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Journal of Business Ethics (2005) 59: 347360 Springer 2005

DOI 10.1007/s10551-004-7308-2

Agency Theory, Reasoning and


Culture at Enron: In Search of a
Solution Brian W. Kulik

ABSTRACT. Applying evidence from recently available Introduction


public information on Enron, I defined Enrons culture as
one rooted in agency theory by asserting that Enrons What can a corporate executive do to positively
members were predominantly agency-reasoning individ- influence organization-wide ethical conduct? The
uals. I then identified conditions present at Enrons ethics literature is replete with suggestions, including
collapse: a strong agency culture with collectively non-
selection and hiring of ethically-oriented employees
compliant norms, a munificent rare-failure environment,
and new hires with little business ethics training. Turning
(Abdolmohammadi et al., 2003), establishing codes
to four possible antidotes (selection, objectivist integrity, of ethics (Gaumnitz and Lere, 2004), promoting an
integrity capacity, and stewardship reasoning) to an ethical culture (Sims and Brinkmann, 2003), devel-
agency culture under these conditions, I argued that the oping employees internally (Becker, 1998; Petrick
currently available ethics literature would have made little and Quinn, 2000), and taking a stewardship per-
difference toward averting Enrons collapse if any of the spective (Davis et al., 1997). Given the well-known
recommendations from the relevant ethics literature had recent corporate scandals, and especially the plethora
been implemented. I conclude by identifying new of now publicly available information that is avail-
directions for business ethics literature in order to make it able from Enron, two critical questions emerge.
more implementable under the conditions identified at First, if the suggestions from the literature cited
Enron. Essentially, we need a way to clearly determine (1) above had been implemented by Enrons top man-
the difference between connivance and commitment, (2)
agement team, could Enrons ethics shortcomings
what is meant by balance with regard to the multiple
dimensions of ethics and legal theories, and (3) the proper
have been avoided and bankruptcy averted? Second,
balance between agency and stewardship reasoning. if the answer to the first question is no, then in
what direction(s) must the relevant ethics literature
KEY WORDS: agency theory, Enron, integrity, integ- proceed before suggestionimplementation congru-
rity capacity, organizational culture, stewardship theory, ence is obtained?
unethical behavior The case of Enron stands as a unique opportunity
to investigate the above critical questions because the
widespread interest in identifying Enrons downfall,
and what the business world should do about it, has
Brian E. Kulik is a Ph.D. candidate in Management at spawned a number of books and articles. In addition,
Washington State Universitys School of Business. His work the previously private information now made public
focuses on the prevention of corporate corruption, corporate by the companys bankruptcy proceedings has shed
governance and ethics, teamwork and diversity, and research
light on Enrons operations to a depth that is not
methods. His research to date has appeared in the Western
available from most other companies, public or
and National Academy of Management conference proceed-
ings and the journal Organizational Analysis. He earned private. For example, bankruptcy court-appointed
M.S. degrees from Washington State University and The examiner Neal Batsons third interim report (2003)
University of Cincinnati, and M.B.A. from The University found that six financial institutions had actual
of Denver. knowledge of Enrons wrongful conduct, gave
348 Brian W. Kulik

substantial assistance by aiding in the structuring basic tenets of the agency relationship, with parallels
and funding of Enrons now infamous special-pur- drawn between their dysfunctional culture and
pose entities, that the amount of money involved agency theorys characteristics. In search of a solution
was material, and that such disguise harmed other based on recommendations made in the ethics liter-
creditors. These findings may help define limits to ature, I investigate alternative approaches that an
strategic alliances more clearly and delineate a firms organizations cultural and ethical base might instead
motivation for the creation of such alliances. In a be founded on, but I find limits to their effectiveness
recent book by Smith and Emshwiller (2003), the in correcting the problems in an agency culture. I
Wall Street Journal reporters who first made known conclude by noting that, while enduring companies
some of Enrons impropriety (specifically, special cannot harbor cultures based purely in agency theory,
purpose entities, or SPEs, named LJM and LJM2) to vital questions must be answered before specific and
the public, chronicled their work before and during effective measures can be taken to avert the emer-
Enrons demise. This work may be interesting to gence of a destructive culture such as Enrons.
researchers in the tactical positioning that companies
use in the disclosure of negative information. Finally,
a book co-authored by Sherron Watkins (Swartz and Agency theory
Watkins, 2003), former vice president at Enron,
details her involvement in Enron since 1993. Their Agency theory, as developed primarily by Jensen and
contribution was essentially an exposure of the cul- Meckling (1976), is a popular tenet in corporate
tural and climatic conditions within which Enron governance today. For example, the ISI Social Sci-
employees worked. There is a growing consensus on ence Citation Index finds that Jensen and Mecklings
the idea that Enrons culture, rather than the isolated (1976) work has been cited more than 3,000 times
actions of a few individuals, was the key enabling since 1989 and every article in the Academy of
mechanism that allowed the widespread practice of Management Reviews 2003 special issue on cor-
unethical and illegal behavior based on self-interest porate governance cited Jensen and Meckling (1976;
(Bryce, 2003; Cruver, 2002; Fusaro and Miller, see Daily et al., 2003), and at least one textbook on
2002; Mills, 2003; Sims and Brinkmann, 2003; strategic management (Hitt et al., 2005) structures its
Swartz and Watkins, 2003; Windsor, 2004). How- chapter on corporate governance around agency
ever, no attempt has been made to link the charac- theory. Typical of its use in articles concerned with
teristics of Enrons culture to a theoretical base that corporate governance, Daily et al. (2003) stated:
might be used to both test the potential imple- Jensen and Meckling (1976) proposed agency
mentability of recommendations to practitioners in theory as an explanation of how the public corpo-
the ethics literature and the closeness of Enrons ration could exist, given the assumption that man-
culture to those of other firms. agers are self-interested, and a context in which
This paper first establishes a theoretical base which those managers do not bear the full wealth effects of
might be used (1) as a means in itself of providing their decisions (p. 372). Thus, one can hardly avoid
practitioners a way to avert future Enron-like deba- discussion of agency theory in any dialogue on
cles by the identification and generalization of corporate governance.
Enrons culture and (2) as a test of the avertability of In particular, agency theory states that, in a public
Enrons downfall through some of the ethics litera- corporation, there exists a central problem with re-
tures recommendations. To this dual end, I draw a gard to shareholders interests: top management does
number of parallels between Enrons culture and not always act to maximize shareholders return on
agency theory, a theory made popular by lawyers, investment. With regard to a corporate executive,
economists, and finance and management theorists, agency costs will be generated by the divergence
that attempts to explain the effectiveness of corporate between his interest and those of outside share-
governance in publicly-held corporations. The next holders (Jensen and Meckling, 1976, p. 313).
section describes the key elements of agency theory According to Rediker and Seth (1995), mechanisms
and how it is purported to work correctly. Then, used to align the interests of the manager with those
Enrons culture is identified as one centered in the of the shareholders take the form of threats (of
Agency Theory, Reasoning and Culture at Enron 349

