Enron & Henry Ford

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Just as every cloud has a silver lining, so disasters always have a redeeming feature. Because of the Titanic , no major ship has struck an iceberg since. That most famous of disasters produced a slew of reforms, all of which made the sea a much safer place. Business and financial disasters, too, have led the way to fundamental reforms that made the capitalist system, as a whole, safer and more productive. The collapse of thousands of banks in the Great Depression resulted in a banking system in which not one depositor has lost a cent of insured funds since 1934. The failure of Samuel Insull’s overleveraged electricity empire in the early 1930s led directly to new rules governing holding companies.

Today’s ongoing Enron saga will undoubtedly lead to many new procedures for bookkeeping, auditing ethics and rules, offshore subsidiaries, and the ways in which Wall Street analyzes stock. The collapse of one of the largest American corporations will also, one hopes, result in thoroughgoing reforms in corporate governance. They are needed.

In theory the stockholders of a corporation elect a board of directors that in turn hires the management and evaluates its performance, rewarding it or firing it as needed. But because of one of the iron laws of human nature, that institutions tend to evolve in ways that favor their elites, many corporate boards today are, in fact, controlled by the management they are supposed to supervise. The chief executive is often the board chairman as well, as was the case with Enron, and frequently decides who else sits on the board. Thus the other members of the board are not about to criticize the chief executive freely. And, since it is the board of directors that sets the compensation of top management, it is small wonder that management salaries have escalated far faster than inflation or even corporate profits in recent years.

In effect, then, in many American corporations with widely dispersed stockholders, the top management has no boss. But everyone needs a boss, for the reason Lord Acton made clear more than a hundred years ago and, it seems, Enron has proved once again: Power corrupts, and absolute power corrupts absolutely.

There could be no better historical example of what happens when top management answers only to itself than the Ford Motor Company in the 1920s, as Peter Collier and David Horowitz make clear in their book The Fords: An American Epic . In that case, of course, it was not that management became unaccountable to stockholders; it was that Henry Ford and his son, Edsel, owned 100 percent of the stock.

The Ford Motor Company was founded in 1903. For capital, Henry Ford turned to Alexander Malcomson, a successful Detroit coal merchant. Together Ford and Malcomson held 51 percent of the stock; the rest belonged to such investors as John and Horace Dodge, who supplied such automotive components as engine blocks and transmissions (and who would later build their own line of cars).

The Ford company got off to a successful start, thanks to successes in automobile racing. But Malcomson wanted to concentrate on a larger model, the Model K, with six cylinders, aimed at the uppermiddle-class market. Ford would have none of it. “A car should not have any more cylinders than a cow has teats,” he proclaimed. Instead he wanted to make a plain car for the masses. “The way to make automobiles,” he told his attorney, “is to make one automobile like another automobile ... just as one pin is like another pin when it comes from a pin factory.” In July 1906 Ford and Malcomson parted company, Ford paying Malcomson $175,000 for his 25.5 percent interest in the business. Now, with 51 percent of the stock, Ford was in unquestioned control of the company.

And as the world knows, Ford was right. The Model T, introduced in October 1908, was an immediate success. Simple, rugged, and affordable, it caught the wave of rising enthusiasm for the new form of transportation and rode it to glory. And the Ford Motor Company became one of the great cash cows in the history of capitalism. In July 1909, the company paid out $1.7 million in dividends to its handful of investors and also distributed $1.9 million of new stock. A week later it declared an extra dividend of $600,000.

But while Henry Ford was deeply interested in endlessly refining the manufacturing process in order to lower the manufacturing cost and thus the sales price (he would introduce the revolutionary assembly line in 1913), he believed that the Model T was the answer to the nation’s automotive needs and always would be. In 1912, while he and his family toured the British Isles, Harold Wills, one of the company’s top executives, decided to surprise him with a new version of the T, to take advantage of rapidly evolving automotive technology. One employee thought the new version was “so much over the original it was like night and day.”

When Ford returned to Detroit, he went directly to the plant and quickly spotted it. He asked what it was.

“Well, Mr. Ford,” answered an employee, “that’s the new car.”

“Ford car?” he asked.

“Yes, sir.”