity. Senior managers in a company may well have a particular facility for rationalization. "As a result, the leader's vanities often trigger a cascade of conforming behaviors that, in turn, reinforce those vanities."136

Ego blindness explains why people will not give enough attention to situations that trigger some worry response. That is, the ego will want to quickly dismiss one's gut reaction, and forget about it. This pattern of cognitive dissonance occurred in the actions of Beech-Nut executives who allowed the introduction of increasing levels of foreign substances into apple juice that a large number of children consumed.137

The diffusion of authority in a hierarchical organization tends to reduce an individual's sense of moral responsibility for his or her actions.138 For instance, when supervisors parcel out subtasks to a number of subordinate employees, none of the subordinates may have more than an inkling of what the entire project is about, while the supervisor may know little of the details of each subordinate's subtasks. No one in the firm might recognize a moral problem, because the problem arises not out of what any single worker is doing, but out of everyone's action as a whole. The fact that everyone is merely a member of a large work force helps workers feel a sense of security, with little need to find out more about what is going on even if they have their suspicions.

A particular person can always choose to violate a norm and adopt behavior that bypasses the company's norms. There may be a shared feeling on the part of subordinate officials that they owe their loyalty chiefly to senior management and not to the board. Cynicism in a corporate culture can foster the breaking of rules as a means to succeed. An element of cynicism in a company's culture about accounting norms or about SEC regulatory protocols may affect the actor's evaluation of the legitimacy of the regulation. One might understand that certain ethical rules are underenforced, that the probability of sanction from some violation is remote, or that successful people can question the legitimacy of ethical principles and make excuses.139 To be successful in a highly competitive environment one needs to filter legal and ethical expectations through the group lens. "For many, that filtration will involve an implicit and unconscious search for ways to maintain consistency between the desire to be good and the desire to be successful. This form of rationalization can readily blunt the power of 'official' norms."140

It has been pointed out that people in corporations tend to make decisions that may not be in keeping with their own sense of morality. People working within corporations often have a distinct business persona, different from the one they display within their family relationships or in other roles in society. The idea is that people may act in seemingly altruistic ways outside the corporation, but in the firm there is a business morality that is somehow different from one's personal morality, that "business is business," with the focus being to maximize profit without regard to other considerations.141

Benjamin Cardozo, the judge and moral scholar, referred to distinct "morals of the market place"142 that are different from everyday morality outside the business world. Robert Jackall commented regarding corporate culture that independent morally evaluative judgments get subordinated to the social intricacies of the bureaucratic workplace. Notions of morality that one might hold and indeed practice outside the workplace . . . become irrelevant . . . Under certain conditions, such notions may even become dangerous. For the most part, then, they remain unarticulated lest one risk damaging crucial relationships with significant individuals or groups.143

This idea conjures up a culture in which corporate agents who engage in business wrongdoing escape "not only moral and psychological responsibility but legal responsibility as well. Legal rules designed to deter individual wrongdoing are simply not directly transferable to the corporate setting."144 Thus, the convergence of various factors, including the pressure people feel from their superiors, their peers and the norms of corporate culture, the fact that most corporate cultures hold power in high esteem and have a diffusion of responsibility, may contribute to a sense that certain wrongful conduct is permissible.145

People who act in groups may impose greater risks to society, and thus deserve greater blame (or at least some blame) when they act wrongly, than individuals acting alone. That is, there are special dangers associated with group plots, as reflected in the common law of conspiracy.146 As noted by a classic commentary, "[I]t is more difficult to guard against the antisocial designs of a group of persons than those of an individual. . . . The advantages of division of labor and complex organization characteristic of modern economic society have their counterparts in many forms of criminal activity."147

The fact that there is a certain permissive corporate culture in a given company should not excuse conduct any more than a criminal syndicalist associating with bad associates would be excused from responsibility due to keeping bad company. That is, blaming a culture does not excuse or mitigate the conduct of the individuals who are part of it, in my opinion.

We all move in and out of various roles during the day, operating as moral agents in being a parent, being a driver, being a friend to someone, or being a consumer, and so on. It seems unreasonable to demand that anyone operate in the firm with blinkers shielding one from the moral awareness that operates in other sectors of one's life.


I have attempted to explain how insiders may overlook danger signs obvious to a neutral observer. What sort of solutions are possible to move the board closer to the locus of problems?

How can a company be structured so that the board can monitor the corporation's internal environment, and discover or correct trouble before it reaches the emergency stage?

1. Companies should implement programs to encourage employees to expose wrongdoing without fear of retribution. Organizational theorists agree that in order for information sharing within an organization to be optimal there must be a reasonable degree of trust and confidence between the informant and the recipient.148 There needs to be incentives for subordinates to divulge potentially adverse information. A complication is that any potential informer may be reluctant to supply information because there may be feelings of loyalty to one's superior and coworkers. There is concern for backlash, retaliation, and ruination of one's own chance for advancement, and the risk of losing one's position and accumulated benefits even if there is a strong company policy to prevent such backlash. Directors need to implement procedures through which employees with knowledge of wrongdoing may make such information known in a manner that will permit objective evaluation of the information.

An ombudsman of some sort, with direct access to a senior official, would be helpful. Exxon Corporation, among other companies, has enacted a policy requiring employees who notice possible misconduct or dangerous or troublesome situations, to notify their superiors in writing, and if no written response is forthcoming, the employee must jump the chain of command and inform senior executives.149

2. The reputational risk of concealment of information, both to the company and to top executives, is substantial. Corporations need to devise some kind of communication system that enables important information to move upward to the proper decisionmaker without getting distorted. I would not recommend the simplistic solution of allowing all units of a company to communicate directly with senior management. That could easily create informational overload, an overabundance of irrelevant information, and the problem of sensory decoupling on the part of senior management, and thus might be ineffective.

3. Directors should make it an affirmative duty for individuals in the firm to discern the nature of their own projects and to know what other employees are working on the same project. This will enable them to know where they can go to gather further information about the project, or to "compare notes."

4. The directors must satisfy themselves periodically through reports that the company has appropriate programs in place to inform its employees on an ongoing basis of the need to avoid conflicts of interest, and of the need to comply with laws applicable to its operations. Directors should understand that even the unqualified advice of legal counsel as to the lawfulness of conduct will not necessarily immunize the board or the corporation from legal sanctions.

