Serving Two Masters

Talk about corruption in developing countries -- and in some developed ones -- is running rampant. In the past, corruption was usually said to be located within the ranks of public servants, and this was used as a partial justification for privatization, especially in developing countries. Cheerleaders of the private sector, however, failed to reckon with the ability of company bosses to indulge in corrupt practices on an almost unfathomable scale, something American corporate capitalism has demonstrated amply of late.

Corrupt bosses put to shame petty government bureaucrats who steal a measly few thousand dollars -- even a few million. The scale of theft achieved by those who ransacked Enron, Worldcom, and other corporations is in the billions of dollars, greater than the GDP of many countries.

My research over the past thirty years focused on the economics of information. With perfect information -- an assumption made by traditional economics, though one not fully appreciated by free market advocates -- these problems would never have occurred. Shareholders would instantly realize that the books were cooked, and roundly punish the offending company's share price.

But information is never perfect. Because of tax advantages and inappropriate accounting practices firms richly rewarded executives with stock options. With these in hand, company bosses could ensure that they were well paid without doing anything to benefit their company's bottom line. All they needed to do was boost the stock price, then cash in their option. It was a system almost too good to be true: while executives received millions in compensation, no one seemed to be bearing the cost.