Business: In Nothing We Trust

July 8 -- "In God We Trust," it says on the back of a dollar bill. That may be the only bit of trust left in the U.S. financial system.

Enron. Andersen. Tyco. Qwest. Global Crossing. Adelphia. Now WorldCom. Or should that be WorldCon? Where can anyone have any confidence in the probity of corporate America if a company's accounts aren't worth the paper they are printed on?

As Francis Fukuyama argues in Trust: The Social Virtues and the Creation of Prosperity, high levels of trust facilitate economic interaction and lower transaction costs, thus encouraging development of large-scale corporations which help a society compete in the global economy.

Low trust entails higher transaction costs, as suspicious people protect themselves with negotiations, detailed contracts and lawyers. Development lags accordingly.

The Reason for Rules

There is nothing inherently trustful about business. That is why there are rules. Accounting rules, corporate governance rules, antitrust rules, anti-corruption rules, rules of contract and property.

Capitalism couldn't work successfully without them. The system is based on everyone — investors, executives, consumers and employees — making informed decisions based on information they can trust. Fraud undermines capitalism just as much as theft by violence.

That is why companies have to file financial statements in standard formats that comply with generally accepted accounting principles. That is why stock exchanges require information that could affect a stock's price to be disclosed to all investors simultaneously. Insider trading is illegal for a reason.

But the system only works if the penalties outweigh the potential gains from breaking the rules. In the tech bubble years they simply didn't.

The numbers were so big, the enforcement so lax that the temptation became too great for too many top executives who started treating their companies like personal piggy banks.

Help yourself to stock options. Keep the share price high to cash in. Keep the earnings growing to keep the stock price up. Just do what it takes to get the numbers to come out right. Smart accountants write accounting rules. So hire even smarter ones to get around them. And everyone was getting rich so it seemed no one cared.