Chapter 6: U.S. Businesses

Historical Developments
Legal Structures of Businesses
The Role of Small Business in a Complex Economy
The Role of Big Business in the U.S. and Global Economies
Business and Politics
Economic Performance
Federal Regulation of Business
Market Power: Monopolies and Monopsonies
Corporate Behavior and Responsibility

The chief business of the American people is business.

—President Calvin Coolidge, 1925

Businesses are diverse in the United States. They range in size from the huge multinational corporation employing thousands of people to the self-employed individual. They include large and small businesses, home-based businesses, Internet-based businesses, and corporate and family farms. Businesses are a vital part of the American economic engine. They supply goods and services to the world. The consumption of business output is the primary driver behind the growth of the nation's gross domestic product (GDP; the total market value of final goods and services produced within an economy in a given year). Businesses also provide opportunities for employment, wealth-building, and investment.

Capitalism encourages business growth. However, businesses can become so large and powerful that they trigger concern about the lack of competition within an industry. Corporate fraud and accounting scandals have eroded the public's trust in the integrity of “big business.” American society also has certain expectations regarding the effects of business on the environment, local development, and public welfare and well-being.

Historical Developments

When the first colonists arrived in North America, they traded in furs and food with the native peoples and exchanged North American resources for goods from other countries. The primary industries were agriculture, timber harvesting, and shipbuilding. Manufacturing gradually grew in importance as the United States became an independent country and underwent the Industrial Revolution. Agriculture accounted for 22% of the national income in 1869. (See Figure 1.2 in Chapter 1.) Other major sectors were trade and manufacturing (15% each), services (14%), and finance, insurance, and real estate (12%). The U.S. Census Bureau reports in Historical Statistics of the United States, Colonial Times to 1970, Bicentennial Edition, Part 1 (September 1975, http://www2.census.gov/prod2/statcomp/documents/CT1970p1-07.pdf) that by 1929 the contribution of agriculture to the national income had shrunk to only 12%, whereas manufacturing had grown to 22%. By the mid-1950s agriculture accounted for only 5% of the national income, whereas manufacturing had grown to 31%. (See Figure 1.8 in Chapter 1.)

Over the next half-century, the United States underwent a gradual change from dependence on manufacturing as its primary business to reliance on service industries. Services accounted for only 10% of national income in the mid-1950s. (See Figure 1.8 in Chapter 1.) By the beginning of the twenty-first century, service industries dominated the American business world.

Legal Structures of Businesses

For legal and tax purposes, all businesses must be structured as one of several legally defined forms: sole proprietorships, business partnerships, corporations, or limited liability companies. Each offers both advantages and disadvantages to the business owner.

Sole Proprietorships

In a sole proprietorship one person owns and operates the whole business. Because the business and its owner are considered a single entity under the law, the owner assumes all the risk but also reaps all the benefits of the business. If the business fails, the sole proprietor may have to cover the losses from his or her personal assets, but if the business succeeds, he or she keeps all the profits. Sole proprietors can pay lower taxes than those who head corporations or other forms of small businesses. Still, because almost all credit decisions are based on the owner's assets and credit history, it is often difficult for businesses set up under this structure to borrow enough money to expand as rapidly as other kinds of businesses.

Business Partnerships

A business partnership has two or more co-owners. As in a sole proprietorship, members of a business partnership are legally recognized as one and the same with their company, meaning that they are personally responsible for the company's debts and other liabilities. Most partnerships start with the partners signing agreements that specify their duties in the business. Many states allow for silent partners, who invest start-up capital but have little role in the company's day-to-day affairs. (Start-up capital is the money used to start a new business.) A significant drawback of this form of business is that each of the partners is responsible for every other partner's actions. If a partner loses or steals money from the company, the other partners will have a legal responsibility to pay that debt.

There are three kinds of business partnerships: A general partnership is the simplest form, in which profits and liability are equally divided among partners or divided according to the terms of the signed agreement; a limited partnership allows partners to have limited liability for the company but also limited decision-making rights; and a joint venture, while similar legally to a general partnership, is used only for single projects or short periods of time.

