Journal of Business Ethics (2005) 59: 347360 DOI 10.

1007/s10551-004-7308-2

Springer 2005

Agency Theory, Reasoning and Culture at Enron: In Search of a Solution

Brian W. Kulik

ABSTRACT. Applying evidence from recently available public information on Enron, I dened Enrons culture as one rooted in agency theory by asserting that Enrons members were predominantly agency-reasoning individuals. I then identied conditions present at Enrons collapse: a strong agency culture with collectively noncompliant norms, a municent rare-failure environment, and new hires with little business ethics training. Turning to four possible antidotes (selection, objectivist integrity, integrity capacity, and stewardship reasoning) to an agency culture under these conditions, I argued that the currently available ethics literature would have made little difference toward averting Enrons collapse if any of the recommendations from the relevant ethics literature had been implemented. I conclude by identifying new directions for business ethics literature in order to make it more implementable under the conditions identied at Enron. Essentially, we need a way to clearly determine (1) the difference between connivance and commitment, (2) what is meant by balance with regard to the multiple dimensions of ethics and legal theories, and (3) the proper balance between agency and stewardship reasoning. KEY WORDS: agency theory, Enron, integrity, integrity capacity, organizational culture, stewardship theory, unethical behavior

Introduction What can a corporate executive do to positively inuence organization-wide ethical conduct? The ethics literature is replete with suggestions, including selection and hiring of ethically-oriented employees (Abdolmohammadi et al., 2003), establishing codes of ethics (Gaumnitz and Lere, 2004), promoting an ethical culture (Sims and Brinkmann, 2003), developing employees internally (Becker, 1998; Petrick and Quinn, 2000), and taking a stewardship perspective (Davis et al., 1997). Given the well-known recent corporate scandals, and especially the plethora of now publicly available information that is available from Enron, two critical questions emerge. First, if the suggestions from the literature cited above had been implemented by Enrons top management team, could Enrons ethics shortcomings have been avoided and bankruptcy averted? Second, if the answer to the rst question is no, then in what direction(s) must the relevant ethics literature proceed before suggestionimplementation congruence is obtained? 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 spawned a number of books and articles. In addition, the previously private information now made public by the companys bankruptcy proceedings has shed light on Enrons operations to a depth that is not available from most other companies, public or private. For example, bankruptcy court-appointed examiner Neal Batsons third interim report (2003) found that six nancial institutions had actual knowledge of Enrons wrongful conduct, gave

Brian E. Kulik is a Ph.D. candidate in Management at Washington State Universitys School of Business. His work focuses on the prevention of corporate corruption, corporate governance and ethics, teamwork and diversity, and research methods. His research to date has appeared in the Western and National Academy of Management conference proceedings and the journal Organizational Analysis. He earned M.S. degrees from Washington State University and The University of Cincinnati, and M.B.A. from The University of Denver.

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Brian W. Kulik basic tenets of the agency relationship, with parallels drawn between their dysfunctional culture and agency theorys characteristics. In search of a solution based on recommendations made in the ethics literature, I investigate alternative approaches that an organizations cultural and ethical base might instead be founded on, but I nd limits to their effectiveness in correcting the problems in an agency culture. I conclude by noting that, while enduring companies cannot harbor cultures based purely in agency theory, vital questions must be answered before specic and effective measures can be taken to avert the emergence of a destructive culture such as Enrons.

substantial assistance by aiding in the structuring and funding of Enrons now infamous special-purpose entities, that the amount of money involved was material, and that such disguise harmed other creditors. These ndings may help dene limits to strategic alliances more clearly and delineate a rms motivation for the creation of such alliances. In a recent book by Smith and Emshwiller (2003), the Wall Street Journal reporters who rst made known some of Enrons impropriety (specically, special purpose entities, or SPEs, named LJM and LJM2) to the public, chronicled their work before and during Enrons demise. This work may be interesting to researchers in the tactical positioning that companies use in the disclosure of negative information. Finally, a book co-authored by Sherron Watkins (Swartz and Watkins, 2003), former vice president at Enron, details her involvement in Enron since 1993. Their contribution was essentially an exposure of the cultural and climatic conditions within which Enron employees worked. There is a growing consensus on the idea that Enrons culture, rather than the isolated actions of a few individuals, was the key enabling mechanism that allowed the widespread practice of unethical and illegal behavior based on self-interest (Bryce, 2003; Cruver, 2002; Fusaro and Miller, 2002; Mills, 2003; Sims and Brinkmann, 2003; Swartz and Watkins, 2003; Windsor, 2004). However, no attempt has been made to link the characteristics of Enrons culture to a theoretical base that might be used to both test the potential implementability of recommendations to practitioners in the ethics literature and the closeness of Enrons culture to those of other rms. This paper rst establishes a theoretical base which might be used (1) as a means in itself of providing practitioners a way to avert future Enron-like debacles by the identication and generalization of Enrons culture and (2) as a test of the avertability of Enrons downfall through some of the ethics literatures recommendations. To this dual end, I draw a number of parallels between Enrons culture and agency theory, a theory made popular by lawyers, economists, and nance and management theorists, that attempts to explain the effectiveness of corporate governance in publicly-held corporations. The next section describes the key elements of agency theory and how it is purported to work correctly. Then, Enrons culture is identied as one centered in the

