Chapter 6
American Businesses

The business of America is business.

—President Calvin Coolidge, 1925

Businesses are diverse in America. They range in size from the huge multinational corporation employing thousands of people to the self-employed individual. They include large and small businesses, home-based businesses, Internet-based businesses, and corporate and family farms. Businesses are a vital part of the American economic engine. They supply goods and services to the world. Consumption of business output is the primary driver behind the growth of the nation's gross domestic product (GDP). Businesses also provide opportunities for employment, wealth-building, and investment.

Capitalism encourages business growth. However, businesses can become so large and powerful that they trigger concern about lack of competition within an industry. Corporate fraud and accounting scandals have eroded the public's trust in the integrity of "big business." American society also has certain expectations regarding the effects of business on the environment, local development, and public welfare and well-being.

HISTORICAL DEVELOPMENTS

When the first colonists arrived in America, they traded in furs and food with the native peoples and exchanged American resources for goods from other countries. The primary industries were agriculture, timber harvesting, and ship building. Manufacturing gradually grew in importance as the United States became an independent country and underwent the Industrial Revolution. As shown in Figure 1.2 in Chapter 1, agriculture accounted for 22% of national income in 1869. Other major sectors were trade and manufacturing (15% each), services (14%), and finance, insurance, and real estate (12%). The U.S. Census Bureau reports that by 1929 the contribution of agriculture to national income had shrunk to only 12%, while manufacturing had grown to 22%. By the mid-1950s agriculture accounted for only 5% of national income, while manufacturing had grown to 31%. (See Figure 1.9 in Chapter 1.)

Over the next half century, the United States underwent a gradual change from dependence on manufacturing as its primary business to reliance on service industries. As shown in Figure 1.9 in Chapter 1, services accounted for only 10% of national income in the mid-1950s. By the beginning of the twenty-first century, service industries dominated the American business world.

LEGAL STRUCTURES OF BUSINESSES

For legal and tax purposes, all businesses must be structured as one of several legally defined forms: sole proprietorships, business partnerships, corporations, or limited liability companies (LLC). Each offers both advantages and disadvantages to the business owner.

Sole Proprietorships

In a sole proprietorship one person owns and operates the whole business. Because the business and its owner are considered a single entity under the law, the owner assumes all of the risk but also reaps all of the benefits of the business. If the business fails, the sole proprietor may have to cover the losses from his or her personal assets, but if the business succeeds, he or she keeps all of the profits. Sole proprietors can pay lower taxes than those who head corporations or other forms of small businesses. Still, because almost all credit decisions are based on the owner's assets and credit history, it is often difficult for businesses set up under this structure to borrow enough money to expand as rapidly as other kinds of businesses.

Business Partnerships

A business partnership has two or more co-owners. As in a sole proprietorship, members of a business partnership are legally recognized as one and the same with their company, meaning that they are personally responsible for the company's debts and other liabilities. Most partnerships start with the partners signing agreements that specify their duties in the business. Many states allow for "silent partners," who invest start-up capital but have little role in the company's day-to-day affairs. (Start-up capital is the money used to start a new business.) A significant drawback of this form of business is that each of the partners is responsible for every other partner's actions. If a partner loses or steals money from the company, the other partners will have a legal responsibility to pay that debt.

There are three kinds of business partnerships: A general partnership is the simplest form, in which profits and liability are equally divided among partners or divided according to the terms of the signed agreement; a limited partnership allows partners to have limited liability for the company but also limited decision-making rights; and a joint venture, while similar legally to a general partnership, is used only for single projects or short periods of time.

Corporations

A corporation is an entity recognized by the state and federal governments as entirely separate from its owner or owners. As such, a corporation can be taxed and sued, and it can enter into contractual agreements. Because it is an individual legal entity, a corporation allows its owners to have less personal liability for debts and lawsuits than a sole proprietorship or partnership. Owners of corporations are considered shareholders, and they may elect a board of directors to oversee management of the company.

While corporations are commonly thought of as large companies with hundreds or thousands of employees and publicly traded stock, this is not always the case. Owners of small businesses frequently incorporate as their business expands. All corporate owners must file "articles of incorporation" with their state governments. For smaller businesses these forms are simple to fill out and file. One option is to file with the Internal Revenue Service (IRS) as a subchapter S corporation. In an S corporation the owner must pay him- or herself wages like any other employee, but the structure also offers substantial tax flexibility. All corporations that are publicly traded have C corporation status. This means they have nearly unrestricted ownership and they are subject to corporate taxes, paying at both the corporate and stockholder levels.

Limited Liability Company

The limited liability company is a combination of a corporation and a partnership in which the owners (or shareholders) have less personal liability for the company's debts and legal issues and also have the benefit of simpler tax filings and more control over management issues.