Corporations

A corporation is an entity recognized by the state and federal government as entirely separate from its owner or owners. As such, a corporation can be taxed and sued, and it can enter into contractual agreements. Because it is an individual legal entity, a corporation allows its owners to have less personal liability for debts and lawsuits than a sole proprietorship or partnership. Owners of corporations are considered shareholders, and they may elect a board of directors to oversee management of the company.

Even though corporations are commonly thought of as large companies with hundreds or thousands of employees and publicly traded stock, this is not always the case. Owners of small businesses frequently incorporate as their business expands. All corporate owners must file “articles of incorporation” with their state government. For smaller businesses these forms are simple to fill out and file. One option is to file with the Internal Revenue Service as a subchapter S corporation. In an S corporation the owner must pay him- or herself wages like any other employee, but the structure also offers substantial tax flexibility. All corporations that are publicly traded have C corporation status. This means they have nearly unrestricted ownership and they are subject to corporate taxes, paying at both the corporate and stockholder levels.

Limited Liability Company

The limited liability company is a combination of a corporation and a partnership in which the owners (or shareholders) have less personal liability for the company's debts and legal issues and have the benefit of simpler tax filings and more control over management issues.

The Role of Small Business in a Complex Economy

Many people perceive the U.S. economy as being dominated by large businesses, such as McDonald's and Microsoft. Even though it is true that many of the world's largest companies are headquartered in the United States, small businesses exert enormous influence on the U.S. economy.

The Small Business Administration (SBA) is a federal agency created in 1953 with the passage of the Small Business Act. The SBA's purpose is to support small businesses by offering financial and counseling assistance and ensuring that small businesses can compete against large companies in receiving government contracts.

The size of what is considered a small business varies by industry, and official size standards are determined by the SBA's Office of Size Standards, which issues standards according to a business's number of employees or its average annual receipts. However, the more generally accepted definition of a small business is one that employs fewer than five hundred people at any one time. Of the 5,983,546 firms in business in 2005, 5,966,069 had less than 500 employees. (See Table 6.1.) These small businesses employed 6.4 million of the nearly 7.5 million workers employed by businesses. In addition, small businesses accounted for $2 trillion in payroll in 2005 out of nearly $4.5 trillion in total business payrolls. As such, small businesses accounted for 99.7% of the number of business firms, 50.4% of total business employment, and 44.9% of total business annual payroll. (See Figure 6.1.)

Of the nearly 6 million small businesses in operation in 2005, the vast majority (5.4 million, or 89.5%) were firms that employed less than twenty people each. (See Table 6.2.) Close to 3.7 million (61.5%) of all small business firms had four or less employees each.

Small business employment is not evenly distributed among all industry sectors. The construction industry accounted for the largest percentage (86.1%) of small business employment in 2005. (See Table 6.3.) In other words, 86.1% of people employed in construction in 2005 worked in small businesses. The industry dubbed “other services” was also dominated by small business employment. More than 85% of employees in this industry worked in small businesses. As noted in Chapter 5, “other services” includes jobs such as repairing

equipment and machinery, promoting or administering religious activities, operating dry cleaning and laundry services, conducting personal care, death care, and pet care services, and supplying photo processing services, temporary parking, dating services, grant making, and advocacy services.

Every year since 1982 the SBA has prepared a report for the U.S. president that summarizes the economic status and impact of small businesses. In The Small Business Economy for Data Year 2006: A Report to the President (December 2007, http://www.sba.gov/advo/research/sb_econ2007.pdf), the SBA indicates that small businesses accounted for all the net new jobs in the United States in 2004 (the most recent year for which data were available). Small businesses (i.e., those with less than five hundred employees each) added 1.8 million net jobs that year, whereas larger firms suffered a net loss of 181,000 jobs.

Katherine Kobe of the Economic Consulting Services examines in The Small Business Share of GDP, 1998–2004 (April 2007, http://www.sba.gov/advo/research/rs299tot.pdf) the contribution of small businesses to the

nation's GDP. Kobe notes that U.S. businesses with less than five hundred employees were responsible for approximately 48% to 51% of the nation's nonfarm, private industry GDP between 1998 and 2004. Thus, small businesses produce roughly half of the nation's nonfarm, private industry GDP.