takeover, competition in product markets, and tune named Enron the most innovative company for
competition in executive labor markets), monitoring seven consecutive years prior to its downfall (Cruver,
(from outside shareholders, boards of directors, and 2003; Swartz and Watkins, 2003), and as late as 2001 it
according to Jensen, 1986, creditors under high debt printed a glowing interview of Ken Lay (Hamel,
levels), and incentives (stock ownership, salary, and 2001). An article appeared in Money as one of six
perquisites). Unfortunately, these mechanisms are energy stocks that can light up your profits (Brush,
limited in use because they are associated with costs 1997, p. 108). Chief Executive (1997) wrote a positive
(called agency costs), so that there always exists an profile of Ken Lay, stating that Lay estimates com-
agency problem (Fama, 1980) in that managers petition will reduce consumer electricity bills by 30 to
behavior will never be fully aligned with the 40 percent which would be like a national tax cut of
interests of the firms shareholders (or more gener- around $70 billion. (p. 41). That same year (1997),
ally, risk bearers after Fama, 1980). Furthermore, Ken Lay also attended the World Economic Forum,
it is likely that the most important conflict arises and was an honored guest at the opening of Rice
from the fact that as the managers ownership claim Universitys James A. Baker III Institute for Public
falls, his incentive to devote significant effort to Policy (Swartz and Watkins, 2003). Even when near
creative activities such as searching out new profit- bankruptcy, despite a falling stock price throughout
able ventures falls (Jensen and Meckling, 1976, p. 2001 and some negative press, a positive article ap-
313). Said another way, in addition to agency costs, peared as late as November, 2001 in which the mag-
divergence of interest also generates a divergence of azine Better Investing (2001) noted that the
managerial attention to his or her own interests, and consensus opinion among the analysts making esti-
not to the interests of the shareholders. Thus, agency mates was that Enrons earnings will grow at an
theory assumes that publicly held firms endure by average annual rate of 17 percent over the next five
finding ways to efficiently solve the agency problem years (p. 54), while on October 26, the Wall Street
by aligning their managers behavior with share- Journals article on Enron began: Enron: Rarely have
holders interests in such a way that agency costs are so many analysts liked a stock they concede they know
low enough to allow for the creation of corporate so little about (Craig and Weil, 2001), an article that
profits. was at least backhandedly positive in that the stock was
Unfortunately, some self-serving executives may seen as still popular among investors even though it
have interpreted this theory as a way to act in a self- was acknowledged that no one understood its balance
serving, even unethical manner as long as they sheets. Furthermore, Enron had the support and
operate within certain constraints (governance direction of consulting firm McKinsey and Co., case
mechanisms) and with an effort roughly proportional studies were written by Harvard Business School
to their incentives (a combination of pay and per- Publishing (Rangan et al., 1996; Tufano and
quisites the pay package point). As long as their Bhatnagar, 1994), and a supposedly exemplary Enron
behavior is not outside the boundaries set by the team was profiled in a popular teamwork book that is
governance mechanisms in place, an anything-goes still widely cited in the literature for its teamwork
type of attitude may emerge, which can become the theory (Katzenbach and Smith, 1993). Enron was also
foundation for an organizations culture. Below, I popular from a societal point of view, as CEO Ken Lay
elaborate on what is meant by an agency culture became a well-known philanthropist who contrib-
and offer evidence of its existence in the Enron case. uted generously to a number of charities and politi-
cians campaigns with personal and Enron funds.
Philanthropy was not limited to Lay, but Swartz and
Agency culture: The Enron case Watkins (2003) and Bryce (2003) claimed that each
senior executive was involved in his or her favorite
Until November 2001, Enron was a highly respected charity. Taken collectively, one could conclude that
organization. For example, in 1997, Business Week Enron had built up a considerable amount of reputa-
named CEO Ken Lay one of the top 25 managers of tional capital with politicians, minorities, local
the year, followed by a positive profile on Enrons businesspeople, charities, academia, investors, and the
electricity trading business (McWilliams, 1997). For- business press. At the same time, however, unusually
350 Brian W. Kulik