5. In corporate settings power and responsibility are diffused, but connected. Many boards seem to lack the time and expertise to deal with all the complexities of modern public corporation business. Often directors seem to perform a largely reactive function. Thus, developing an effective program for discovering corporate wrongdoing and preventing its reoccurrence is a daunting task."150 But it is always possible to implement some system of corporate checks and balances that reduce the likelihood that one or a small number of biased managers will cause significant failure of disclosure. It is important to work out a policy to reduce the likelihood that plans may subsequently turn into unethical or unlawful operations. A commitment is required from both the board and senior management that deviations from the policy of compliance with the law will not be tolerated.

Implementation of such a policy requires an adequate monitoring system at both the board and management levels. Of course, monitoring has its own problems in accomplishing the aim of oversight while avoiding the negative feature of setting up such an elaborate system of signals, checks, balances, and reviews as to stifle all activity. A good monitoring program will protect the interests of the shareholders by avoiding governmental and private litigation against the company and the depletion of the corporate reputation, not to mention its stock value.

6. Some companies may want to have more widespread use of an outside director who plays a lead role. One of the more radical solutions involving outside directors was proposed by Ralph Nader in 1976, namely the "politicization" of the corporation by requiring the presence of various representatives of "public interest" groups on the corporate board.151 The suggestion here is that each director would represent a specified special interest constituency, such as environmentalists or consumers, and others whose goals may be in conflict with the goal of profit maximization. It is far from clear, however, how such a restructuring of the board would solve the problem of information blockage from lower echelons to the board, and it interjects a more acute adversarial dimension between the board and management, not to mention within the board itself.

7. In cases where a corporation's own system of internal accountability has broken down, the SEC has structured consent orders to force companies to restructure their audit committee, provide adequate training for new directors, install a majority of independent directors, and expand the number of independent outsiders on the board.152

8. Another solution is to hire emotionally intelligent workers. A CEO who throws his or her weight around, intimidates other directors - the table-pounding type - might be temperamentally ill-suited for the job. Search committees should look for people with people skills.

Emotions are relevant in deciding an issue. Appropriate appeals to emotion are important ingredients that contribute to, rather than sabotage, corporate decision making.153 Emotion tends to mold strict logic to achieve truly balanced quest for the truth. Proving the truth of an issue requires not just an analysis of the concrete evidence, but the shading of emotional sensitivities.

Emotional responses can send us important messages to which we should listen. Emotions help us sort through vast quantities of information, highlight those aspects that have particular meaning for us, and help us assign meaning to things that might otherwise seem chaotic. Emotions open us to the possibilities of enhanced awareness and improved judgment.

Emotions serve as warning signals that certain judgments or decisions need to be scrutinized more carefully. People should be aware of warning signals that may prompt them to reconsider a particular decision or action. If we feel a negative feeling immediately upon hearing a proposal, this is what researchers refer to as intuition.154 We cannot rationally explain this initial gut reaction, but we commonly take the negative feelings to mean that something is wrong, and feel moved to search for more facts or to reflect further on the issue. Once people are aware of the validity of intuitive feelings, they can deploy rather than suppress powerful feelings that can help guide decisionmaking. Intuition doesn't guarantee truth, but it is a form of knowledge which we can develop and let run alongside our rational thinking.

According to Justice William J. Brennan, Jr., ignoring what our passions tell us cuts us "off from the wellspring from which concepts such as dignity, decency, and fairness flow."155 Understanding reality and responding to it appropriately requires "the full measure of all our human capacities."156

Emotion can be used by a forceful manager to block communication or to shut down dialogue. This is an abusive and wrong use of emotion. Outbursts of anger and table-pounding in an attempt to suppress critical questioning of others closes down creates a corporate culture that denigrates legitimate discourse, and limits the quest for the truth.


There are numerous subtle but powerful forces at work in corporations. The mere existence of a hierarchical structure prevents individuals from obtaining complete knowledge needed to make informed moral decisions, and prevents them from really knowing the role their acts play in the larger corporate scheme. Directors are likely to face much greater demands of accountability in the wake of Enron. There is growing awareness among directors themselves of the need to take their role seriously.157 Companies are likely to put more emphasis on having directors who are not afraid to challenge senior management by asking inconvenient questions.

The public has traditionally regarded information disclosed by corporations with a certain degree of trust, on the assumption that managers have unique access to certain kinds of risk-related information, and that securities laws make it punishable to mislead investors. Business organizations are undeniably human affairs, and classic occurrences of information blockage undermine the board's ability to monitor the company. Savvy investors and market professionals are able to discount many kinds of corporate hype. But there is a difference between corporate hype and corporate deception and fraud that are due to information flow blockages. A corporation's disclosure to investors may sometimes be distorted, not in bad faith, but rather because cognitive forces and information flow problems lead to a skewed perception of reality by senior officials.

In my opinion, the true purpose of corporations is to make society better off, and to create societal wealth, not just to create wealth for shareholders. To accomplish this, the corporation must be viewed as a holistic blend of constituencies with multiple and changing interests, neither a shareholder-centric model nor a stakeholder model, but a corporate constituency model, that balances the two (see Appendix). This concept focuses on the interests of "the corporation" broadly construed as representing various constituencies.

Perhaps rejection of traditional corporate norms will come from an internal desire to become socially responsible together with society's pullings for the corporation to act on conscience, and to operate on the maxim that there are other important social goods that sometimes trump the notion of profit-maximization. And in the wake of Enron corporations may simply have no choice but to meet increased demands by workers, shareholders, customers and the government for greater accountability.


1 John C. Coffee, Jr., Beyond the Shut-Eyed Sentry: Toward a Theoretical View of Corporate Misconduct and an Effective Legal Response, 63 Va. L. Rev. 1099, 1132 (1977).

2 The theme dates back to at least 1907, with the discussion, Dwight, Liability of Corporate Directors, 17 Yale L.J. 33 (1907).
3 Id. at 1133..
4 Id.
5 Id.

6 See Richard A. Oppel, Jr., Enron Official Says Many Knew About Shaky Company Finances, N.Y. Times, Feb. 15, 2002, at Al.
7 See "Lone Voice": Excerpts From Testimony of Executive Who Challenged Enron (excerpts from the testimony of Sherron S. Watkins), N.Y. Times, Feb. 15, 2002, at C7.
8 See Richard A. Oppel, Jr., supra note 6 at C6.
9 See Stephen Labaton and Richard A. Oppel, Jr., Testimony of Enron Executives is Contradictory, N.Y. Times, Feb. 8, 2002, at Al.
10 Id.
11 Id.