Home-Based Businesses

Small businesses operated out of a person's home may be organized as any of the legal business structures. The latest comprehensive data on home-based businesses were collected in 2002 by the Census Bureau in its Survey of Business Owners (SBO; May 16, 2008, http://www.census.gov/csd/sbo/cbsummaryoffindings.htm). Approximately 16.7 million businesses participated in the SBO, representing nearly three-fourths (72.6%) of the nation's total nonfarm businesses operating at that time. Over eight million firms reported being home-based businesses. Nearly all (99.8%) were small businesses with less than five hundred employees. The four industries accounting for the most home-based businesses were professional, scientific, and technical services (19%), construction (16%), retail trade (11%), and other services (10%).

The Role of Big Business in the U.S. and Global Economies

Big businesses (i.e., those with five hundred or more employees) accounted for only 0.3% of all nonfarm firms in the United States in 2005. (See Figure 6.1.) However, these 17,477 big firms employed almost 58 million people (nearly half of the nation's total nonfarm workforce) and provided $2.5 trillion in payroll (just over 55% of the total annual payroll).

The business magazine Forbes publishes an annual list of the world's two thousand largest companies, with the most recent being “The Global 2000” (April 2, 2008, http://www.forbes.com/2008/04/02/worlds-largest-companies-biz-2000 global08-cx_sd_0402global_land.html). Forbes ranks public companies using a composite score based on sales, assets, profits, and market value. The top-ten-ranked companies in the 2008 report and their primary areas of business were:

• HSBC Holdings (banking)
• General Electric (conglomerate)
• Bank of America (banking)
• JP Morgan Chase (banking)
• Exxon Mobil (oil and gas)
• Royal Dutch Shell (oil and gas)
• BP (oil and gas)
• Toyota Motor (consumer durables)
• ING Group (insurance)
• Berkshire Hathaway (diversified financials)

Five of the top ten companies—General Electric, Bank of America, JP Morgan Chase, Exxon Mobil, and Berkshire Hathaway—are based in the United States. Together, the two thousand top-ranked public companies in the world employed seventy-two million people, had $119 trillion in assets, $30 trillion in revenues, $2.4 trillion in profits, and $39 trillion in market value.

Multinational Corporations

Many large businesses operate in more than one country, through subsidiaries or part ownership of foreign companies. These companies are called multinational or transnational corporations. Generally through mergers and acquisitions, a large company can grow beyond the boundaries of a single nation, buying and taking over companies in other countries to form a global network of subsidiaries. For example, Exxon Mobil, which was formed in 1999 by the merger of the two oil companies Exxon and Mobil, is headquartered in Irving, Texas, but it operates affiliated companies in at least forty countries on six continents.

Business and Politics

Large companies often have strong ties to the government. They have the resources to be able to donate millions of dollars to political campaigns to elect sympathetic lawmakers and to otherwise encourage the passage of pro-business legislation. Likewise, lawmakers, eager to have companies locate facilities in their constituencies to boost local economies, may support policies that favor business interests to the detriment of other programs. Members of Congress may be more inclined to pass pro-business laws if their region has benefited from a large corporation's presence, or if they or their party have received campaign contributions from such a company. This raises concerns that big businesses may be able to convince the government to favor their interests at the expense of the interests of other businesses, or even the population as a whole.

Economic Performance

U.S. businesses produce goods and provide services that are purchased by consumers. The consumption of business output is the major driving force behind the nation's GDP growth.

The U.S. Department of Commerce's Bureau of Economic Analysis (BEA) compiles data on the contributions made to the GDP by various industries. One measure of output is called real value added. This is defined as gross output minus the consumption of intermediate inputs. For example, the real value added to the economy by a manufacturer is calculated using the market value of the goods sold minus the cost of producing the goods.

Figure 6.2 shows the BEA breakdown of GDP growth per year by industry category from 2004 through 2007. In 2004 goods-producing and service-producing industries contributed almost equally to the annual GDP growth rate

of 3.6%. Over the next two years the contribution of services-producing industries increased slightly, whereas that of the goods-producing industries dropped dramatically to 1.3% in 2005 and to 0.8% in 2006. In 2007 the goods-producing sector had negative GDP growth. The services-producing sector experienced GDP growth of 3.2% in 2007, contributing to the overall rate of 2.2%.

The growth in the service-providing industry during 2007 was due to strong performance by information services (with a 9% increase) and professional and business services (with a 4.6% increase). (See Table 6.4.) The leading performer in the goods-producing sector was manufacturing of durable goods (with a 4.9% increase). Declines were reported in the construction industry (down 12.1%), manufacturing of nondurable goods (down 1.1%), and finance and insurance (down 0.3%).