Agency theory Agency theory, as developed primarily by Jensen and Meckling (1976), is a popular tenet in corporate governance today. For example, the ISI Social Science Citation Index nds that Jensen and Mecklings (1976) work has been cited more than 3,000 times since 1989 and every article in the Academy of Management Reviews 2003 special issue on corporate governance cited Jensen and Meckling (1976; see Daily et al., 2003), and at least one textbook on strategic management (Hitt et al., 2005) structures its chapter on corporate governance around agency theory. Typical of its use in articles concerned with corporate governance, Daily et al. (2003) stated: Jensen and Meckling (1976) proposed agency theory as an explanation of how the public corporation could exist, given the assumption that managers are self-interested, and a context in which those managers do not bear the full wealth effects of their decisions (p. 372). Thus, one can hardly avoid discussion of agency theory in any dialogue on corporate governance. In particular, agency theory states that, in a public corporation, there exists a central problem with regard to shareholders interests: top management does not always act to maximize shareholders return on investment. With regard to a corporate executive, agency costs will be generated by the divergence between his interest and those of outside shareholders (Jensen and Meckling, 1976, p. 313). According to Rediker and Seth (1995), mechanisms used to align the interests of the manager with those of the shareholders take the form of threats (of

Agency Theory, Reasoning and Culture at Enron takeover, competition in product markets, and competition in executive labor markets), monitoring (from outside shareholders, boards of directors, and according to Jensen, 1986, creditors under high debt levels), and incentives (stock ownership, salary, and perquisites). Unfortunately, these mechanisms are limited in use because they are associated with costs (called agency costs), so that there always exists an agency problem (Fama, 1980) in that managers behavior will never be fully aligned with the interests of the rms shareholders (or more generally, risk bearers after Fama, 1980). Furthermore, it is likely that the most important conict arises from the fact that as the managers ownership claim falls, his incentive to devote signicant effort to creative activities such as searching out new protable ventures falls (Jensen and Meckling, 1976, p. 313). Said another way, in addition to agency costs, divergence of interest also generates a divergence of managerial attention to his or her own interests, and not to the interests of the shareholders. Thus, agency theory assumes that publicly held rms endure by nding ways to efciently solve the agency problem by aligning their managers behavior with shareholders interests in such a way that agency costs are low enough to allow for the creation of corporate prots. Unfortunately, some self-serving executives may have interpreted this theory as a way to act in a selfserving, even unethical manner as long as they operate within certain constraints (governance mechanisms) and with an effort roughly proportional to their incentives (a combination of pay and perquisites the pay package point). As long as their behavior is not outside the boundaries set by the governance mechanisms in place, an anything-goes type of attitude may emerge, which can become the foundation for an organizations culture. Below, I elaborate on what is meant by an agency culture and offer evidence of its existence in the Enron case.

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Agency culture: The Enron case Until November 2001, Enron was a highly respected organization. For example, in 1997, Business Week named CEO Ken Lay one of the top 25 managers of the year, followed by a positive prole on Enrons electricity trading business (McWilliams, 1997). For-

tune named Enron the most innovative company for seven consecutive years prior to its downfall (Cruver, 2003; Swartz and Watkins, 2003), and as late as 2001 it printed a glowing interview of Ken Lay (Hamel, 2001). An article appeared in Money as one of six energy stocks that can light up your prots (Brush, 1997, p. 108). Chief Executive (1997) wrote a positive prole of Ken Lay, stating that Lay estimates competition will reduce consumer electricity bills by 30 to 40 percent which would be like a national tax cut of around $70 billion. (p. 41). That same year (1997), Ken Lay also attended the World Economic Forum, and was an honored guest at the opening of Rice Universitys James A. Baker III Institute for Public Policy (Swartz and Watkins, 2003). Even when near bankruptcy, despite a falling stock price throughout 2001 and some negative press, a positive article appeared as late as November, 2001 in which the magazine Better Investing (2001) noted that the consensus opinion among the analysts making estimates was that Enrons earnings will grow at an average annual rate of 17 percent over the next ve years (p. 54), while on October 26, the Wall Street Journals article on Enron began: Enron: Rarely have so many analysts liked a stock they concede they know so little about (Craig and Weil, 2001), an article that was at least backhandedly positive in that the stock was seen as still popular among investors even though it was acknowledged that no one understood its balance sheets. Furthermore, Enron had the support and direction of consulting rm McKinsey and Co., case studies were written by Harvard Business School Publishing (Rangan et al., 1996; Tufano and Bhatnagar, 1994), and a supposedly exemplary Enron team was proled in a popular teamwork book that is still widely cited in the literature for its teamwork theory (Katzenbach and Smith, 1993). Enron was also popular from a societal point of view, as CEO Ken Lay became a well-known philanthropist who contributed generously to a number of charities and politicians campaigns with personal and Enron funds. Philanthropy was not limited to Lay, but Swartz and Watkins (2003) and Bryce (2003) claimed that each senior executive was involved in his or her favorite charity. Taken collectively, one could conclude that Enron had built up a considerable amount of reputational capital with politicians, minorities, local businesspeople, charities, academia, investors, and the business press. At the same time, however, unusually