12 See Steven Greenhouse and Stephen Labaton, Enron Executives Say They Debated Freeze on Pension, N.Y Times, Feb. 6, 2002, at Al, C8.
13 See Don Van Natta, Jr. and Alex Berenson, Enron's Chairman Received Warning About Accounting, N.Y. Times, Dec. 29, 2001, at Al.
14 See Neela Banerjee, At Enron, Lavish Excess Often Came Before Success, N.Y. Times, Feb. 26, 2002, at C1.

15 See Richard A. Oppel, Jr., Wall St. Analysts Faulted on Enron, N.Y. Times, Feb. 28, 2002, at A1.
16 Id.
17 Id.
18 Id.

19 See Richard A. Oppel, Jr., supra note 6.
20 See "Lone Voice": Excerpts From Testimony of Executive Who Challenged Enron (excerpts from the testimony of Sherron S. Watkins), supra note 7.
21 Id.

22 See Steven Greenhouse, U.S. Pressing For Trustees Of Enron Plan To Step Down, N.Y. Times, Feb. 11, 2002, at A20.
23 Id.

24 See Reed Abelson, Enron's Board Quickly Ratified Far-Reaching Management Moves, MY Times, Feb. 22, 2002, C6.
25 Id.

26 See Excerpts From Testimony Before House

Subcommittee on Enron Collapse (quoting from a prepared statement by William C. Powers, Jr.), N.Y. Times, Feb. 5, 2002, at C4.
27 Id. (emphasis added.)
28 See Neela Banerjee, supra note 14.
29 Id.

30 See Steven Greenhouse and Stephen Labaton, Enron Executives Say They Debated Freeze on Pension, MY Times, Feb. 6, 2002, at Al, C8.
31 See, eg., Gretchen Morgenson, A Bubble No One Wanted to Pop, N.Y Times, Jan. 14, 2002, at Al. Aggressive accounting like Enron's method of shifting large obligations off its balance sheet, is not limited to Enron, but has become not uncommon in recent years. See id. Moreover, Wall Street analysts cannot be relied upon to dig deeply into the books of firms because they are eager to generate business selling securities to investors and have made it a habit to ignore negative data regarding corporate misdeeds. See id.

32 See, eg., Del. Gen. Corp. Law (sec) 141 (a) (Del. Code Ann. tit. 8 141(a)(1991).
33 See, e.g., N.Y [Bus. Corp.] law 717(a). See also Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963), in which the Delaware Supreme Court stated that "directors ... in managing the corporate affairs are bound to use that amount of care which ordinarily careful and prudent men would use in similar circumstances."
34 See generally Dennis J. Block, Nancy E. Barton and Stephen A. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors (4th ed. 1993) at 5-28.

35 See S. Samuel Arsht, Fiduciary Responsibilities of Directors, Officers and Key Employees, 4 Del. J. Corp. L. 652, 659 (1979).
36 Graham v. Allis-Chalmers Manufacturing Co., 188 A.2d 125 (Del. 1963).
37 In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996).
38 Id. at 970.
39 Id. at 971.
40 Id. at 969.

41 See Samuel Arsht, Fiduciary Responsibilities of Directors, Officers and Key Employees, 4 Del. J. Corp. L. 652, 659 (1979); E. Norman Vessey and Julie M. S. Seitz, The Business Judgment Rule in the Revised Model Act, the Trans Union Case, and the ALI Project A Strange Porridge, 63 Tex. L. Rev. 1483 (1985); Charles Hansen, The Business Judgment Rule and the American Law Institute Corporate Governance Project, 48 Bus. Law. 1355, 1360 (1993); Bayless Manning, The Business Judgment Rule and the Director's Duty of

Attention: Time for Reality, 39 Bus. Law 1477, 1494 (Aug. 1984).

42 See Julian P. Rotter, Interpersonal Trust, Trustworthiness, and Gullibility, 35 Am. Psychol. 1 (1980).
43 Carol M. Rose, Trust in the Mirror of Betrayal, 75 B.U. L. Rev. 531, 540-541 (1995). See also Michael E. Porter, Clusters and the New Economics of Competition, Harvard Bus. Rev. Nov.-Dec. 1998, at 9, 10 (noting that German and Japanese companies are more relationship-oriented in contrast with American companies, which are more "transaction-- driven"). The "stick" style of monitoring that often is found in American companies is in sharp contrast to the management practices of other countries with a more benign approach, such as German, Japan and the Scandanavian countries. David M. Gordon, Fat and Mean: The Corporate Squeeze of Working Americans and the Myth of Managerial "Downsizing" (1996) As the French philosopher Michel Serres remarked, "In America, money is the goal and things are the means to achieve it, while in Europe our goal is to achieve things, with money as the means.

44 See, e.g., Julian P. Potter, Interpersonal Trust, Trustworthiness, and Gullibility, 35 Am. Psychol. 1 (1980) (providing empirical support for the proposition that higher trusting people are more likely to be happier than lower trusting people); Morton Deutsch, Trust and Suspicion, 2 J. Conflict Resol. 278 (1858) ("trusting people are 'nicer' than suspicious people").
45 John C. Coffee, Jr. supra note 1 at 1131.
46 17 C.FER. 240.10b-5 (2000).
47 See Donald Langevoort, Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Market Investors (And Cause Social Harms), 146 U. PA. L. Rev. 101 (1997).

48 See John C. Coffee, Jr., supra note 1 at 1134.
49 Peter Drucker, Management: Tasks, Responsibilities, Practices 628 (1973).
50 Kenneth Boulding, The Economics of Knowledge and the Knowledge of Economics, Am. Econ. Rev., May, 1966, at 1, 8.

51 See John C. Coffee, Jr. supra note 1 at 1127-- 1129.

52 See Lawrence E. Mitchell, Cooperation and Constraint in the Modern Corporation: An Inquiry into the Causes of Corporate Immorality, 73 Tex. L. Rev. 477, 508 (1995).

53 Robert Jackall, Moral Mazes: The World of Corporate Managers 17, 20-21 (1988).
54 See John C. Coffee, Jr., supra note 1 at 1104-1105.
55 Anthony Downs, Inside Bureaucracy (1966) at 143.