Agriculture

The U.S. Department of Agriculture's National Agricultural Statistics Service (NASS) performs a census of

agriculture every five years. The most recent census was conducted in 2002 (http://www.agcensus.usda.gov/Publications/2002/index.asp). According to the results, there were just over two million farms and ranches operating in 2002. The NASS (http://www.agcensus.usda.gov/Help/FAQs/2002_Census/index.asp#1) defines a farm/ranch as an establishment from which at least $1,000 in agricultural products is produced or sold (or normally would be produced or sold) during a year. Even though less than 10% of farm/ranch establishments were owned by corporations or business partnerships in 2002, these farms accounted for nearly half of all sales and government payments.

The number of U.S. farms declined dramatically during the twentieth century, from 5.7 million in 1900 to 2.1 million in 2000. (See Table 6.5.) Likewise, farming's share of the nation's workforce decreased from 41% to only 2%. However, the average farm size increased from 146 acres to 441 acres. This growth, combined with advances in agricultural science and technology, has resulted in an increase in farm output, even as farming's contribution to the nation's GDP has diminished. (See Figure 6.3.)

Nonagricultural Businesses

The Census Bureau conducts an economic census every five years. Table 6.6 shows results from the 2002 economic census. (Note that the results from the 2007 economic census were not available as of July 2008). This table provides an economic overview of nonagricultural industry sectors with employee payrolls. The sectors are listed from largest to smallest in terms of value of sales, receipts, or shipments. Also included for each sector are the number of establishments, the number of paid employees, and the annual payroll.

Wholesale trade had $4.6 trillion in sales, receipts, or shipments during 2002. (See Table 6.6.) Wholesalers buy large quantities of finished goods from manufacturers and sell the goods in smaller lots to businesses engaged in retail trade. Retailers then offer the goods for sale to consumers at an increased price. There were over 1.1 million retail establishments operating in 2002. Even though the traditional notion of a retail establishment

includes at least one store location, many retailers operate via the Internet and/or catalog sales, instead of or besides their physical locations.

The manufacturing sector had the highest annual payroll in 2002 at $576 billion. (See Table 6.6.) Nearly 14.7 million people were employed in this sector, the second-highest number of the sectors listed. The health care and social assistance sector was the top employer with nearly 15.1 million paid employees.

Corporate Profits

One of the economic indicators tracked by the BEA is corporate profits. This is a measure of the income generated by corporations from the current production of goods and services. Because only current production is counted, corporate profits do not include capital gains, such as inventory profits.

Table 6.7 lists the corporate profits by industry from 2005 through 2007 and the change from 2006 to 2007. Corporate profits totaled almost $1.6 trillion in 2007, up by $41.5 billion from 2006. Domestic industries accounted for $1.3 trillion (79%) of the total in 2007. These values include adjustments for inventory valuation and capital consumption.

Among domestic industries, corporations engaged in financial services had the highest corporate profits in 2007. These businesses had profits of $498.5 billion (including only the inventory valuation adjustment). (See Table 6.7.) Similarly, the manufacturing sector had

corporate profits of $305.7 billion during 2007. Corporate profits were positive for all subsectors.

Figure 6.4 shows the percentage change in year-overyear growth in corporate profits for the first quarter of 2004 through the fourth quarter of 2007. Corporate profits for each quarter of 2007 were down, compared to the same quarter in 2006, indicating a general slowdown in the overall U.S. economy.

Industry Outlook

Table 6.8 lists the industries expected to undergo the greatest growth or decline in output through 2016. This list was compiled by the U.S. Bureau of Labor Statistics (BLS). The BLS expects phenomenal growth (a 20.5% increase) from businesses engaged in the manufacture of computers and peripheral equipment. This industry is expected to increase its output by $732.5 billion between 2006 and 2016. Strong performance is also expected from manufacturers of semiconductors and other electronic components, with an increase in output of $380.8 billion. Likewise, software publishers are expected to increase output by $266.5 billion during this period.

Industries expected to suffer the largest declines in output between 2006 and 2016 include footwear manufacturers (down 8.4%), cut and sew apparel manufacturers (down 5.9%), and tobacco manufacturers (down 5.6%). (See Table 6.8.)