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Brian W. Kulik describing the mechanisms of corporate governance. His own Ph.D. work was centered in free market theory (Fusaro and Miller, 2002), which he applied both outwardly as a corporate strategy, or formula, for success (Swartz and Watkins, 2003), and inwardly by retaining, every six months, only the upper 85th percentile of Enrons employees after their semiannual ranking by the rms performance appraisal (Cruver, 2002; Swartz and Watkins, 2003). Executives Jeffrey Skilling and Rebecca Mark, both Harvard MBAs, also must have been familiar with agency theory. So too should have Andy Fastow, with an undergraduate degree in economics (and Chinese) from Tufts University and an MBA from Northwestern University. Finally, Michael Kopper, who worked with Fastow on the now-infamous SPEs, held an advanced degree from the London School of Economics, and also must have been familiar with agency theory. Even if agency theory were not known among these and other executives, one of its central assumptions, that of self-interested parties (Eisenhardt, 1989), is certainly a fairly common theory in many economics theories (Harrison, 1986), and it is this assumption that is essential to thinking within an agency theory framework. If Enrons executives were taught agency theory as part of their business/economics education, then they may have used agency reasoning in the design of Enrons organizational structure and its policies.
Denition 1: Agency Reasoning is any behavior or demonstration of rational thought that links corporate governance mechanisms (incentives and controls) with individual behavior.

excessive perquisites were apparently consumed by Enron employees at all levels of the organization (Bryce, 2003; Cruver, 2002; Swartz and Watkins, 2003) as discussed in more detail below. As Petrick et al. (1999) highlighted, reputational capital is an important antecedent to sustainable competitive advantage. How, then, could the simultaneous building up of social capital and the excessive, nonsustainable acquisition of pay and perquisites by the very same corporate executives have occurred? Identifying some of Enrons executives as anomalous bad apples, with personality traits including greed, dishonesty, arrogance, selfishness, cowardice, hypocrisy, disrespect, and injustice (Petrick and Scherer, 2003, p. 40) ignores Enrons prior popularity and the substantial social capital that these same executives had shored up. To alternatively point to the system as awed and in need of more controls, such as the use of more, better, and more transparent accounting rules (Petrick and Scherer, 2003; Senate Subcommittee on Investigations, 2002) may merely motivate immoral, but innovative executives, accountants, and lawyers to nd different ways around the new controls (Mills, 2003). Instead, Enrons core beliefs and values must be investigated in an effort to query just how Enron could be simultaneously popular and insidious. Only then can one hope to curtail the proliferation of corruption, what Petrick and Scherer (2003) called Enronitis (p. 37), regardless of any future accounting, SEC, or NYSE rule changes. Below, I argue that Enrons core values and beliefs were forged by the basic tenets of agency theory. My argument is in two steps: (1) Enrons senior executives used agency reasoning to both determine and explain their behavior and (2) this agency reasoning resulted in a corporate attitude throughout the organization that led to a culturally accepted behavioral norm: an agency culture.

Thus, an individual expressing agency reasoning might express that his/her low pay has a negative effect on his/her incentive to maximize his/her companys prots. This denition leads us to a proposition that summarizes the rst step of my argument:
Proposition 1: If Enron executives applied agency reasoning to both determine and explain their behavior, then published material describing their behavior will contain agency reasoning.

Enron executives and agency reasoning In speculative support of the rst step of my argument, note that many of Enrons executives were well educated in business and economics to be sufciently familiar with agency theory. For example, Ken Lay, with a Ph.D. in economics, must have known about agency theory as one of several economic theories

Evidence for agency reasoning by Enron executives The rst piece of evidence is an argument given to the board of directors for approval of one of Fastows SPEs, LJM2:

Agency Theory, Reasoning and Culture at Enron

Based on Fastows presentation, the Directors envisioned a model in which Enron business units controlled the assets to be sold to LJM2 (or alternative potential buyers) and would be negotiating on behalf of Enron. Because each business units nancial results were at stake, the Board assumed they had an incentive to insist that transactions were on the most favorable terms available in the market (Powers, Troubh and Winokur, 2002, pp. 152153).