56 John C. Coffee, Jr., supra note 1 at 1136.
57 Id. at 1143.

58 See Roy Radner, Hierarchy: The Economics of Managing, 30 J. Econ. Literature 1382, 1387-1401 (discussing corporate hierarchies).
59 See John C. Coffee, Jr., supra note 1 at 1138.
60 See Frank H. Easterbrook and Daniel R. Fischel, Mandatory Disclosure and the Protection of Investors, 70 Va. L. Rev. 669, 673-677 (1984) (describing management's interest in its own trustworthiness).
61 Tom R. Tyler and Peter Degoey, Trust in Organizational Authorities: The Influence of Motive Attributions on Willingness to Accept Decisions, in Trust in Organizations: Frontiers of Theory and Research (Roderick M. Kramer and tom R. Tyler eds., 1995) at 331.

62 See Barry M. Staw, The Escalation of Commitment to a Course of Action, 6 Acad. Mgmt. Rev. 577, 580-581 (emphasizing the virtue of appearing consistent).

63 The temptation to distort disconfirming information increases until the information becomes so clearcut that its implications are unavoidable. In a company that may take some time, but at some point the project's risks or dangers crystallizes. At that point an active cover-up might begin. As one of the more polite sayings goes, the managers may find themselves "knee-deep in the big muddy." Barry M. Staw et al., Knee-Deep in the Big Muddy: A Study of Escalating Commitment to a Chosen Course of Action, 16 Org. Behav. & Hum. Performance 27 (1976) (quoting the title).

64 See "Lone Voice": Excerpts From Testimony of Executive Who Challenged Enron, supra note 7.
65 See, e.g., Kenneth J. Arrow, The Limits of Organization 75 (1974) ("The efficiency loss due to informational overload is increased by the tendency in that situation to filter information in accordance with one's preconceptions.").
66 See Canice Prendergast, A Theory of "Yes Men", 83 Am. Econ. Rev. 757 (1993).
67 Id. at 1105. On the other hand, action undertaken to maximize corporate profits in the short run at the expense of long-term growth brings to the surface a conflict of interest between management and investors. Management's interest may be particularly focused on the short term, because salary, bonuses and stock options are likely to be based upon performance in the short term, while the investor usually is more interested in long-term capital appreciation. See Bower, On the Amoral Organization, in The Corporate Society (R. Morris, ed. 1974) at 178, 191-192.
68 See Donald C. Langevoort, supra note 47 at 135.

69 See e.g., O. Williamson, Corporate Control and Business Behavior (1970) at 47-49.
70 Id.

71 See Jon D. Hanson and Douglas A. Kysar, Taking Behavioralism Seriously: The Problem of Market Manipulation, 74 N.YU. L. Rev. 630, 672 Gune 1999).
72 Robert C. Ellickson, Bringing Culture and Human Frailty to Rational Actors: A Critique of Classical Law and Economics, 65 Chi.-Kent L. Rev. 23, 23 (1989).
73 Id.

74 See Jon D. Hanson and Douglas A. Kysar, supra note 71 at 633.

75 Herbert A. Simon, A Behavioral Model of Rational Choice, 69 Q. J. Econ. 99, 104 (1955).
76 See id.

77 See Sandra Blakeslee, Hijacking the Brain Circuits With a Nickel Slot Machine, MY Times, Feb. 19, 2002, at Dl.

78 See Anne C. Dailey, Striving for Rationality, 86 Va. L. Rev. 349, 383 (Mar. 2000).
79 See L. Festinger, A Theory of Cognitive Dissonance (1957).
80 Id.

81 Donald C. Langevoort, supra note 47 at 136.
82 See Jon D. Hanson and Douglas A. Kysar, supra note 71 at 646.

83 See Susan T. Fiske and Shelley E. Taylor, Social Cognition 149-151, 150 (2d ed. 1991) ("Welldeveloped schemas generally resist change and can even persist in the face of disconfirming evidence.").
84 Jon D. Hanson and Douglas A. Kysar, supra note 71 at 648.
85 Id. at 649.

86 See text accompanying note 20 supra.
87 See Donald C. Langevoort, Where Were the Lawyers?: A Behavioral Inquiry into Lawyer Responsibility for Clients' Fraud, 46 Vand. L. Rev. 75, 111 (1993) ("[T]here are reasons . . . to doubt that lawyers will be very good gatekeepers once they have committed to representation and built a positive schema regarding the client and the situation.").
88 See Jon D. Hanson and Douglas A. Kysar, supra note 71 at 646.

89 See, e.g., Marjorie A. Lyles and Charles R. Schwenk, Top Management, Strategy and Organizational Knowledge Structures, 29 J. Mgmt. Stud. 155, 170 (1992) (noting that "[strategic responses to new situations may be the result of generalizing from the existing knowledge structure"); see also William H. Starbuck, Congealing Oil: Inventing Ideologies to Justify Acting Ideologies Out, 19 J. Mgmt. Stud. 3.
90 See Craig A. Anderson, Mark R. Lepper, Lee Ross, Perseverance of Social Theories: The Role of

Explanation in the Persistence of Discredited Information, 39 J. Personality & Soc. Psychol. 1037, 1045 (1980).
91 Jon D. Hanson and Douglas A. Kysar, supra note 71 at 650.
92 Id. at 653.

93 Donald C. Langevoort, Taking Myths Seriously: An Essay for Lawyers, 74 Chi.-Kent L. Rev. 1569, 1571 (2000).

94 Jon D. Hanson and Douglas A. Kysar, supra note 71 at 654,

95 Irving L. Janis, Groupthink 9 (1982).
96 See Donald C. Langevoort, supra note 93 at 1578.
97 Id.

98 See Craig D. Parks and Rebecca A. Cowlin, Acceptance of Uncommon Information into Group Decisions When That Information Is or Is Not Demonstrable, 66 Org. Behav. & Hum. Decision Processes 307, 307 (1996) ("Facts that are known by only one member are treated with skepticism by others and do not factor terribly into the group's decision.").
99 See Irving L. Janis and Leon Mann, Decision Making: A Psychological Analysis of Conflict, Choice, and Commitment 129 (1977) (The authors claim that when adverse information is introduced into a group, "the members use their collective cognitive resources to develop rationalizations supporting shared illusions about the invulnerability of their organization or nation and display other symptoms of `group-think' - a collective pattern of defensive avoidance."
100 See id. at 280-284.