Federal Regulation of Business

Historically, U.S. economic philosophy has been to let the market operate with a minimum of government interference. This does not mean, however, that U.S. businesses go unregulated. Many local, state, and federal laws exist to protect the public and the economy from dangerous, unfair, or fraudulent activities by businesses. Major federal programs that oversee business activities are:

• Federal Trade Commission (FTC)—created in 1914 with the passage of the Federal Trade Commission Act. Originally intended to combat the rise of business monopolies, the FTC grew to become the U.S. government's consumer protection agency, addressing consumer issues such as identity theft, false advertising, telemarketing and Internet scams, and anticompetition moves by businesses.
• Consumer Product Safety Commission (CPSC)— established in 1973 to protect the American public from unreasonable risks of serious injury or death from consumer products. Through a combination of voluntary and mandatory safety standards, the CPSC tries to prevent dangerous products from entering the market. If a product is found to be dangerous after it has already been sold to consumers, the CPSC has the duty to inform the public and the power to force a recall of the product if it is deemed necessary.
• Equal Employment Opportunity Commission (EEOC)— established in 1965, the EEOC is the primary federal agency responsible for preventing discrimination in the workplace. Its original purpose was to investigate violations of the Civil Rights Act of 1964, which prohibited discrimination in the workplace on the basis of race, color, national origin, sex, and religion. Over the years its powers have been expanded and it has been given responsibility to enforce other antidiscrimination laws.
• Employment Standards Administration (ESA)—one of the largest branches of the U.S. Department of Labor, the ESA is charged with enforcing a wide variety of labor laws dealing with minimum wage requirements, overtime pay standards, child labor protections, and unpaid leaves of absence. It also provides oversight of federal contractors about employment issues.
• The U.S. Environmental Protection Agency (EPA)— develops and enforces federal environmental regulations. The EPA keeps track of industrial pollutants and regularly updates its compliance codes for individual sectors and industries.
• The U.S. Food and Drug Administration (FDA)— works to ensure that the food, drugs, and cosmetics sold in the United States are safe and effective. It establishes safety and sanitation standards for manufacturers of these goods, as well as quality standards that the goods themselves must meet. FDA scientists must prove that certain products, especially drugs, are safe and effective before they can be sold in the United States, and it can force products off the market if they are later discovered to be dangerous. In addition, the FDA ensures that the labeling of food, drugs, and cosmetics is complete and truthful.

• The Occupational Safety and Health Administration (OSHA)—establishes and enforces workplace safety standards. One or more OSHA standards covers almost every workplace in the United States.

Other Agencies

Besides the previously mentioned agencies, there are a number of other government agencies that regulate specific industries or aspects of the economy. Some of them are well known, whereas many others may be virtually unknown to people outside the fields they regulate. A few examples are:

• The Federal Communications Commission regulates the telecommunications industry, including all television, radio, satellite, cable, and wire services in the United States and its territories.
• The Federal Energy Regulatory Commission regulates the national transmission network for oil, natural gas, and electricity.
• The Federal Maritime Commission regulates the waterborne foreign commerce of the United States.
• The National Highway Traffic Safety Administration regulates automobile design and safety.
• The Office of Surface Mining regulates surface coal mining.
• The Securities and Exchange Commission (SEC) regulates the stock market.

Government Regulation and Deregulation

Since the late 1970s the federal and many state governments have lessened their restrictions on certain industries. Called deregulation, this process allows industries to set their own standards and control their own systems of pricing and other business functions. For example, beginning in 1938 the airline industry was regulated by a federal body called the Civil Aeronautics Board, which controlled airlines' schedules, flying routes, and prices. To stimulate competition in the industry, Congress passed the Airline Deregulation Act of 1978. The industry experienced a flood of new airlines offering low fares to compete with the established airlines. Even though deregulation has actually caused some problems with larger airlines having too much control (or monopolizing) of the industry and with overly crowded flight routes, most economists agree that the result has been an air transportation system that offers some of the lowest costs and safest flights in its one-hundred-year history. Other industries that have experienced some degree of deregulation include electric utilities, telephone services, trucking, railroads, and banking.