excessive perquisites were apparently consumed by describing the mechanisms of corporate governance.
Enron employees at all levels of the organization His own Ph.D. work was centered in free market
(Bryce, 2003; Cruver, 2002; Swartz and Watkins, theory (Fusaro and Miller, 2002), which he applied
2003) as discussed in more detail below. both outwardly as a corporate strategy, or formula, for
As Petrick et al. (1999) highlighted, reputational success (Swartz and Watkins, 2003), and inwardly by
capital is an important antecedent to sustainable retaining, every six months, only the upper 85th per-
competitive advantage. How, then, could the centile of Enrons employees after their semiannual
simultaneous building up of social capital and the ranking by the firms performance appraisal (Cruver,
excessive, nonsustainable acquisition of pay and 2002; Swartz and Watkins, 2003). Executives Jeffrey
perquisites by the very same corporate executives Skilling and Rebecca Mark, both Harvard MBAs, also
have occurred? Identifying some of Enrons execu- must have been familiar with agency theory. So too
tives as anomalous bad apples, with personality should have Andy Fastow, with an undergraduate de-
traits including greed, dishonesty, arrogance, self- gree in economics (and Chinese) from Tufts University
ishness, cowardice, hypocrisy, disrespect, and injus- and an MBA from Northwestern University. Finally,
tice (Petrick and Scherer, 2003, p. 40) ignores Michael Kopper, who worked with Fastow on the
Enrons prior popularity and the substantial social now-infamous SPEs, held an advanced degree from the
capital that these same executives had shored up. To London School of Economics, and also must have been
alternatively point to the system as flawed and in familiar with agency theory. Even if agency theory
need of more controls, such as the use of more, were not known among these and other executives,
better, and more transparent accounting rules one of its central assumptions, that of self-interested
(Petrick and Scherer, 2003; Senate Subcommittee parties (Eisenhardt, 1989), is certainly a fairly common
on Investigations, 2002) may merely motivate im- theory in many economics theories (Harrison, 1986),
moral, but innovative executives, accountants, and and it is this assumption that is essential to thinking
lawyers to find different ways around the new within an agency theory framework.
controls (Mills, 2003). Instead, Enrons core beliefs If Enrons executives were taught agency theory
and values must be investigated in an effort to query as part of their business/economics education, then
just how Enron could be simultaneously popular and they may have used agency reasoning in the design
insidious. Only then can one hope to curtail the of Enrons organizational structure and its policies.
proliferation of corruption, what Petrick and Scherer
(2003) called Enronitis (p. 37), regardless of any Definition 1: Agency Reasoning is any behavior or
future accounting, SEC, or NYSE rule changes. demonstration of rational thought that links corporate
governance mechanisms (incentives and controls) with
Below, I argue that Enrons core values and be-
individual behavior.
liefs were forged by the basic tenets of agency the-
ory. My argument is in two steps: (1) Enrons senior
Thus, an individual expressing agency reasoning
executives used agency reasoning to both determine
might express that his/her low pay has a negative effect
and explain their behavior and (2) this agency rea-
on his/her incentive to maximize his/her companys
soning resulted in a corporate attitude throughout
profits. This definition leads us to a proposition that
the organization that led to a culturally accepted
summarizes the first step of my argument:
behavioral norm: an agency culture.
Proposition 1: If Enron executives applied agency rea-
soning to both determine and explain their behavior,
Enron executives and agency reasoning then published material describing their behavior will
contain agency reasoning.
In speculative support of the first step of my argument,
note that many of Enrons executives were well edu- Evidence for agency reasoning by Enron executives
cated in business and economics to be sufficiently
familiar with agency theory. For example, Ken Lay, The first piece of evidence is an argument given to
with a Ph.D. in economics, must have known about the board of directors for approval of one of Fastows
agency theory as one of several economic theories SPEs, LJM2:
Agency Theory, Reasoning and Culture at Enron 351