101 See Gary Marks and Norman Miller, Ten Years of Research on the False-Consensus Effect: An Empirical and Theoretical Review, 102 Psychol. Bull. 72, 72 (1987).
102 See generally, Richard R. Nelson, Recent Evolutionary Theorizing About Economic Change, 33 J. Econ. Literature 48 (1995).
103 In sociobiology literature. See generally Lionel Tiger, Optimism: The Biology of Hope (1979).
104 See, Paul Zarnoth and Janet A. Sniezek, The Social Influence of Confidence in Group Decision Making, 33 J. Experimental Soc. Psychol. 345 (1997).
105 Courts have been increasingly protective of optimistic statements by corporate officials, requiring significant evidence of bad intent or scienter in securities fraud cases. See, eg., In re Apple Computer Sec. Litig., 886 E2d 1109, 1113-1115, 1118-1119 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990); Raab v. General Physics Corp., 4 EM 286, 290 (4th Cir. 1993) ("No reasonable investor would rely on these statements [i.e., statements of "puffing" that predicted the company's growth], and they are certainly not specific enough to perpetrate a fraud on the market.

Analysts and arbitrageurs rely on facts in determining the value of a security, not mere expressions of optimism from company spokesmen. . . . '[P]rojections of future performance not worded as guarantees are generally not actionable under the federal securities laws."' [citations omitted]; see also Carl W Schneider, Soft Disclosure: Thrusts and Parries When Bad News Follows Optimistic Statements, 26 Rev. Sec. & Commod. Reg. 33 (1993). Moreover, corporate law typically insulates the business judgments of corporate officials when made in good faith, so long as the process of deliberation is not grossly deficient. See American Law Institute, Principles of Corporate Governance 54.01 (1992) ("A director or officer has a duty to the corporation to perform the director's or officer's functions in good faith, in a manner that he or she reasonably believes to be in the best interests of the corporation, and with the care that an ordinarily prudent person would reasonably be expected to exercise in a like position and under similar circumstances.") For a criticism of this rule, see Franklin A. Gevurtz, The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?, 67 S. Cal. L. Rev. 287 (1994).

106 See, e.g., Jeffrey Pfeffer, Management as Symbolic Action: The Creation and Maintenance of Organizational Paradigms, in 3 Research in Organizational Behavior 1, 4 (L.L. Cummings and Barry M. Staw eds., 1981 (stating that "it is the task of management to provide explanations, rationalizations, and legitimization for the activities undertaken in the organization").
107 See In re Apple Computer Sec. Litig. 886 F2d 1109, 1119 (9th Cir. 1989).
108 See In re Time Warner Sec. Litig. 9 F3d 259 (2d Cir. 1993).

109 See Backman v. Polaroid Corp., 910 f.2d 10 (1st Cir. 1990).

110 See Susan T. Fiske and Shelley E. Taylor, Social Cognition 543-550 (2d ed. 1991).
111 See Donald C. Langevoort supra note 47 at 155.
112 Donald C. Langevoort, supra note 47 at 154.
113 See Max H. Bazerman, Judgment in Managerial Decision Making 37-39, 46 (3d ed. 1994).
114 See Donald C. Langevoort, supra note 93 at 1581.
115 See id. at 74.
116 Id. at 1575.

117 See, e.g., Dennis A. Gioia, Pinto Fires and Personal Ethics: A Script Analysis of Missed Opportunities, 11 J. Bus. Ethics 379 (1992).
118 See Donald C. Langevoort, supra note 93 at 74.
119 See Ellen J. Langer, The Illusion of Control, 32 J. Personality & Soc. Psychol. 311 (1975).
120 See Robyn M. Dawes, Rational Choice in an

Uncertain World 256 (1988) (reviewing modern origins of rationality theory).
121 See Donald C. Langevoort, supra note 93 at 1574.
122 See id. at 1574.

123 See Donald C. Langevoort, Selling Hope, Selling Risk: Some Lessons for Law from Behavioral Economics About Stockbrokers and Sophisticated Customers, 84 Cal. L. Rev. 627 at 639 (May 1996).
124 See Max H. Bazerman, Judgment in Managerial Decision Making 37-39 (3d ed. 1994) (discussing overconfidence among managers).
125 See Donald C. Langevoort, supra note 47 at 140.
126 See Martin E.P. Seligman, Learned Optimism (1991), 98-101.
127 See id. at 141.

128 See Andrew D. Brown, Narcissism, Identity and Legitimacy, 22 Acad. Mgmt. Rev. 643, 651-660 (1997).

129 See Jack Katz, Concerted Ignorance: The Social Construction of Cover-up, 8 Urb. Life 295, 297 (1979) (discussing insulation of individual from group culpability that can result from concerted ignorance); see also John C. Coffee, Jr., supra note 1 (discussing similar observed phenomenon in corporate hierarchies of directors acting as "shut-eyed sentries" - deliberately looking away from management operations in order to avoid witnessing misconduct).
130 See Lawrence E. Mitchell, supra note 52 at 481.
131 There might also be subsidiary motivations whereby a worker may be interested in adopting the company's "mission" because he or she wants to keep the job, while another worker may be interested in building his or her reputation and rising in the hierarchy.

132 See Chris Argyris, Overcoming Organizational Defenses 14-31 (1990).
133 See Canice Prendergast, A Theory of "Yes Men", 83 Am. Econ. Rev. 757, 769 (1993).
134 See, e.g., Clearing Payoff Storm, Northrop Chief Keeps Firm Hand on Controls, Wall St. J., Dec. 15, 1976, at 1.

135 Robert Jackall, supra note 53 at 22.
136 See, e.g., Donald C. Langevoort, Ego, Human Behavior, and Law, 81 Va. L. Rev. 853, 873-874 (1995).