Market Power: Monopolies and Monopsonies

One of the foundations of a capitalistic economy is competition. Competition for customers among sellers theoretically ensures that buyers receive the lowest price. If an industry becomes dominated by one seller, the lack of competition allows that entity to set prices in the marketplace—a situation known as monopolization. The federal government has long fought against monopolization in most U.S. industries. In 1890 Congress passed the Sherman Antitrust Act to strengthen competitive forces in the economy. Section 2 of the law states: “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony.”

A monopsony is a different situation, in which the power lies with one buyer. This arrangement can occur if one company wields enormous power over the suppliers in that industry. The lack of other customers forces the suppliers to meet the price and quota demands of the monopsonist. Monopsony is an obscure economic concept to most Americans. However, changing market forces in the retail industry are drawing attention to the possible existence and consequences of monopsony in some business sectors.

The Microsoft Monopoly?

In 1993 the U.S. Department of Justice began an investigation of the software company Microsoft based on allegations that the company was engaging in unfair competition. Microsoft's Windows program already dominated the operating systems market. By bundling Web browsers and other applications with Windows, Microsoft made it difficult for other companies to compete in the market for these other applications as well.

In 1994 Microsoft reached an agreement with the Department of Justice, and the company agreed to stop bundling other products with Windows. In 1998 Microsoft was accused of violating its agreement, and the Department of Justice and the attorneys general of twenty states brought an antitrust suit against it. Microsoft reached a settlement in the case but still faced a number of class-action lawsuits. (A class-action lawsuit is one that is filed by a large group of people, all of whom accuse a single company of engaging in the same illegal acts against them.)

During the early 2000s Microsoft fought and lost antitrust cases brought against it in Japan, South Korea, and Europe. In 2004 a European court ordered Microsoft to pay a fine of $613 million for violating the European Union's competition law. The company was also ordered to offer for sale a modified version of Windows that does not include a media player and to share certain communications protocols with competitors. In July 2006 the European Commission levied a $357 million fine against Microsoft for failing to fully comply with the 2004 ruling. Microsoft appealed the fine, but lost in September 2007. In February 2008 the European Commission claimed that Microsoft had failed to fully comply with the original ruling, so it levied an additional $1.3 billion fine against the company. In May 2008 the company announced that it would appeal the latest fine.

The Wal-Mart Monopsony?

During the early 2000s the mega-retailer Wal-Mart became the subject of much media attention for its business practices. In November 2003 the Los Angeles Times published a three-part series on Wal-Mart. In part two, Nancy Cleeland, Evelyn Iritani, and Tyler Marshall describe in “Scouring the Globe to Give Shoppers an $8.63 Polo Shirt” the relentless push at Wal-Mart for suppliers to lower costs. One textile producer summed up Wal-Mart's power: “They control so much of retail that they can put someone into business or take someone out of business if they choose to.”

In November 2004 the Public Broadcasting System (PBS) series Frontline aired the episode “Is Wal-Mart Good for America?” (http://www.pbs.org/wgbh/pages/frontline/shows/walmart/). The episode traces the rise of Wal-Mart as a major force in the retail industry and describes the power that the company developed over its suppliers. Sam Hornblower notes in “Always Low Prices” (November 23, 2004, http://www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/pricing.html) that “Wal-Mart used its buying power and its information about consumer buying habits to force vendors into squeezing their costs and keeping their profit margins low. Over time, some suppliers—especially middle-sized and smaller firms— were bankrupted.”

In 2004 Wal-Mart employed 1.2 million employees and served 100 million shoppers per week at more than 3,000 stores around the country. The company had sales of $256 billion in 2003 and accounted for approximately 8% of total U.S. retail sales (excluding automobiles).

Wal-Mart's relatively small share of retail sales is one factor that helps the company avoid antitrust charges. In “Discount Nation: Is Wal-Mart Good for America?” (New York Times, December 7, 2003), Steve Lohr asserts that Wal-Mart's emphasis on low prices to consumers is another factor. Peter J. Solomon states in “A Lesson from Wal-Mart” (Washington Post, March 28, 2004) that “federal regulators have refrained from pursuing monopsony antitrust action against Wal-Mart for putting the squeeze on its suppliers, because of the price benefits to consumers.”