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In other words, Enrons directors reasoned that the incentives of agents for Enrons business units were sufciently aligned with Enrons stockholders interests, and not with Fastows. Following Rediker and Seth (1995), the aligning mechanism that the board of directors assumed was active in this case was the threat of takeover (of losing ones job because of the business units poor performance), which implies further that mechanisms of monitoring performance and motivation through the incentive of a high pay package point were also active. That Fastow, as CFO, had sufcient control over the performance review process and distribution of bonuses to manipulate his own incentives (Swartz and Watkins, 2003) is beside the point here: In his presentation to Enrons board of directors, the board itself being an important governance mechanism according to Hitt et al. (2005), Fastow applied agency theory to predict the behavior of Enron executives in their negotiations with LJM2 by using an incentive argument. In short, Fastow, and the Enron directors in their approval of LJM2, applied agency reasoning. As further support for Proposition 1, I offer a description of Rebecca Marks closing of the second phase of the Dabhol power plant deal (before the rst phase was completed) as described by Bryce (2003):
Mark prevailed. She got a bigger project. And a bigger project meant no surprise a bigger bonus. Getting the second phase of Dabhol approved right away meant doubling or tripling her bonus, said one Enron employee who worked on Dabhol. Ill never again underestimate the power of an incentive compensation program and the desire it can instill in people (p. 172).

project. Mark, however, made money on the project because she had incentive to close the deal the biggest possible but no incentive to show profitability from operations or even a nished project. Thus, Mark allowed herself to follow her own selfinterest as long as the boundaries set by control mechanisms (such as scrutiny by Enrons awardwinning board of directors or internal managerial accounting efforts) were not crossed and sufcient incentive was provided for through bonus pay: Agency reasoning.

Evidence for agency reasoning by Enron employees Leaders can have a major inuence on an organizations culture (Schein, 1992) which in turn can act as an important control mechanism for individual behavior. Schein (1992) described culture as emerging from the repeated resolution of recurring problems in the same way over time. Thus, followers may adopt their leaders values, beliefs, assumptions, and expectations (Clawson, 2002) if these help solve recurring problems. Scheins (1992) theory has recently received some empirical support at the supervisorsubordinate dyad level (Block, 2003), wherein cultural dimensions of involvement, consistency, mission, and adaptability were observed to be strongly and positively correlated with the transformational leadership styles, weakly correlated with the transactional style, and negatively correlated with the laissez-faire style of leadership (see Yukl, 1998, for denitions of these three leadership styles). These results suggest that leaders values, beliefs, assumptions, and expectations may at least partially explain the behavior of followers, especially for value-oriented transformational-style leaders. Furthermore, ve of Scheins (1992) six primary leadership mechanisms of attention, reaction to crises, role modeling and a leaders behavior, the allocation of rewards, and criteria of selection and dismissal have recently been used as a framework for explaining why Enrons culture contradicted its own code of ethics (Sims and Brinkmann, 2003). Thus, assuming that Scheins leadership mechanisms were active and effective, and that leaders styles were predominantly transformational (as Bryce, 2003, suggested when describing the differences in styles between the transactional-styled Kinder, and

Phase one was never nished at Dabhol and Enron realized signicant losses upon the failure of this

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Brian W. Kulik control mechanism here, where all of the other governance mechanisms lay dormant (referred to as no rules in the above excerpt). Bryces (2003) account of employees expectations was little different:
Flowers, rst-class airfare, rst-class hotels, limousines, new computers, new Palm Pilots, new desks Enron employees began to expect the best of everything, all of the time. And there were salaries, lots of salaries (p. 134);

Skilling, his transformational-styled successor as COO), the agency problem may be one of those recurring problems identied by Schein (1992) that allows leaders to propose their own solutions. Such leaders may thereby inuence their followers who subsequently adopt their leaders solution. For example, Jeffrey Skilling, Enrons de facto leader while acting as its COO and then CEO (Bryce, 2003; Cruver, 2002; Swartz and Watkins, 2003), apparently knew about and fostered his own agency reasoning as a way of solving the problem of innovation and motivation among employees. Bryce (2003) noted that Fastow absorbed Skillings methods of managing people and his view of the world (p. 202). It seems reasonable, then, to consider that Enrons employees at all levels of the organizational hierarchy applied agency reasoning as a means to solve the agency problem, and evidence of agency reasoning should appear in published stories of Enron employees:
Proposition 2: If employees at the lower levels of Enrons hierarchy frequently applied agency reasoning to both determine and explain their behavior, then published material describing their behavior will contain agency reasoning.

as was Cruvers (2003) account of his own behavior and attitude:

I continued taking business-related trips, staying in the best hotels and eating in the best restaurants. These were the perks that the majority of Enron employees enjoyed and it was fair trade for being on the road, for being away from families, and for working fourteen-hour days. I considered it part of our compensation (p. 73).

In support of Proposition 2, while numerous examples were discovered, only three corroborating excerpts are offered here. The rst excerpt, from Swartz and Watkins (2003), demonstrates employees use of agency reasoning in their summarized view of Enrons culture what the authors termed a high risk/high reward mentality:
You deserved the best laptop and hotel room because you were traveling around the world booking million dollar deals. You deserved to cheat on your spouse because you were so stressed. . . booking million dollar deals. On the edge, there were no rules to constrain your thinking at the ofce and, as it happened, no rules to constrain your behavior outside it. The youngest traders bought themselves silver Porsche Boxters and submitted $10,000 expense reports. . . They deserved it (p. 192).