Based on Fastows presentation, the Directors envi- project. Mark, however, made money on the project
sioned a model in which Enron business units con- because she had incentive to close the deal the
trolled the assets to be sold to LJM2 (or alternative biggest possible but no incentive to show prof-
potential buyers) and would be negotiating on behalf itability from operations or even a finished project.
of Enron. Because each business units financial results Thus, Mark allowed herself to follow her own self-
were at stake, the Board assumed they had an incentive
interest as long as the boundaries set by control
to insist that transactions were on the most favorable
mechanisms (such as scrutiny by Enrons award-
terms available in the market (Powers, Troubh and
Winokur, 2002, pp. 152153).
winning board of directors or internal managerial
accounting efforts) were not crossed and sufficient
In other words, Enrons directors reasoned that the incentive was provided for through bonus pay:
incentives of agents for Enrons business units were Agency reasoning.
sufficiently aligned with Enrons stockholders
interests, and not with Fastows. Following Rediker
and Seth (1995), the aligning mechanism that the Evidence for agency reasoning by Enron employees
board of directors assumed was active in this case was
the threat of takeover (of losing ones job because of Leaders can have a major influence on an organi-
the business units poor performance), which implies zations culture (Schein, 1992) which in turn can act
further that mechanisms of monitoring performance as an important control mechanism for individual
and motivation through the incentive of a high pay behavior. Schein (1992) described culture as
package point were also active. That Fastow, as emerging from the repeated resolution of recurring
CFO, had sufficient control over the performance problems in the same way over time. Thus, followers
review process and distribution of bonuses to may adopt their leaders values, beliefs, assumptions,
manipulate his own incentives (Swartz and Wat- and expectations (Clawson, 2002) if these help solve
kins, 2003) is beside the point here: In his presen- recurring problems. Scheins (1992) theory has re-
tation to Enrons board of directors, the board itself cently received some empirical support at the
being an important governance mechanism accord- supervisorsubordinate dyad level (Block, 2003),
ing to Hitt et al. (2005), Fastow applied agency wherein cultural dimensions of involvement, con-
theory to predict the behavior of Enron executives sistency, mission, and adaptability were observed to
in their negotiations with LJM2 by using an be strongly and positively correlated with the
incentive argument. In short, Fastow, and the transformational leadership styles, weakly correlated
Enron directors in their approval of LJM2, applied with the transactional style, and negatively correlated
agency reasoning. with the laissez-faire style of leadership (see Yukl,
As further support for Proposition 1, I offer a 1998, for definitions of these three leadership styles).
description of Rebecca Marks closing of the second These results suggest that leaders values, beliefs,
phase of the Dabhol power plant deal (before the assumptions, and expectations may at least partially
first phase was completed) as described by Bryce explain the behavior of followers, especially for
(2003): value-oriented transformational-style leaders. Fur-
thermore, five of Scheins (1992) six primary lead-
ership mechanisms of attention, reaction to crises,
Mark prevailed. She got a bigger project. And a
bigger project meant no surprise a bigger bonus.
role modeling and a leaders behavior, the allocation
Getting the second phase of Dabhol approved right of rewards, and criteria of selection and dismissal
away meant doubling or tripling her bonus, said one have recently been used as a framework for
Enron employee who worked on Dabhol. Ill never explaining why Enrons culture contradicted its own
again underestimate the power of an incentive com- code of ethics (Sims and Brinkmann, 2003). Thus,
pensation program and the desire it can instill in assuming that Scheins leadership mechanisms were
people (p. 172). active and effective, and that leaders styles were
predominantly transformational (as Bryce, 2003,
Phase one was never finished at Dabhol and Enron suggested when describing the differences in styles
realized significant losses upon the failure of this between the transactional-styled Kinder, and
352 Brian W. Kulik

Skilling, his transformational-styled successor as control mechanism here, where all of the other
COO), the agency problem may be one of those governance mechanisms lay dormant (referred to as
recurring problems identified by Schein (1992) that no rules in the above excerpt). Bryces (2003)
allows leaders to propose their own solutions. Such account of employees expectations was little dif-
leaders may thereby influence their followers who ferent:
subsequently adopt their leaders solution. For
example, Jeffrey Skilling, Enrons de facto leader Flowers, first-class airfare, first-class hotels, limou-
while acting as its COO and then CEO (Bryce, sines, new computers, new Palm Pilots, new desks
Enron employees began to expect the best of every-
2003; Cruver, 2002; Swartz and Watkins, 2003),
thing, all of the time. And there were salaries, lots of
apparently knew about and fostered his own agency salaries (p. 134);
reasoning as a way of solving the problem of inno-
vation and motivation among employees. Bryce as was Cruvers (2003) account of his own behavior
(2003) noted that Fastow absorbed Skillings and attitude:
methods of managing people and his view of the
world (p. 202). It seems reasonable, then, to con- I continued taking business-related trips, staying in
sider that Enrons employees at all levels of the the best hotels and eating in the best restaurants. These
organizational hierarchy applied agency reasoning were the perks that the majority of Enron employees
as a means to solve the agency problem, and evi- enjoyed and it was fair trade for being on the road,
dence of agency reasoning should appear in pub- for being away from families, and for working four-
lished stories of Enron employees: teen-hour days. I considered it part of our compen-
sation (p. 73).
Proposition 2: If employees at the lower levels of En-
rons hierarchy frequently applied agency reasoning to Taken together, evidence in Swartz and Watkins
both determine and explain their behavior, then (2003), Bryce (2003) and Cruver (2003) provide
published material describing their behavior will corroborative support for agency reasonings preva-
contain agency reasoning. lence at lower levels in the organizations hierarchy:
individual behavior and motivation was explained by
In support of Proposition 2, while numerous a particular combination of pay and perquisites
examples were discovered, only three corroborating Jensen and Mecklings (1976) pay package point
excerpts are offered here. The first excerpt, from where, in the Enron case, high levels of motivation
Swartz and Watkins (2003), demonstrates employ- and incentive alignment (personal and corporate
ees use of agency reasoning in their summarized interests) were associated with the high position of
view of Enrons culture what the authors termed a each individuals pay package point.
high risk/high reward mentality:

You deserved the best laptop and hotel room because Agency culture
you were traveling around the world booking million
dollar deals. You deserved to cheat on your spouse
A definition of agency culture
because you were so stressed. . . booking million dollar
If individuals throughout both the upper and lower
deals. On the edge, there were no rules to constrain
your thinking at the office and, as it happened, no rules levels of Enrons hierarchy employed agency rea-
to constrain your behavior outside it. The youngest soning, then one might generalize the Enron context
traders bought themselves silver Porsche Boxters and to a particular kind of culture that might develop
submitted $10,000 expense reports. . . They deserved elsewhere. Thus, I assert that Enron executives ap-
it (p. 192). plied a corporate governance theory as a basis for the
foundation of their organizational culture. It is one
If Rediker and Seths (1995) substitution principle thing to acknowledge the existence of the agency
were to be applied to the Enron case, one would relationship, but quite another to develop a corpo-
have to conclude that incentive, in a combination rate culture from agency theorys basic tenets. While
of many perquisites and high pay, was the active the idea that culture, rather than individual traits,
Agency Theory, Reasoning and Culture at Enron 353

may be the cause of corporate improprieties in Agency culture: In search of an antidote


general (Paine, 1994) and white collar crime in
particular (Sutherland, 1940) is not new, the con- Integrity and selection
tribution here is the idea that the basis for at least one
such improper culture is agency theory. No con- The idea that a manager should act with integrity is
nection between culture and agency theory has not new. Fayols (1949) second principle of man-
explicitly been identified in the current body of agement includes the following recommendation:
literature.
The best safeguard against abuse of authority and
Definition 2: Agency Culture is a type of culture against weakness on the part of a higher manager is
wherein members repeatedly solve the agency problem personal integrity and a particularly high moral char-
with agency reasoning to the extent that agency-rea- acter of such a manager, and this integrity, it is well
soned solutions become instilled in members values, known, is conferred neither by election nor owner-
beliefs, assumptions, and expectations. ship (p. 22).

Implications of a strong agency culture That is, after being selected manager, an individual
As mentioned above, culture is considered an does not then suddenly increase his or her moral
important behavioral control mechanism of an character and personal integrity to match the
organizations members (Schein, 1992). In partic- requirements of the position held, but moral char-
ular, strong culture that is, a culture in which acter and personal integrity must pre-exist within the
there is a strong homogeneity of beliefs held individuals character. One might navely ask why
throughout the organization is expected to de- these additional factors should be considered. Isnt
crease the cost of controls (i.e., reduce agency technical and organizational skill sufficient for to-
costs), and increase financial performance. Re- days manager? Barnard (1968 [originally published
cently, Sorensen (2002) found strong culture to be in 1938]) provides some further insight:
less effective in conditions of volatility, but even
under these conditions, strong culture is expected That which is unique to the executive functions,
to serve a company well by providing a solid rule however, is that they also impose the necessity of
creating moral codes. Thus, to the moral problem of
base. At Enron, there appears to have emerged a
individuals generally, organization adds in the case of
strong, homogeneous culture (Bryce, 2003; Cruver,
the executive substantial increase of moral complexity,
2002; Swartz and Watkins, 2003). For example, and of tests of responsibility, and the function of cre-
within Enron Capital and Trade, Swartz and ating moral conditions. The latter is a distinguishing
Watkins (2003) described the culture as almost characteristic of executive work. . . (p. 274).
cultlike (p. 193) a very strong culture indeed.
The problem with Enron may therefore have been Barnard went on to assert that unresolved moral
that the strong culture was also an agency culture: dilemmas move up through the organizational
employees and owners assume a divergence of hierarchy until they are resolved. Therefore, a cor-
interest from stockholders in the first place, and porations senior executives encounter only the most
then concentrated on that divergence of interest difficult moral dilemmas that exist in the organiza-
throughout the duration of the employment con- tion; they may often have no choice but to create a
tract. The first critical question in the paper can new moral code to resolve a situation. This explains
now be addressed; specifically: Could Enrons why high moral character is important for managers
strong agency culture have been prevented or to possess, as the creation of new moral codes
avoided given alternatives to the resolution of the through the resolution of moral dilemmas is an
agency problem provided in the ethics literature? I important function of management.
argue below that there currently is no solution for One might suggest a solution based on these
an agency culture in the ethics literature given at preliminary assertions: Select only those employees
least four approaches: Selection, objectivist integ- with high levels of moral character and integrity.
rity, integrity capacity, and stewardship. This was in fact the recommendation of at least one
354 Brian W. Kulik

