As reported in the BusinessWeek Online article, “The Skilling Trap” (June 12, 2020), Jeffrey Skilling, former CEO of Enron, said on the courthouse steps, after being convicted of white-collar crimes that will send him to jail, probably for the rest of his life,

Gamblers' Ethics: Win Some, Lose Some
Gamblers' Ethics: Win Some, Lose Some

“Obviously I’m disappointed. But that’s the way the system works.”

The BusinessWeek article, went on to say:

… walking out of his trial into the prospect of decades of imprisonment, he stayed in character. He did not say that he was robbed of justice or express regret or defiance. He proved himself, considering the circumstances, a maestro of emotional detachment.

Jeff Skilling’s comments suggest a professional gambler who, having lost a fortune, shrugs and says,

“That’s the way the game is played. You win some, you lose some.”

It may be unfortunate and lamentable for society, but Jeff Skilling was simply telling the truth as he saw it, according to tenets of moral relativism learned at the Harvard Business School and his interpretation of corporate behavior observed while working as a consultant with McKinsey and Company.

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The Sarbanes-Oxley Act of 2002, by discouraging companies to go public, will exacerbate the shortage of equities, with a negative effect on the U.S. stock market, although this was not the intent of its authors.

The formal intent of the Act was to “protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws.”

This goal will not be achieved. In fact, the opposite may be the outcome.

Inspired by Enron

The December 2001 bankruptcy of the Enron Corporation was the legislative inspiration for Senators Sarbanes and Oxley who swallowed hook, line, and sinker the popular press story that the Enron bankruptcy would not have happened if it were not for devious accounting practices of its admittedly unscrupulous executives.

When Enron shares reached the all-time high of $90 in August 2000 (just as the Great Bubble of the 1990s was about to burst), its shares were selling at a speculative 61 times earnings with a dividend yield of only 0.5%. The financial statement of December 2000 showed a current ratio of a mere 1.06 with equity only 17.4% of total assets. The company was engaged principally in speculating in exotic energy contracts and derivatives. Its bonds never rose above the lowest investment grade.

In other words, a quick examination of the published statements would reveal the plain truth, even to an amateur analyst, that this was an extremely highly-leveraged speculative company, with no cash reserves or working capital, borderline credit, with little investment merit and with stock that was wildly over-priced, floating in the clouds of Wall Street ballyhoo.

Many things, from a terrorist bombing to a catastrophic hurricane, could have driven Enron into bankruptcy. The company existed on the extreme edge of an asset-lite financial fantasy world created by Jeffrey Skilling, the Harvard MBA and fair-haired boy from McKinsey and Company. Just as in the case of Long Term Capital Management, the nutty ideas of the Nobel Gods had fallen to earth.

The Sarbanes-Oxley Act would not have prevented the Enron bankruptcy and does absolutely nothing to protect investors against the far more common, harmful, and widely accepted corporate practice of diverting hundreds of billions of dollars of corporate cash reserves each year into company executive bank accounts through stock buyback-option schemes, instead of equitably paying dividends to shareholders.

See: Essays on Stock Buybacks and Options.

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On January 28, 2020, an Associated Press dispatch proclaimed: “Corporate Earnings Good Despite Headlines”, stating that “corporate profits remain very healthy overall, and the majority of corporations are beating expectations.”

Michael Mauboussin, chief investment strategist of a large fund management group, in the report cited in “Legg Mason Argues For More Efficient Stock Buybacks“, also wrote in January 2006 that “corporate America is flush, and returns and cash flows remain strong.”

Are these assertions true and does this mean that the outlook is rosy for the average investor in U.S. equities?

As the Federal Reserve national flow of funds table F102 reveals, the answer is,

“Yes, U.S. corporations are flush with cash and profits are growing”, and

“No, this does not mean the outlook is rosy for the average investor in equities.”

The reason for this apparent contradiction is that the most practical and useful measure of value for corporate profits depends on who you are.

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