Taken together, evidence in Swartz and Watkins (2003), Bryce (2003) and Cruver (2003) provide corroborative support for agency reasonings prevalence at lower levels in the organizations hierarchy: individual behavior and motivation was explained by a particular combination of pay and perquisites Jensen and Mecklings (1976) pay package point where, in the Enron case, high levels of motivation and incentive alignment (personal and corporate interests) were associated with the high position of each individuals pay package point.

Agency culture A denition of agency culture If individuals throughout both the upper and lower levels of Enrons hierarchy employed agency reasoning, then one might generalize the Enron context to a particular kind of culture that might develop elsewhere. Thus, I assert that Enron executives applied a corporate governance theory as a basis for the foundation of their organizational culture. It is one thing to acknowledge the existence of the agency relationship, but quite another to develop a corporate culture from agency theorys basic tenets. While the idea that culture, rather than individual traits,

If Rediker and Seths (1995) substitution principle were to be applied to the Enron case, one would have to conclude that incentive, in a combination of many perquisites and high pay, was the active

Agency Theory, Reasoning and Culture at Enron may be the cause of corporate improprieties in general (Paine, 1994) and white collar crime in particular (Sutherland, 1940) is not new, the contribution here is the idea that the basis for at least one such improper culture is agency theory. No connection between culture and agency theory has explicitly been identied in the current body of literature.
Denition 2: Agency Culture is a type of culture wherein members repeatedly solve the agency problem with agency reasoning to the extent that agency-reasoned solutions become instilled in members values, beliefs, assumptions, and expectations.

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Agency culture: In search of an antidote Integrity and selection The idea that a manager should act with integrity is not new. Fayols (1949) second principle of management includes the following recommendation:
The best safeguard against abuse of authority and against weakness on the part of a higher manager is personal integrity and a particularly high moral character of such a manager, and this integrity, it is well known, is conferred neither by election nor ownership (p. 22).

Implications of a strong agency culture As mentioned above, culture is considered an important behavioral control mechanism of an organizations members (Schein, 1992). In particular, strong culture that is, a culture in which there is a strong homogeneity of beliefs held throughout the organization is expected to decrease the cost of controls (i.e., reduce agency costs), and increase nancial performance. Recently, Sorensen (2002) found strong culture to be less effective in conditions of volatility, but even under these conditions, strong culture is expected to serve a company well by providing a solid rule base. At Enron, there appears to have emerged a strong, homogeneous culture (Bryce, 2003; Cruver, 2002; Swartz and Watkins, 2003). For example, within Enron Capital and Trade, Swartz and Watkins (2003) described the culture as almost cultlike (p. 193) a very strong culture indeed. The problem with Enron may therefore have been that the strong culture was also an agency culture: employees and owners assume a divergence of interest from stockholders in the rst place, and then concentrated on that divergence of interest throughout the duration of the employment contract. The rst critical question in the paper can now be addressed; specically: Could Enrons strong agency culture have been prevented or avoided given alternatives to the resolution of the agency problem provided in the ethics literature? I argue below that there currently is no solution for an agency culture in the ethics literature given at least four approaches: Selection, objectivist integrity, integrity capacity, and stewardship.

That is, after being selected manager, an individual does not then suddenly increase his or her moral character and personal integrity to match the requirements of the position held, but moral character and personal integrity must pre-exist within the individuals character. One might navely ask why these additional factors should be considered. Isnt technical and organizational skill sufcient for todays manager? Barnard (1968 [originally published in 1938]) provides some further insight:
That which is unique to the executive functions, however, is that they also impose the necessity of creating moral codes. Thus, to the moral problem of individuals generally, organization adds in the case of the executive substantial increase of moral complexity, and of tests of responsibility, and the function of creating moral conditions. The latter is a distinguishing characteristic of executive work. . . (p. 274).

Barnard went on to assert that unresolved moral dilemmas move up through the organizational hierarchy until they are resolved. Therefore, a corporations senior executives encounter only the most difcult moral dilemmas that exist in the organization; they may often have no choice but to create a new moral code to resolve a situation. This explains why high moral character is important for managers to possess, as the creation of new moral codes through the resolution of moral dilemmas is an important function of management. One might suggest a solution based on these preliminary assertions: Select only those employees with high levels of moral character and integrity. This was in fact the recommendation of at least one