137 See Philip G. Zimbardo and Michael R. Leippe, The Psychology of Attitude Change and Social Influence 120-121 (1991). At the outset, a cheating supplier introduced small amounts of the substances, which raised some suspicion in quality control. Executives felt that preliminary data was inconclusive so they choice to continue using the supplier pending results of an internal investigation. The executives

then were motivated to justify their actions to themselves, rationalizing away data as being a simple misunderstanding, that the existence of a health threat was inconclusive, and acknowledging that the supplier had a good reputation in the past. The executives convinced themselves that their actions were neither harmful nor wrong. This false consensus effect fostered the likely assumption that most others would share their perception. Thus, they allowed the use of the adulterated apple juice to continue unchecked until it blew up in their face.
Another example of the false consensus effect involved Michael Milken and the demise of Drexel Burnham Lambert. Milken invented the junk bond market and apparently sincerely believed that it was a significant financial boon to investors and his company. He apparently took small steps along the way to conceal some of the more tentative features of the scheme. Each incremental action was part of a slippery slope, and the accumulated efforts at concealment eventually resulted in flagrant improprieties. But a host of self-protective posturing, including rationalizations, optimism about the market and the wealth that he had produced for some clients, apparently deflected concerns that he might be engaging in fraudulent conduct. See Jesse Kornbluth, Highly Confident: The Crime and Punishment of Michael Milken 367 (1992).
138 See Richard T. De George, Business Ethics 90-96 (2d. ed. 1986).

139 "No feelings of guilt are required, no attributions of moral blame permitted" in corporate decisionmaking "because [t]he institution defines the moral role, and in the case of the corporation the moral role is narrow indeed." Lawrence. E. Mitchell, supra note 52 at 523-524.

140 Donald C. Langevoort, supra note 93 at 1590.
141 See Lawrence E. Mitchell supra note 52 at 522.
142 See Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y 1928).

143 Robert Jackall, supra note 53 at 105.
144 Dennis R. Fox, The Law Says Corporations are Persons, but Psychology Knows Better, 14 Behav. Sciences 7 Law 339, 349 (1996).
145 See David Luban, Alan Strudler and David Wasserman, Moral Responsibility in the Age of Bureaucracy, 90 Mich. L. Rev. 2348 (1992). In contrast to ordinary moral choices confronting individuals, certain knowledge conditions are frequently absent in corporations:

(1) The actor might not have any time constraint regarding when a decision must be made.
(2) There may not be much clarity that a decision

needs to be made in the first place on a given point or at a given juncture in a project.
(3) The actor may not know the full range of available options in making a decision.
(4) The actor may have only piecemeal information and therefore, be further in the dark.
By contrast, when we make individual moral decisions, as we do every day, we know that a decision must be made, when a decision must be made, what options are available, and what steps are necessary in order to make the decision. For instance, as a lawyer confronted with a client who intends to lie on the witness stand, I know that a decision must be made on my part, when it must be made, what choices are available (be silent or blow the whistle, or resign as attorney), and what is needed to make the choice. See id. at 2364 from which this four-prong analysis is derived. If these conditions are missing, most moral systems allow that the agent "knew not what he was doing," and should therefore be excused from moral blame.
146 A conspiracy is an agreement by two or more persons to commit an unlawful act. See W LaFave and A. Scott, Criminal Law 453 (1972) The crime of conspiracy is completed, and may be prosecuted, before any overt action occurs beyond the formation of the agreement. See Thomas Church, Jr., Conspiracy Doctrine and Speech Offenses: A Reexamination of Yates v. United States from the Perspective of United States v. Spoke, 60 Cornell L.R. 569, 572 (Apr. 1975). An "overt act" refers to any legal or illegal act in furtherance of the conspiracy. A conspiracy is thought to pose a greater threat than the same plot in the mind of a single individual because the joint illegal intent of two or more individuals is significantly more dangerous than a similar intent on the part of an individual. Id.; see also LaFave and Scott, supra, at 459-460.

When two agree to carry [a plot] into effect, the very plot is an act in itself . . .The agreement is an advancement of the intention which each has conceived in his mind; the mind proceeds from a secret intention to the overt act of mutual consultation and agreement.

State v. Carbone, 10 N.E. 329, 336-337, 91 A.2d 571, 574 (1952).

147 Note, The Conspiracy Dilemma: Prosecution of Group Crime, 62 Harv. L. Rev. 276, 283-284 (1948) (footnotes omitted).
148 See John C. Coffee, Jr., supra note 1 at 1265.
149 See David Luban, Alan Strudler and David Wasserman, supra note 145 at 2389.

150 This task involves problems similar to those faced by any law enforcement agency, including the difficulty of securing reliable evidence of wrongdoing, the need to protect the rights of potential accused, the need to encourage disclosure, and the need to apply appropriate sanctions. The handling of information concerning corporate misconduct is a delicate matter, since there will tend to be support, at least initially, for a manager who has performed well and in whom trust has been reposed by the company. In addition, the accuracy and motivates of the informant may be suspect for several reasons, including incomplete information, unreliable or ambiguous facts, reasonable disagreement over the ethical or legal conclusions, and ulterior motives of the informant such as desire for advancement, or personal antagonism.
151 See R. Nader, M. Green and J. Seligman, Constitutionaliational of the Corporation: The Case for the Federal Chartering of Giant Corporations (1976).

152 See John C. Coffee, Jr., supra note 1 at 1236.
153 See D. Don Welch, Ruling From the Heart: Emotio-- based Public Policy, 6 S. Cal. Interdisc. L.J. 55 (1997).
154 Research has identified intuition as a brain function. A brain region called the limbic system, which is involved with emotions, interacts with another brain region called the prefrontal cortex, involved in decisionmaking. When people think about doing something, the prefrontal cortex calls up knowledge related to feelings they recall from their memory about earlier similar situations.
We are not conscious of the signals, although more sensitive people are. These emotional signals are very active and they trigger what we call intuition. See Sandra Blakeslee, "Study Links Antisocial Behavior to Early Brain Injury That Bars Learning," N.Y. Times, Oct. 19, 1999, Science Section.
Scientists define intuition as a sudden, strong "gut feeling" to do something, or coming to suddenly get a hunch or premonition, a kind of knowing, without any rational explanation or how this idea came about at this moment. Intuition is like an inner voice giving you a strong feeling about what's right, sometimes subtle enough to be easily disregarded,. Sometimes it manifests like a flash of knowledge, or sudden insight.

Intuitions are things which we "know" immediately - they are unmediated, non-inferred feelings, a sense of knowing tied to a feeling or an emotional draw, an attractive emotional draw or a negative one. You may feel a strong intuition about something but there is no guarantee that your hunch is true. Time will tell. People who are rigidly logical have blocked

their intuitive skills. Japan is often cited as a culture that encourages and fosters intuition in workers, which they think helps advance science and technology. Also, as people become experts in their given field, they tend to be more in touch with intuition. 155 See William J. Brennan, Reason, Passion and "The Progress of the Law," Forty-Second Annual Benjamin N. Cardozo Lecture delivered at the Association of the Bar of the City of New York (Sept. 14, 1987), reprinted in 10 Cardozo L. Rev. 3, 22 (1988).
156 Id. at 22-23.