empirical study (Abdolmohammadi et al., 2003) of begins with a number of axioms that are self-evident
accountants weak ethical reasoning. However, such through direct perception, and using the standard of
a solution would not have been easily implemented human ethics that is a persons life and happiness,
by Enron executives, even if attempted, because objective values are developed, such as long-term
Enrons main source of employees was graduates of survival, well-being, reason, purpose, and self-es-
top-tier American MBA programs (i.e., the techni- teem. Objectivists, then, define integrity as loyalty,
cally and organizationally competent individuals) in action, to rational principles (general truths) and
who were apparently lacking the moral competency values. . . Integrity . . . requires acting in accordance
recommended by Fayol (1949) quoted above, as with rational values (Becker, 1998, p. 157). Thus,
described by Swartz and Watkins (2003): objectivist ethicists assume that each individual
rationally develops a moral code of principles and
Business was being reinvented, and as [new hires values, and upgrades it periodically based on the
from recently-completed MBA programs] saw it, more congruence of observed results with ones own
money could be made than ever before. These were
long-term survival. The result is behavior that is
young men and women to whom $1 million a year did
not seem like an outrageous benefits package. They
aligned with that code.
didnt wish for luxuries, they expected them flashy When this definition of integrity is applied to the
cars, cutting-edge art, trekking trips to exotic locales Enron case as a means by which its employees might
(p. 58). experience growth in moral character, one might
surmise that its senior executives indeed had a code,
For the new hires entering Enron as described agency reasoning, and acted on it according to their
above, agency reasoning matched expectations. In- expectations of at least their own long-term survival.
deed, it may have been from the exposure and The principles of agency theory had failed none of
learning in these MBA programs (Mills, 2003) that them in the past, as none of them had failed at
Enrons employees held fast to agency reasoning in anything business-related before. In the munificent
the first place, making it difficult for Enron to dis- times of the late 1990s, few were able to adjust their
cover and hire employees out of MBA programs moral codes through objective observation and ra-
who were both technically competent and non- tional analysis because failure was not prevalent en-
agency reasoning. Thus, choosing individuals with ough to require adjustments to moral codes
high integrity, a priori, may not have provided Enron developed during the executives university educa-
with sufficient quantities of talented employees tions and hierarchy-climbing work experience when
needed to develop a non-agency, morally-grounded the set of codes was apparently being assembled
culture. Enron would have needed to embark on (Mills, 2003; Windsor, 2004). Perhaps this inability
internal efforts to ensure that employees had at least to learn from failure explains why white-collar crime
the external appearance of integrity as proposed increases during boom times the recent spate of
above by Barnard (1968 [1938]) and Fayol (1949). 2002 bankruptcies, the junk bond/savings and loan
Given such an environment, selection alone does crisis of the eighties, and even the boom times of the
not appear to have provided a way to avert Enrons twenties that preceded the Great Depression was
agency culture. We must therefore turn our atten- accompanied by a notable increase in white-collar
tion toward recommendations found in the literature crime (Mills, 2003; Sutherland, 1940). However, in
that emphasize internal processes designed to elevate addition to Sutherlands (1940) suggestion that
the moral character of existing employees. white-collar criminality is learned, the objectivist
definition of integrity suggests that white-collar
criminality, once learned, also has no mechanism for
Integrity and objectivist ethics un-learning in a munificent, rare-failure environ-
ment. The point here is that, from an objectivist
The first approach I consider toward internal em- viewpoint, one could conclude that Enrons exec-
ployee development is that of objectivist ethics utives acted on what they believed was their own
(Becker, 1998), based on the philosophy of Ayn long-term self-interest, and so they acted with
Rand (Peikoff, 1991; Rand, 1964). This approach integrity based on a set of up-to-date but rarely
Agency Theory, Reasoning and Culture at Enron 355