Corporate Behavior and Responsibility

Businesses play a vital role in the economic well-being of the United States. Besides economic performance, Americans also expect businesses to behave in a legally and socially responsible manner. There is no public or political consensus on the exact social responsibilities of businesses. However, it is recognized that the decisions and practices of company officials, particularly of large corporations, affect not only employees and investors but also the communities in which businesses are located. Fraud and corruption at the corporate level can adversely affect large numbers of people. Likewise, poor performance by businesses in meeting environmental, health, or consumer-protection standards has detrimental effects on society at large.

Corporate Scandals

ENRON. Based in Houston, Texas, Enron was an international broker of commodities such as natural gas, water, coal, and steel. In August 2000 Enron's stock rose to an all-time high of $90 per share. However, the company was incurring more and more debt because its contracts outstripped its ability to deliver. To hide its liabilities, Enron created a web of partnerships; the idea was to transfer debt so it would not show on the company's books. Enron's accounting firm, Arthur Andersen, helped the company hide its debts and shredded key documents. With debts transferred to other entities, Arthur Andersen and Enron could overstate the value of the company, and its stock continued to perform well.

Enron eventually had to pay the debts either with cash or with stock, which would create a huge loss that the company could not hide. Sherron Watkins (1959–), the vice president of Enron, discovered the accounting discrepancy in the summer of 2001, and she became the key whistleblower when she sent a memo about the problem to the chief executive officer (CEO) Kenneth Lay (1942–2006). In October 2001 Enron announced part of the loss—$638 million in the third quarter of 2001, with a loss in shareholder equity of $1.2 billion—and its stock price plummeted. The company announced that it was being investigated by the SEC for possible conflicts of interest with its many partnerships. In November 2001 Enron stock dropped to less than a dollar per share, and in December the company filed for bankruptcy. Four thousand employees were laid off at that time.

Shortly before announcing the income overstatement, Enron executives took two additional steps. First, some of them sold their stock so they could get their money out before the stock lost all its value. Second, the company imposed a freeze on employee sales of the stock shares in their 401(k) plans. So when the news broke and employees tried to sell their stock to save what they could of their retirement savings funds, they found that they were stuck with worthless stock in a bankrupt company. Thousands of people lost their jobs, along with their health care, retirement funds, and, in many cases, life savings. Even though investors both in and outside the company lost tens of billions of dollars, Enron wrote $55 million in bonus checks for company executives the day before it declared bankruptcy.

In 2002 Arthur Andersen, Enron's accounting firm, was found guilty of obstruction of justice charges; two years later the company also lost its appeal of the original ruling.

In December 2005 the former accounting officer Richard Causey (1960–) pleaded guilty to securities fraud and agreed to cooperate with authorities in exchange for a plea deal that included a five- to seven-year prison term and a $1.3 million fine. In May 2006, after a long trial, Lay and the former CEO Jeffrey Skilling (1953–) were found guilty on various counts of fraud and conspiracy. Lay died six weeks later from a heart attack. In October 2006 Skilling was sentenced to more than twenty-four years in prison and was fined $45 million. As of July 2008, his case was under appeal. Dozens of other people were charged in the Enron scandal, including three British bankers who were sentenced in February 2008 to thirty-seven-month prison terms.

WORLDCOM. In 2002 the federal government began investigating the accounting practices of WorldCom, the second largest long-distance telephone company in the United States and the world's largest Internet service provider. Eventually, an $11 billion scandal was uncovered. The company filed for bankruptcy—the largest such filing in U.S. history to date. The stock held by investors was worthless, and thousands of former employees lost their jobs, pensions, benefits, and severance pay.

Company executives were indicted on fraud charges; several agreed to testify against the former CEO Bernard J. Ebbers (1941–) in exchange for lighter sentences. In March 2005 Ebbers was convicted of all nine charges against him. He received a sentence of twenty-five years in prison.

TYCO. In 2002 Tyco International became embroiled in a series of scandals centered on L. Dennis Kozlowski (1946–), the company's CEO, and Mark H. Swartz (1960–), the company's chief financial officer (CFO). Both men resigned and were sued by Tyco in connection with $600 million in loans, salary, and fringe benefits they allegedly took from the company without board approval. The government indicted the men for grand larceny and securities fraud, among other criminal charges.