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Brian W. Kulik begins with a number of axioms that are self-evident through direct perception, and using the standard of human ethics that is a persons life and happiness, objective values are developed, such as long-term survival, well-being, reason, purpose, and self-esteem. Objectivists, then, dene integrity as loyalty, in action, to rational principles (general truths) and values. . . Integrity . . . requires acting in accordance with rational values (Becker, 1998, p. 157). Thus, objectivist ethicists assume that each individual rationally develops a moral code of principles and values, and upgrades it periodically based on the congruence of observed results with ones own long-term survival. The result is behavior that is aligned with that code. When this denition of integrity is applied to the Enron case as a means by which its employees might experience growth in moral character, one might surmise that its senior executives indeed had a code, agency reasoning, and acted on it according to their expectations of at least their own long-term survival. The principles of agency theory had failed none of them in the past, as none of them had failed at anything business-related before. In the municent times of the late 1990s, few were able to adjust their moral codes through objective observation and rational analysis because failure was not prevalent enough to require adjustments to moral codes developed during the executives university educations and hierarchy-climbing work experience when the set of codes was apparently being assembled (Mills, 2003; Windsor, 2004). Perhaps this inability to learn from failure explains why white-collar crime increases during boom times the recent spate of 2002 bankruptcies, the junk bond/savings and loan crisis of the eighties, and even the boom times of the twenties that preceded the Great Depression was accompanied by a notable increase in white-collar crime (Mills, 2003; Sutherland, 1940). However, in addition to Sutherlands (1940) suggestion that white-collar criminality is learned, the objectivist denition of integrity suggests that white-collar criminality, once learned, also has no mechanism for un-learning in a municent, rare-failure environment. The point here is that, from an objectivist viewpoint, one could conclude that Enrons executives acted on what they believed was their own long-term self-interest, and so they acted with integrity based on a set of up-to-date but rarely

empirical study (Abdolmohammadi et al., 2003) of accountants weak ethical reasoning. However, such a solution would not have been easily implemented by Enron executives, even if attempted, because Enrons main source of employees was graduates of top-tier American MBA programs (i.e., the technically and organizationally competent individuals) who were apparently lacking the moral competency recommended by Fayol (1949) quoted above, as described by Swartz and Watkins (2003):
Business was being reinvented, and as [new hires from recently-completed MBA programs] saw it, more money could be made than ever before. These were young men and women to whom $1 million a year did not seem like an outrageous benets package. They didnt wish for luxuries, they expected them ashy cars, cutting-edge art, trekking trips to exotic locales (p. 58).

For the new hires entering Enron as described above, agency reasoning matched expectations. Indeed, it may have been from the exposure and learning in these MBA programs (Mills, 2003) that Enrons employees held fast to agency reasoning in the rst place, making it difcult for Enron to discover and hire employees out of MBA programs who were both technically competent and nonagency reasoning. Thus, choosing individuals with high integrity, a priori, may not have provided Enron with sufcient quantities of talented employees needed to develop a non-agency, morally-grounded culture. Enron would have needed to embark on internal efforts to ensure that employees had at least the external appearance of integrity as proposed above by Barnard (1968 [1938]) and Fayol (1949). Given such an environment, selection alone does not appear to have provided a way to avert Enrons agency culture. We must therefore turn our attention toward recommendations found in the literature that emphasize internal processes designed to elevate the moral character of existing employees. Integrity and objectivist ethics The rst approach I consider toward internal employee development is that of objectivist ethics (Becker, 1998), based on the philosophy of Ayn Rand (Peikoff, 1991; Rand, 1964). This approach

Agency Theory, Reasoning and Culture at Enron updated objective codes that was the basis of continued success to that point in their lives. One cannot merely argue that executives sets of codes needed an infusion of integrity, because it may have never lost its sense of integrity in the rst place, at least from an objectivists point of view. Thus, objectivist ethics fails to provide an antidote to agency culture in a municent, rare-failure environment. Clearly, waiting for failure to occur in such an environment before employees learn important moral lessons may be too little too late for organizations already exhibiting agency culture characteristics. Again, we must look elsewhere in the literature for any antidote to agency culture.

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Integrity and integrity capacity A second approach rooted in integrity is the multidimensional construct of integrity capacity as proposed by Petrick and Quinn (2000), and recently applied to the Enron scandal (Petrick and Scherer, 2003). In short, integrity capacity explains that an organizations members exhibiting high levels of integrity capacity cognitively balance the use of four ethics theories (teleological, deontological, virtue, and systems development), combined with the balanced use of four legal theories (positive law, natural law, civic responsibility, and social reform) to develop (from collective connivance to compliance to integrity) and institutionalize a system of ongoing moral improvement (Petrick and Quinn, 2000). Integrity capacity assumes that any imbalance in the above construct would likely lead to instances of unethical behavior. This approach would not have been effective in a pure agency culture for two reasons. First, the term balanced in this construct is ambiguous. How can ethical dilemmas be objectively balanced? Was Skilling balancing deontological and teleological ethics equally by rst rejecting Fastows chief executive position in an early SPE named Chewco (according to deontological ethics by following Enrons ethics code), but later approving Fastows chief executive position for SPEs LJM1 and LJM2 (according to teleological ethics by maximizing benet to stakeholders after the code of ethics was waived by the board of directors)? Second, Enron executives may have actually been operating under