updated objective codes that was the basis of con- collective integrity as defined by Petrick and Quinn
tinued success to that point in their lives. One (2000). Petrick and Scherer (2003) associated
cannot merely argue that executives sets of codes Enrons employees with normative behaviors of
needed an infusion of integrity, because it may have connivance and compliance, rather than collective
never lost its sense of integrity in the first place, at integrity. The way for an organization to proceed
least from an objectivists point of view. Thus, toward collective integrity would be to anticipate
objectivist ethics fails to provide an antidote to and avoid any behaviors today that will become
agency culture in a munificent, rare-failure envi- illegal tomorrow, thus moving beyond mere
ronment. Clearly, waiting for failure to occur in compliance (Petrick and Quinn, 2000). However,
such an environment before employees learn senior executives at Enron presented many of the
important moral lessons may be too little too late for now-illegal accounting practices of the SPEs as
organizations already exhibiting agency culture cutting-edge practices to the board of directors
characteristics. Again, we must look elsewhere in the (Zandstra, 2002), suggesting that Enron executives
literature for any antidote to agency culture. may have been trying to anticipate the direction of
future compliance, and were in fact changing the
current laws (such as deregulation of gas and elec-
Integrity and integrity capacity tricity) to fit with their cutting edge practices. This
appears at least on the surface to be an integrity-
A second approach rooted in integrity is the multi- based approach to such an extent that it won the
dimensional construct of integrity capacity as pro- approval of Enrons board of directors. Furthermore,
posed by Petrick and Quinn (2000), and recently Swartz and Watkins (2003) referred to widespread
applied to the Enron scandal (Petrick and Scherer, deregulation as the New Economy, and to Enron
2003). In short, integrity capacity explains that an as Houstons ambassador to it (p. 132). Impropriety
organizations members exhibiting high levels of was acceptable in corporate life because it was seen as
integrity capacity cognitively balance the use of four a game, the goal of which was to see how much
ethics theories (teleological, deontological, virtue, could be extracted without ever paying up (p. 196).
and systems development), combined with the bal- In this sense, it could be argued that it was actually
anced use of four legal theories (positive law, natural collective integrity that Enron employees practiced
law, civic responsibility, and social reform) to de- as defined by Petrick and Quinn (2000). In other
velop (from collective connivance to compliance to words, if integrity capacity were to be implemented
integrity) and institutionalize a system of ongoing in its current state of development, it may be difficult
moral improvement (Petrick and Quinn, 2000). in non-compliance situations to discern between
Integrity capacity assumes that any imbalance in the connivance and commitment. What is legal, yet
above construct would likely lead to instances of morally questionable today may be legally proscribed
unethical behavior. tomorrow or it may be both legal and morally
This approach would not have been effective in a acceptable tomorrow. Enron executives may have
pure agency culture for two reasons. First, the term seen market deregulation, balance sheet manage-
balanced in this construct is ambiguous. How can ment, and the privatization of corporate information
ethical dilemmas be objectively balanced? Was as trends following the latter direction rather than
Skilling balancing deontological and teleological the former. Perhaps the crux of the matter here is the
ethics equally by first rejecting Fastows chief exec- development of the idea of collective commitment,
utive position in an early SPE named Chewco in which managers are expected to be concerned
(according to deontological ethics by following with answering the question, What principled
Enrons ethics code), but later approving Fastows system is worth multiple stakeholders ongoing
chief executive position for SPEs LJM1 and LJM2 participation and commitment? (Petrick and
(according to teleological ethics by maximizing Scherer, 2003, p. 40). For Enron, deregulated elec-
benefit to stakeholders after the code of ethics was tricity and gas markets were seen as just such a
waived by the board of directors)? Second, Enron principled system in which there were only
executives may have actually been operating under winners: Consumers paid fairer prices and Enron
356 Brian W. Kulik

employees realized high pay package points for their culture, could stress what objectives the firm and its
services. Likewise, hiding debt and poorly per- employees have in common. For Enron, chief
forming assets through SPEs may have been regarded executives could have stressed the traders love of
as another principled system with only winners: gambling, Enrons excellent reputation, and the flow
Enron was able to keep its debt rating above junk experience (Csikszentmihalyi, 1990; Csikszentmihalyi
status (Bryce, 2003), thus keeping the company and LeFevre, 1989) that results from taking risks as
operational and maintaining a high stock price based an intrinsic reward for making profits while trading
on its considerable reputational capital. For this, gas and electricity. At Enron International, the idea
Fastow, architect of the many SPEs, undoubtedly of making a difference to those in less fortunate
justified his huge personal gains by his creation of the countries by providing more people in those coun-
principled system that benefited the most stake- tries access to basic utilities could have been ad-
holders simultaneously. My point here is not to vanced. In this way, the bonus would have existed
defend the behavior of Enron executives by any in the form of intrinsic rewards rather than end-of-
means, but to illustrate how agency reasoning and the-year cash bonuses and stock options. But in this
culture might circumvent the construct of integrity sort of stewardship culture, power might swing over
capacity in its current form. It seems that more work to the profit-seeking firm, which could manipulate
needs to be done in the construct of integrity the stewardship perspective to underpay its
capacity before it can be applied as a pragmatic employees. As with the integrity capacity literature,
solution to the problematic agency culture. one might argue for a balance between agency and
stewardship, but again the term balance suggests
more the existence of ambiguity in its application
Stewardship than an implementable solution.

Stewardship theory, developed as the antithesis to


agency theory, assumes that the agents sense of Discussion
responsibility has already aligned her or his interests
with that of the principal: Stewardship theory de- Clearly, more work must be done before imple-
fines situations in which managers are not motivated mentable recommendations may be applied on a
by individual goals, but rather are stewards whose systemic, organizational level to counter any extant
motives are aligned with the objectives of their agency culture. To make a difference, researchers
principals (Davis et al., 1997, p. 20). Thus, have until the next economic boom period, and
stewardship theorists assume that a pure agency consequent wave of corporate improprieties, to find
relationship as put forth by Jensen and Meckling implementable recommendations, if any exist. With
(1976) does not, in reality, exist. While Eisenhardt regard to the approaches discussed above, a number
(1989) cited somewhat consistent evidence for the of questions must be addressed before any solution to
agency relationship, there is more recent evidence the agency culture question might be found. Con-
from perhaps finer-grained studies that the stew- cerning integrity based on objectivism, its strength
ardship relationship may also be needed to more lies in the idea that ethics are objective rather than
completely explain empirical results (Conger et al., relative, and thus integrity means more than simply
2001; Elloumi and Gueyie, 2001; Finklestein and doing what one believes, but also in having beliefs
DAveni, 1994; Frankforter et al., 2000; Golden and based on rational values in the first place. However,
Zajac, 2001; Rediker and Seth, 1995). The discus- more work must be done in the development of the
sion here does not concern the empirical existence sets of objective codes held by senior executives.
of agency and stewardships prevalence in todays How and where are sets of objective, rational codes
corporations, but rather poses the question: Would a of values developed? Are MBA and other university
culture based on stewardship a stewardship rea- business programs influential in altering an individ-
soning culture solve the problem of an agency uals integrity and mitigating agency reasoning?
culture? At first blush, one may have reason for Perhaps more importantly, how and when do these
optimism: managers, when coalescing corporate codes change to account for new perceptions and
Agency Theory, Reasoning and Culture at Enron 357