Kozlowski and Swartz were first tried in September 2003. Particularly at issue during the trial was Kozlowski's extravagant lifestyle. Prosecutors told of Kozlowski throwing his wife a $2.1 million birthday party paid for in part by Tyco, living in a $19 million Manhattan duplex bought for him by the company, and purchasing a $6,000 shower curtain, all while Tyco investors lost millions because of his stock manipulations. The case was declared a mistrial in April 2004 when a juror, suspected of communicating with defense attorneys, was named in the media and subsequently received threatening letters and phone calls. In 2005 the men were retried, found guilty, and sentenced to up to twenty-five years in prison.

QWEST COMMUNICATIONS. In 2001 federal officials began investigating an accounting scandal at Qwest Communications International. The government ultimately found that the company had overstated its earnings by more than $2 billion. By the time the scandal became public in 2002, top Qwest executives had sold millions of dollars in company stock, even though they knew the company was in serious financial trouble. In 2006 Robin Szeliga (1961–), Qwest's former CFO, was sentenced to two years' probation, with the first six months home detention, and fined $250,000 for her role in the scandal. She received a light sentence in exchange for testifying against other top executives, including the CEO Joseph P. Nacchio (1949–). In July 2007 Nacchio was sentenced to six years in federal prison, fined $19 million, and ordered to forfeit $52 million he made from illegal stock sales. In March 2008 Nacchio's lawyers won an appeal for a retrial.

Big Tobacco: An Industry under Attack

In the 1990s many state governments brought lawsuits against the nation's major tobacco firms to recoup taxpayer money spent treating sick smokers under state Medicaid programs. In 1998 a settlement was reached in which the companies agreed to pay a total of $246 billion spread among the governments of all fifty states. The payments are to be made over a twenty-five-year period. The settlement also required the tobacco companies to change their advertising methods and reduce their political lobbying efforts.

In 1999 the federal government filed its own lawsuit, United States v. Philip Morris (116 F. Supp. 2d 131), against the tobacco companies, alleging that the defendants had engaged in a decades-long scheme to “defraud the American public” regarding the safety of cigarette smoking. The case centered on internal documents obtained from tobacco companies that seemed to demonstrate that the companies were well aware that nicotine was addictive and cigarette smoking caused lung cancer. The trial began in 2004 and lasted for nine months.

In August 2006 Judge Gladys Kessler (1938–) of the U.S. District Court for the District of Columbia ruled that the cigarette companies had committed civil violations of the Racketeer Influenced and Corrupt Organizations (RICO) Act. However, rulings by other courts during 2005 meant that the government could not receive billions of dollars in penalty fines that it had sought from the tobacco companies. Kessler did order the companies to remove terms such as light and ultra light from cigarette packaging. That order was stayed (delayed) several months later when the companies appealed the case. In 2007 the federal government began filing legal briefs indicating its intent to also appeal the case. As of July 2008, those appeals had not been heard in court.

The lawsuits represent an unusual occurrence in U.S. history, because the government has brought financial pressure on an entire industry. Rising costs of doing business in an unfavorable climate have led tobacco companies to raise prices. Price inflation for tobacco products has outpaced the general inflation rate over this period, particularly since 1999. On the flip side of the supply-demand relationship, the consumption of cigarettes has dropped dramatically. This is likely due to a combination of price pressure and greater public awareness about the dangers of smoking. The total U.S. consumption of cigarettes peaked in the 1980s at around 640 billion cigarettes per year. (See Figure 6.5.) Since then, consumption has plummeted; only 378 billion cigarettes were purchased in 2005, based on preliminary estimates.

Gregory N. Connolly and Hillel R. Alpert report in “Trends in the Use of Cigarettes and Other Tobacco Products, 2000–2007” (Journal of the American Medical Association, vol. 299, no. 21, June 11, 2008) that U.S. sales of cigarette packs decreased from 21.1 billion in 2000 to 17.4 billion in 2007, an 18% decline.

Public Perception of Big Business

In June 2007 the Gallup Organization conducted a poll to gauge public confidence in various institutions.

The military garnered the highest rating, with 69% of those asked expressing a great deal or quite a lot of confidence in the military. (See Figure 6.6.) Small business also fared well with 58% of respondents providing a favorable opinion. Big business received a much lower rating. Only 18% of respondents had a great deal or quite a lot of confidence in big business.