Faculty comment on Enron debacle
SOM profs say case will produce mistrust in employers, rethinking of boards' role

By JOHN DELLA CONTRADA
Reporter Contributor

In the wake of the Enron debacle, many Americans will begin to question how much they trust their employers, says a School of Management faculty member who researches the development and consequences of trust in the workplace.

"I expect that a number of people will re-evaluate their relationship with their company and consider whether the trust they placed in their leaders in the past still is warranted," says Donald Ferrin, associate professor of organization and human resources.

"It's the people who have even the smallest suspicions about their own company who will be affected most by the Enron situation," he adds.

Ferrin notes there are several factors that contribute to the breakdown of trust at companies. The most damaging factor, he says, is the one perpetrated by Enron's leadership: failing to meet the expectations of employees.

"Unmet expectations lead to a breach in the psychological contract between employee and employer, which is defined as 'what the company owes us, and what we owe the company,'" he says.

The breakdown of trust has obvious negative consequences for both employee and employer, such as poor job satisfaction and poor job performance, says Ferrin. But, he adds, the most underreported result of employee mistrust could be the one that's most damaging to a company: a decline in what Ferrin calls "organizational citizen behavior."

"These are the duties that we perform on the job that fall outside of our formal job description," he explains. "If you think about it, much of what we do in our jobs falls outside of our job description. We do them for the good of the organization."

"When there's mistrust, we're much less likely to perform those duties."

Ferrin's research points to several actions and practices that promote employee trust in a company and its leadership. The most influential is "transformational leadership," where leaders gain trust by showing concern and respect for employees.

Other key trust-building factors include how much support a leader has, or is perceived to have, within an organization and whether employees feel they are treated fairly by company policy and in their personal dealings with their employer.

The fall of Enron also demonstrates that an inherent management problem previously thought to occur only among a company's top managers also occurs within a company's board of directors, according to two other SOM faculty members specializing in strategic management.

In Enron's case, the existence of the "agency problem" within its board of directors is partly to blame for the company's mismanagement and apparent unethical behavior, say John Stephan and Harold Star, assistant professors of management science and systems, who are researching the role of boards and CEOs in setting corporate strategy.

"The agency problem states that because top managers are typically not owners of a company, they can't be trusted to act in the best interest of those who do own the company—the shareholders," says Stephan. "Boards of directors were seen as a solution to the agency problem because they have a legal responsibility to protect and serve the shareholders.

"But what the Enron case illustrates is that the agency problem also exists within a company's board of directors," he adds. "Boards, too, have incentives not to act in the best interest of shareholders."

Stephan and Star maintain that the agency problem at Enron and other companies often is created because the CEO also serves as chairman of the company's board of directors.

"When the chairman is the CEO, then the nature of information that goes to the board is often distorted," says Star. "Making matters worse, the CEO typically stacks the board with cronies and supporters.

"As a result, the oversight role of the board is very easily co-opted into a rubber stamp role," he adds. "That was the case at Enron."

The researchers predict the Enron case will prompt a lot of re-thinking about the role of the board of directors and whether it's better or worse for a board to own shares of a company.

"The general feeling has been that board members should own shares if they are to represent the shareholders," says Stephan. "But what we're learning from Enron is that when board members own shares, there's a disincentive to ask the really tough questions for fear that those questions will drive down the stock prices."

Adds Star: "The scary thing about Enron isn't Enron. It's that Enron may be just the tip of the iceberg. There are lots of companies who have boards that are closing their eyes to some pretty shady practices."