experiences? With regard to the development of the A potential limitation of this paper is the relevance
construct of integrity capacity, considerable progress of an analysis of Enron in the first place: Since the
has already been made toward identifying the multi- corporate scandals of 2002, has corporate culture in
dimensional and multi-step complexity involved in America changed to the extent that the problems
creating an organizational system that is high in attributable to Enron are no longer problems in
integrity capacity. However, the key to the realiza- todays companies? I challenge the relevance of this
tion of integrity capacitys full and considerable relevance argument by suggesting that white-collar
potential is first in the further elaboration of the term crime is cyclical, always re-emerging in economic
balance to account for the co-existence between boom times. While the questions raised in this paper
competing managerial, ethical, and legal theories, may (Mills, 2003) or may not be immediately rele-
and second in the clear distinction of the imple- vant to the present state of corporate America and
mentable differences between collective connivance beyond, finding answers to the questions raised
and collective commitment. Finally, while a stew- herein will likely be directly applicable to the next
ardship-based culture goes a long way toward and future periods of widespread economic growth
reducing the proliferation of perquisites as compared and prosperity, as each such period may well be
to an agency-based culture, a culture based purely on accompanied by corporate scandals.
stewardship is an equally unlikely and unbalanced
solution, so that a similar question of balance be-
tween agency and stewardship in any organizational Summary and Conclusion
culture should be a pressing question for ethics
researchers. It has long been known in the fields of management,
This paper suggests at least two additional direc- social psychology, and organizational behavior that a
tions for ethics researchers. First, much more strong culture can act as a vital control mechanism
empirical work needs to be done to determine just over individual behavior. The field of leadership has
how widespread the existence of an agency culture to some extent investigated a leaders influence over
actually is in todays organizations both in corpo- the culture that controls employees, and how an
rations and in society in general. In particular, organization arrives at a culture in the first place
exactly how is an agency culture detrimental to (Schein, 1992; Sims and Brinkmann, 2003). If a
organizations? Can poor performance be directly leader can influence her or his organizational cul-
related to the presence and/or prevalence of an ture, then it must be considered that the leaders
agency culture? Second, while this paper focused on theories of governance can be transformed into an
the immediately salient agency relationship as a organizational culture that is then used as a general
theoretical foundation, perhaps similar use has been method of solving problems. The best cultures that
made of other economics and governance theories have been proposed are flat, empowered ones in
such as transaction cost economics or game theory. which pay is at least partly based on fair measures of
Fusaro and Miller (2002) suggested Coases (1937) performance and innovation leads to quick adapta-
free-market theory of firm efficiency as a theoretical tion and learning (Galbraith, 2002). The example of
basis for understanding Ken Lays understanding of Enron, which may be generalizable to examples of
market systems. Future work might address the other recently failed companies as well as currently
acculturation of other economics theories. For existing companies (Mills, 2003), suggests the need
example, what is the relationship, if any, between for researchers who apply a best culture approach
the corporate use of outsourcing (as a means of to recognize that an irresponsible use of power
solving the recurring problems of internal cost and (Gandz and Bird, 1996) may be prevalent in an
quality) and the cognizance of transaction cost eco- empowered, innovative culture when incentives are
nomics, and does it have similar moral-erosion ef- established on the assumption of a pure agency
fects on an organizations members as does agency relationship between a firms ownership and its
culture? Based on the theory and perspective employees.
developed in this paper, an empirical study might Using recent literature on Enrons operations, I
shed more light on that and related topics. have argued for the existence of an agency culture that
358 Brian W. Kulik

may well be as detrimental to the long-term health of proaches may not be as effective as they could be upon
corporate America as it was to Enron. I proposed that practitioner implementation.
an agency culture should be distinguishable from
other cultures because, in an agency culture,
employees tend to explain their behavior as controlled
Acknowledgement
by governance mechanisms, defined as agency rea-
soning. It is important to note that, compared to
I would like to thank Richard Reed and Jerry
criticisms of Enrons improprieties and illegal activi-
Goodstein for their many helpful comments on
ties, agency culture was the conclusion reached after
earlier versions of this paper and Dave Lemak for
juxtaposing Enrons popularity on the one hand, and
numerous discussions of the relevance of ethics in
its unsustainable corporate improprieties on the other.
the works of seminal authors in business.
I further noted a number of undesirable behavioral
consequences that managers should expect to see in
their employees operating within an agency culture. References
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