collective integrity as dened by Petrick and Quinn (2000). Petrick and Scherer (2003) associated Enrons employees with normative behaviors of connivance and compliance, rather than collective integrity. The way for an organization to proceed toward collective integrity would be to anticipate and avoid any behaviors today that will become illegal tomorrow, thus moving beyond mere compliance (Petrick and Quinn, 2000). However, senior executives at Enron presented many of the now-illegal accounting practices of the SPEs as cutting-edge practices to the board of directors (Zandstra, 2002), suggesting that Enron executives 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 electricity) to t with their cutting edge practices. This appears at least on the surface to be an integritybased approach to such an extent that it won the approval of Enrons board of directors. Furthermore, Swartz and Watkins (2003) referred to widespread deregulation as the New Economy, and to Enron as Houstons ambassador to it (p. 132). Impropriety was acceptable in corporate life because it was seen as a game, the goal of which was to see how much could be extracted without ever paying up (p. 196). In this sense, it could be argued that it was actually collective integrity that Enron employees practiced as dened by Petrick and Quinn (2000). In other words, if integrity capacity were to be implemented in its current state of development, it may be difcult in non-compliance situations to discern between connivance and commitment. What is legal, yet morally questionable today may be legally proscribed tomorrow or it may be both legal and morally acceptable tomorrow. Enron executives may have seen market deregulation, balance sheet management, and the privatization of corporate information as trends following the latter direction rather than the former. Perhaps the crux of the matter here is the development of the idea of collective commitment, in which managers are expected to be concerned with answering the question, What principled system is worth multiple stakeholders ongoing participation and commitment? (Petrick and Scherer, 2003, p. 40). For Enron, deregulated electricity and gas markets were seen as just such a principled system in which there were only winners: Consumers paid fairer prices and Enron

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Brian W. Kulik culture, could stress what objectives the rm and its employees have in common. For Enron, chief executives could have stressed the traders love of gambling, Enrons excellent reputation, and the ow experience (Csikszentmihalyi, 1990; Csikszentmihalyi and LeFevre, 1989) that results from taking risks as an intrinsic reward for making prots while trading gas and electricity. At Enron International, the idea of making a difference to those in less fortunate countries by providing more people in those countries access to basic utilities could have been advanced. In this way, the bonus would have existed in the form of intrinsic rewards rather than end-ofthe-year cash bonuses and stock options. But in this sort of stewardship culture, power might swing over to the prot-seeking rm, which could manipulate the stewardship perspective to underpay its employees. As with the integrity capacity literature, one might argue for a balance between agency and stewardship, but again the term balance suggests more the existence of ambiguity in its application than an implementable solution.

employees realized high pay package points for their services. Likewise, hiding debt and poorly performing assets through SPEs may have been regarded as another principled system with only winners: Enron was able to keep its debt rating above junk status (Bryce, 2003), thus keeping the company operational and maintaining a high stock price based on its considerable reputational capital. For this, Fastow, architect of the many SPEs, undoubtedly justied his huge personal gains by his creation of the principled system that beneted the most stakeholders simultaneously. My point here is not to defend the behavior of Enron executives by any means, but to illustrate how agency reasoning and culture might circumvent the construct of integrity capacity in its current form. It seems that more work needs to be done in the construct of integrity capacity before it can be applied as a pragmatic solution to the problematic agency culture.

Stewardship Stewardship theory, developed as the antithesis to agency theory, assumes that the agents sense of responsibility has already aligned her or his interests with that of the principal: Stewardship theory denes situations in which managers are not motivated by individual goals, but rather are stewards whose motives are aligned with the objectives of their principals (Davis et al., 1997, p. 20). Thus, stewardship theorists assume that a pure agency relationship as put forth by Jensen and Meckling (1976) does not, in reality, exist. While Eisenhardt (1989) cited somewhat consistent evidence for the agency relationship, there is more recent evidence from perhaps ner-grained studies that the stewardship relationship may also be needed to more completely explain empirical results (Conger et al., 2001; Elloumi and Gueyie, 2001; Finklestein and DAveni, 1994; Frankforter et al., 2000; Golden and Zajac, 2001; Rediker and Seth, 1995). The discussion here does not concern the empirical existence of agency and stewardships prevalence in todays corporations, but rather poses the question: Would a culture based on stewardship a stewardship reasoning culture solve the problem of an agency culture? At rst blush, one may have reason for optimism: managers, when coalescing corporate

Discussion Clearly, more work must be done before implementable recommendations may be applied on a systemic, organizational level to counter any extant agency culture. To make a difference, researchers have until the next economic boom period, and consequent wave of corporate improprieties, to nd implementable recommendations, if any exist. With regard to the approaches discussed above, a number of questions must be addressed before any solution to the agency culture question might be found. Concerning integrity based on objectivism, its strength lies in the idea that ethics are objective rather than relative, and thus integrity means more than simply doing what one believes, but also in having beliefs based on rational values in the rst place. However, more work must be done in the development of the sets of objective codes held by senior executives. How and where are sets of objective, rational codes of values developed? Are MBA and other university business programs inuential in altering an individuals integrity and mitigating agency reasoning? Perhaps more importantly, how and when do these codes change to account for new perceptions and