157 See Reed Abelson, Enron's Board Quickly Ratified Far-Reaching Management Moves, supra note 24.
158 See, e.g., Paramount Communications v. Time, Inc., 571 A.2d 1140, 1150 (Del. 1989) ("[A] board of directors, while always required to act in an informed manner, is not under any per se duty to maximize shareholder value in the short term .... ).
159 Fiduciary duties are governed by state law in this country, and the majority of states describe fiduciary duties of directors in this manner. See Lawrence E. Mitchell, Theoretical and Practical Framework for Enforcing Corporate Constituency Statutes, 70 Tex. L. Rev. 579, 630-640 (1992).

160 See. eg., Frank Easterbrook K. and Daniel Fischel, The Economic Structure of Corporate Law (1991); see also Andrei Shleifer and Robert W Vishny, A Survey of Corporate Governance, 52 J. Fin. 737, 738, 740-748 (1997).

161 See Steven M.H. Wallman, Understanding the Purpose of the Corporation, 24 J. Corp. L. 807 (Summ. 1999).

162 See id. at 813.
163 See id.

164 James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States, 1780-1970, 15-17 (1970).
165 Id. at 15.

166 See, eg., cases cited in John C. Coates IV, State Takeover Statutes and Corporate Theory: The Revival of an Old Debate, 64 N.YU. L. Rev. 806, 834 n. 175 (1989).

167 See Dennis R. Fox, supra note 144 at 344.
168 Steven M.H. Wallman, The Proper Interpretation of Corporate Constituency Statutes and Formulation of Director Duties, 21 Stetson L. Rev. 1, 170-171 (1991).
169 See A. A. Berle, Corporate Powers as Powers in Trust, 44 Harv. L. Rev. 1049 (1931); A. A. Berle, For Whom Corporate Managers Are Trustees: A Note, 45 Harv. L. Rev. 1365 (1932); and E. Merrick Dodd, Jr., For Whom Are Corporate Managers Trustees?, 45 Harv. L. Rev. 1145 (1932).

170 See id. at 44 Harv. L. Rev. 1049, 1049.
171 See E. Merrick Dodd, Jr. supra note 169 at 1148.
172 See id. at 1148.
173 Id. at 1153-1154.

174 See, e.g., Bangor Punta Operations, Inc. v. Bangor & A.R.R., 417 U.S. 703 (1974) in which a majority of the Court seemed to accept the proposition that directors are fiduciaries only for those possessing a "tangible interest in the corporation," not the public at large. See id. at 716 n. 13.
175 See AT Smith Mfg. Co. v. Barlow, 98 A.2d 581, 583 (NJ. 1953) (tracing the general shift in the perspective on corporate activity from a public service focus, which dated from at least 1702, to a more profit-based orientation in the 1930s).
176 See Lawrence E. Mitchell, supra note 52 at 534-535.

177 See Steven M.H. Wallman, supra note 161 at 810.
178 See, e.g., Conn. Gen. Stat. Ann. 33-313(e) (West Supp. 1994); Fla. Stat. Ann. 607.0830(3) (West 1993); La. Rev. Stat. Ann. 12:92(g) (West 1994); Ohio Rev. Code Ann. 1701.59(D) (Baldwin 1993); R.I. Gen. Laws 7-5.2-8 (1992).

[Author Affiliation]
John Alan Cohan

[Author Affiliation]
John Alan Cohan is an attorney, writer, teacher and philosopher. He is a native of Los Angeles, California, and has been a lawyer since 1972, with clients throughout the United States and Europe in the fields of tax law, aviation law, and farming and livestock law. He was graduated from the University of Southern California in 1969, Loyola Law School in 1972, and admitted to the California Bar in 1972. He has studied philosophy in the Philosophy Department of UCLA with the equivalent of a master's degree in philosophy.

[Author Affiliation]
Law Offices of John Alan Cohan, 415 North Camden Dr. Suite 100, CA 90210, Beverly Hills, U.S.A.

[Author Affiliation]


Reevaluation of the shareholder-centric model

The problem of the nature and purpose of the corporation, its function in society, has been of longstanding concern. Corporations make things, do things, buy things and sell things, they have different commitments and different goals, and the levels of commitment to these goals vary. That is, the duties of the board entail focusing on a panoply of concerns, above and beyond maximizing shareholder profits.158

Directors owe fiduciary duties to "the corporation."159 For decades the prevailing theory of corporate governance rested on the shareholder-centric model, that is, on the assumption that the primary duty, or even the sole task, of officers and directors was to maximize shareholder wealth.160
Corporations are granted limited liability for shareholders and given life in perpetuity because they are thought to be business vehicles that serve the goal of promoting overall societal wealth. The genius of U.S. corporate law is that it gives directors and officers the flexibilty to balance shareholders' interests against other stakeholders.161 The corporate vehicle for providing dividends to shareholders is not an end in itself, but is a means to the further end of benefiting society. Increasingly we see that the model of "shareholder primacy" certainly does not tell the whole story, and it may not be the appropriate corporate governance norm. Today it seems that most corporate officers and directors take their job to be a much more complex balancing act in which they must serve not just shareholders' interests, but also those of other stakeholder groups such as managers, creditors, employees, other companies, the community and the environment.
The idea that directors owe their duty solely to shareholders leads to perplexing dilemmas, troubling results, and long-term disadvantages for society. Which shareholders ought to be the focus of maximizing shareholder wealth? Shareholders of the moment? Long-term shareholders? Should actions be directed to maximize the current share price? What about action that will be detrimental to the current share price but will, at least in the directors' view, benefit long-term shareholders, or shareholders at a much later date? And in principal how can corporate action taken today to benefit long-term share

holders be detrimental to the current share price-- oughtn't it help increase today's share price?
Should the directors regard polluting as a matter of trade-offs? That is, are the costs of polluting including the amount of any potential fine, less than the cost of not polluting? If so, then pollute. The fact that pollution could have devastating side effects on the environment and on members of the public might be irrelevant under the shareholder-centric model if no harm is expected to be visited on the polluting corporation's share price. The only question is whether more money can be made from destroying the last old growth of ponderosa pines than from not doing so.
It is not entirely clear how the notion focusing on promoting shareholder interests started to dominate academic discussions of corporate law. In fact, the concept that directors owe their fiduciary duty exclusively to shareholders is not now the law nor has it ever been the law in this country.162 Rather, the law generally grants directors trustee status for the firm as a whole, meaning that they have the discretion to consider the interests of other corporate constituencies, in addition to the interests of shareholders, in shaping business policy.
In the late eighteenth and early nineteenth centuries, American corporations were chartered with the integral purpose of serving public interests.163 As one commentator observed:

Almost all of the business enterprises incorporated . . .in the formative generation starting in the 1780's were chartered for activities of some community interest - supplying transport, water, insurance or banking facilities. that such public-interest undertakings practically monopolized the corporate form implied that incorporation was inherently of such public concern that the public authority must confer it.164

The courts recognized that this integral public-interest purpose was exacted as "a regulatory quid pro quo" in exchange for conferring the corporate entity status.165 While it was clear that shareholders in early American corporations had legal control over the corporation, the early charters emphasized the corporation's larger public-interest purposes. Charters imposed strict limits on corporate organization, function, and even length of existence.167 Similarly, starting with the earliest court cases, the directors' fiduciary duties were interpreted so as to subsume the shareholders' interests to the larger sphere of duties to "the corporation" itself.166

Only in the past century and a half has the United

States treated the corporation as private property rather than as a creation of the state designed to serve a public function.
These core principles underscore the view that the interests of the corporation historically go beyond the wealth-maximization concerns of shareholders. Its interests also include

the interwoven interests of its various constituencies, such as . . . employees, customers, the local community, and others. Linking these interests to the corporation's interests resolves much of the tension that would otherwise exist. . . . [T]hese constituencies' interests are balanced by the board of directors acting in the best interests of the corporation as a whole, as opposed to the best interests of any one particular constituency [such as the shareholders].168

The idea that corporate managers are trustees who must serve the public interest has been debated for many years. A debate from the 1930s involved Professors Adolph A. Berle, Jr. and E. Merrick Dodd, Jr., who debated the obligations of the corporation in Harvard Law Review.169 Professor Berle argued that the corporation was responsible only to its stockholders.170 Professor Dodd argued that a corporation must not only profit its stockholders, but must also engage in social service.171

The debate focused on the idea that the law may be approaching a position in which it will regard all business as affected with a public interest. Their debate discussed the public opinion of the 1930s, which had been moving towards the view that companies are economic institutions that have a social service as well as a profit-making function, and that it was unwise for corporations to emphasize the profit-maximization function. Professor Dodd noted that before modern corporations arose the law regarded engaging in business to be a public profession rather than a purely private matter, with certain high fiduciary standards that have survived in duties owed by public carriers and innkeepers.172 Based on the court of public opinion, Professor Dodd argued that "our corporate managers who control business should voluntarily and without waiting for legal compulsion manage [business] in such a say as to fulfill these responsibilities."173

Professor Berle's view that the fiduciary responsibility of directors is for the exclusive benefit of shareholders has been embraced by the courts.174 Thus, while the general view prior to the 1930s was that corporations have a certain societal orientation, this view got eclipsed by the "modern" belief that profit

maximization for shareholders was the controlling function of firms except those classified as public utilities.175

But it seems to me that concern for the profitability of stockholders and ethical concerns are not inherently separate and apart. Society is free to impose its collective will on the behavior of corporate agents in light of shifting values. Evidence of consumer boycotts against companies that engage in socially irresponsible action, unfair labor practices, or that do business in violation of human rights or in violation of environmental norms - indicates that society wants companies to take account of social concerns in corporate decisionmaking.176 This observation is supported by the fact that over half the states (and almost all the states, absent Delaware, that have a significant number of public companies incorporated in their jurisdiction) have adopted "corporate constituency" statutes.177 These laws allow boards to take into account the interests of a variety of constituencies sufficiently broad enough to accommodate most social concerns.178 These laws seem to endorse Professor Dodd's view, discussed above, by making it clear that directors do not owe their fiduciary duty exclusively to shareholders, and giving corporate managers a green light to behave as morally whole persons both inside the corporate bureaucracy. These laws suggest a growing public policy that encourages directors to take into account other corporate constituencies. Proponents of shareholder primacy seemingly ignore these ubiquitous state laws that reject the shareholder-- only model.

Professor Dodd's view is not inconsistent with the objective of maximizing shareholder profits, but rather provides a certain flexibility. When acting to fulfill their fiduciary duties to society and stakeholders at large within certain parameters, directors need not fear legal action on the part of shareholders for the exercise of its authority in this manner. This does not mean abandonment of the profit motive, but complements it with a broader mandate to permit corporate actors to be more responsive, and more responsible, as a market-driven institution. It means allowing corporate agents to make decisions grounded in their many relations and obligations in life, from the wellspring of their whole moral arena.
Proponents of the shareholder-primacy model may want to point out, however, that management is under no obligation to forego stockholder-centric philosophy in favor of public interest. Management simply has the freedom to choose among the conflicting interests involved. If it does not want to do so in any particular case, it does not violate the law.

Indexing (document details)
Subjects: Case studies,  Business ethics,  Corporate responsibility,  Corruption,  Organizational behavior,  Corporate governance
Classification Codes 9110 Company specific,  2410 Social responsibility,  2500 Organizational behavior,  2110 Boards of directors
Companies: Enron Corp(Ticker:ENE NAICS: 221210 211111 324110 Duns:00-081-4434 )
Author(s): John Alan Cohan
Author Affiliation: John Alan Cohan

John Alan Cohan is an attorney, writer, teacher and philosopher. He is a native of Los Angeles, California, and has been a lawyer since 1972, with clients throughout the United States and Europe in the fields of tax law, aviation law, and farming and livestock law. He was graduated from the University of Southern California in 1969, Loyola Law School in 1972, and admitted to the California Bar in 1972. He has studied philosophy in the Philosophy Department of UCLA with the equivalent of a master's degree in philosophy.

Law Offices of John Alan Cohan, 415 North Camden Dr. Suite 100, CA 90210, Beverly Hills, U.S.A.

Document types: Feature
Publication title: Journal of Business Ethics. Dordrecht: Oct 2002. Vol. 40, Iss. 3;  Part 2. pg. 275, 25 pgs
Part 2
Source type: Periodical
ISSN: 01674544
ProQuest document ID: 240264581
Text Word Count 17155
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