Like Death and Taxes - there are consequences

Advocates of cash flow as the “summum bonum” of capitalism often take the position, as they must, that there are no negative consequences attendant upon such a course of business enterprise worthy of note.

The assumption they make is that the enterprise is autonomous, separated from society by various walls such that the only costs of material concern are those that show up on the income statement.

Thus, the “costs” of enterprise born by stakeholders – the environment, civil society, customers, employees, investors, creditors – do not count. They can be ignored.

This point of view is very short-sighted and so wrong as several developments here in the United States make very clear.

First, in the sub-prime mortgage mess; The consequences of rising foreclosures on home mortgages were set by entrepreneurs who extended mortgages to borrowers who were very much at risk of non-payment when conditions changes. By pushing off risks on borrowers with marginally secure abilities to pay, the originators of the sub-prime lending set off a sequence of developments that carried within its economic logic high risks of social dislocation.

With homes in foreclosure, with the prices of homes dropping for America’s great middle class, with the banking system under great stress, the government could not leave the market alone. Anxieties were too high and the demand for protection from market forces too intense.

So, President Bush felt compelled (it’s presidential election season as well and his party is not doing well in the polls) to step in. He imposed an emergency freeze on the raising of the interest rates on certain mortgages. The freeze will last for five years.

Nothing could be more alien to his principles of free market autonomy, where private actions without government regulation bring about optimal outcomes for society.

The moral lesson from the sub-prime adventures is: as you sow, so shall you reap. There are consequences for business that don’t always show up on the quarterly income statement.

Second, there are recent developments with UnitedHealth Group. This company in Minnesota underwrote for premiums the health care costs of millions of Americans. It paid its CEO William McGuire hundreds of millions of dollars and gave him stock options as well. The company’s stock rose in the market.

But it then turned out that many of his stock options had been rigged – backdated – to give him even more financial advantage.

When the back-dating was discovered, the Securities and Exchange Commission began an investigation and investors brought litigation. On December 6, 2007, McGuire decided to settle the claims against him. He agreed to give back to the company some $420 to $460 million in stock options and pay and to pay a $7 million fine.

He is still left with over $500 million in stock options so he will be able to live for the rest of his life as a gentleman should.

But there were consequences that followed upon his taking short-term financial advantage of the company.

Now, one way in which McGuire’s leadership of UnitedHealth Group had led to substantial profits was to squeeze its customers – the insured and doctor’s to be paid for their services. As a result of these business practices, the company in recent years lost 315,000 customers this year and angered doctors.

So, as a consequence, it is changing its practices. It will now show doctors and patients on the day of a doctor’s visit how a claim will be paid; it will pay doctors more quickly; UnitedHealth employees will be given incentives to put quality and patient advocacy first and productivity (i.e. cash profit) second.

Like death and taxes, consequences cannot be avoided. There is no free lunch in capitalism. Ethics is material to the bottom line.