Agency Theory, Reasoning and Culture at Enron experiences? With regard to the development of the construct of integrity capacity, considerable progress has already been made toward identifying the multidimensional and multi-step complexity involved in creating an organizational system that is high in integrity capacity. However, the key to the realization of integrity capacitys full and considerable potential is rst in the further elaboration of the term balance to account for the co-existence between competing managerial, ethical, and legal theories, and second in the clear distinction of the implementable differences between collective connivance and collective commitment. Finally, while a stewardship-based culture goes a long way toward reducing the proliferation of perquisites as compared to an agency-based culture, a culture based purely on stewardship is an equally unlikely and unbalanced solution, so that a similar question of balance between agency and stewardship in any organizational culture should be a pressing question for ethics researchers. This paper suggests at least two additional directions for ethics researchers. First, much more empirical work needs to be done to determine just how widespread the existence of an agency culture actually is in todays organizations both in corporations and in society in general. In particular, exactly how is an agency culture detrimental to organizations? Can poor performance be directly related to the presence and/or prevalence of an agency culture? Second, while this paper focused on the immediately salient agency relationship as a theoretical foundation, perhaps similar use has been made of other economics and governance theories such as transaction cost economics or game theory. Fusaro and Miller (2002) suggested Coases (1937) free-market theory of rm efciency as a theoretical basis for understanding Ken Lays understanding of market systems. Future work might address the acculturation of other economics theories. For example, what is the relationship, if any, between the corporate use of outsourcing (as a means of solving the recurring problems of internal cost and quality) and the cognizance of transaction cost economics, and does it have similar moral-erosion effects on an organizations members as does agency culture? Based on the theory and perspective developed in this paper, an empirical study might shed more light on that and related topics.

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A potential limitation of this paper is the relevance of an analysis of Enron in the rst place: Since the corporate scandals of 2002, has corporate culture in America changed to the extent that the problems attributable to Enron are no longer problems in todays companies? I challenge the relevance of this relevance argument by suggesting that white-collar crime is cyclical, always re-emerging in economic boom times. While the questions raised in this paper may (Mills, 2003) or may not be immediately relevant to the present state of corporate America and beyond, nding answers to the questions raised herein will likely be directly applicable to the next and future periods of widespread economic growth and prosperity, as each such period may well be accompanied by corporate scandals.

Summary and Conclusion It has long been known in the elds of management, social psychology, and organizational behavior that a strong culture can act as a vital control mechanism over individual behavior. The eld of leadership has to some extent investigated a leaders inuence over the culture that controls employees, and how an organization arrives at a culture in the rst place (Schein, 1992; Sims and Brinkmann, 2003). If a leader can inuence her or his organizational culture, then it must be considered that the leaders theories of governance can be transformed into an organizational culture that is then used as a general method of solving problems. The best cultures that have been proposed are at, empowered ones in which pay is at least partly based on fair measures of performance and innovation leads to quick adaptation and learning (Galbraith, 2002). The example of Enron, which may be generalizable to examples of other recently failed companies as well as currently existing companies (Mills, 2003), suggests the need for researchers who apply a best culture approach to recognize that an irresponsible use of power (Gandz and Bird, 1996) may be prevalent in an empowered, innovative culture when incentives are established on the assumption of a pure agency relationship between a rms ownership and its employees. Using recent literature on Enrons operations, I have argued for the existence of an agency culture that

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Brian W. Kulik proaches may not be as effective as they could be upon practitioner implementation.

may well be as detrimental to the long-term health of corporate America as it was to Enron. I proposed that an agency culture should be distinguishable from other cultures because, in an agency culture, employees tend to explain their behavior as controlled by governance mechanisms, dened as agency reasoning. It is important to note that, compared to criticisms of Enrons improprieties and illegal activities, agency culture was the conclusion reached after juxtaposing Enrons popularity on the one hand, and its unsustainable corporate improprieties on the other. I further noted a number of undesirable behavioral consequences that managers should expect to see in their employees operating within an agency culture. Lastly, I turned to four possible antidotes to an agency culture selection, objectivist integrity, integrity capacity, and stewardship to illustrate both the shortcomings of these solutions and a future direction for making these approaches implementable so that in the future the emergence of an agency culture might be averted. In short, we need to develop answers to a strong agency culture that functions in a municent, few-failure environment containing new hires with low ethical characteristics. We are increasingly a culture that not only focuses on the short term (Piety, 2004), but also on the agency relationship in our pursuit of wealth. The perils involved in this pursuit was noted by Weber (2001 [originally published in 1905]), who warned:
In the eld of its highest development, in the United States, the pursuit of wealth, stripped of its religious and ethical meaning, tends to become associated with purely mundane passions, which often actually give it the character of sport (p. 124).

Acknowledgement I would like to thank Richard Reed and Jerry Goodstein for their many helpful comments on earlier versions of this paper and Dave Lemak for numerous discussions of the relevance of ethics in the works of seminal authors in business. References
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