THE ROLE OF SMALL BUSINESS IN A COMPLEX ECONOMY

Many people perceive the American economy as being dominated by large businesses, like McDonald's and Microsoft. While it is true that many of the world's largest companies are headquartered in the United States, according to the U.S. Census Bureau's 2002 economic census, 57.4 million of America's 115 million workers were employed at companies with fewer than five hundred employees in 2001.

The size of what is considered a small business varies by industry, and size standards are determined by the Small Business Administration's Office of Size Standards, which issues standards according to a business's number of employees or its average annual receipts. The more generally accepted definition of a small business, however, is one that employs fewer than five hundred people at any one time. Table 6.1 provides a breakdown of business sizes in 2003. More than 5.7 million firms each employed less than five hundred workers. The payroll for the 57.4 million employees working in these small businesses was nearly $1.82 trillion, representing 45% of the total payroll for that year.

Home-Based Businesses

Small businesses operated out of a person's home may be organized as any of the legal business structures. In 2003, 53% of all small businesses in the United States were home-based. Of those, 60% were in service industries, 16% in construction, 14% in retail trade, and the remaining 10% in a variety of other sectors, including finance, communications, manufacturing, and transportation. About 91% of home-based businesses were sole proprietorships; 5% were subchapter S corporations; and 4% were partnerships. Almost all (91%) home-based businesses as of 2003 had no employees, and less than half operated on a full-time basis. In fact, owners of home-based businesses reported working approximately twenty-six to thirty-five hours per week, about ten hours per week less than owners of companies that operated outside the home ("The Small Business Economy: A Report to the President," U.S. Small Business Administration Office of Advocacy, 2004, http://www.sba.gov/advo/research/sb_econ2004.pdf).

The Small Business Administration

The Small Business Administration (SBA) was created in 1953 with the passage of the Small Business Act. The SBA's purpose is to support small businesses by offering financial and counseling assistance and ensuring that small businesses can compete against large companies in receiving government contracts. Since the SBA was established, it has granted some form of aid to almost twenty million small businesses. As of 2003, the SBA offered more loans than any other single financial backer in the United States: 219,000 loans worth approximately $45 billion.

BIG BUSINESS: FUELING THE AMERICAN AND GLOBAL ECONOMIES

While small businesses have a significant impact on the U.S. economy and represent more than 99% of U.S. employers, large corporations still dominate the business world. According to the Census Bureau, in 2002 fifty-six million people were employed by the 16,845 U.S. companies with more than five hundred employees, with 30.5 million of them working at companies with more than ten thousand employees. The total payroll for these large businesses was more than $2.16 trillion, compared with $1.77 trillion for all U.S. small businesses.

According to the business magazine Forbes (http://www.forbes.com/2006/03/29/06f2k_worlds-largest-public-companies_land.html), the two companies with the highest sales in 2005 were American-owned: Exxon Mobil Corp. ($328 billion in sales and 83,700 employees) and Wal-Mart ($312 billion in sales and 1.7 million employees). Overall, the two thousand top-grossing public companies in the world in 2005 employed sixty-eight million people and had sales of approximately $24 trillion.

Multinational Corporations

Many large businesses operate in more than one country, through subsidiaries or part ownership of foreign companies. These companies are called multinational or transnational corporations. Generally through mergers and acquisitions, a large company can grow beyond the boundaries of a single nation, buying and taking over companies in other countries to form a global network of subsidiaries. For example, Exxon Mobil, which was formed in 1999 by the merger of the two oil companies Exxon and Mobil, is headquartered in Irving, Texas, but it operates affiliated companies in at least forty countries on six continents.

Drawbacks to Economic Dependence on Big Business

Although it is unlikely that the entire U.S. economy could be affected by a downturn in a single business or industry, local and regional economies often suffer greatly when one kind of business—the automobile industry, for example—experiences a period of slow growth and poor performance.

One of the most notorious instances of a local economy depending too heavily on a single large company happened when the automotive company General Motors, the primary employer in Flint, Michigan, closed eleven plants in 1986 and laid off approximately forty thousand people throughout the 1970s and 1980s, resulting in a 25% unemployment rate and massive poverty by the late 1980s. Flint's rates of suicide, murder, alcoholism, and domestic violence reached unprecedented highs during this period. While the case of Flint and General Motors is extreme, it does illustrate the widespread economic and social problems that can come with a high degree of dependence on a single large corporation or industry.

In 2005 and 2006 the state of Michigan continued to experience an unemployment rate higher than the national average—7% as of August 2006, although that rate was due in part to seasonal layoffs that occur every summer in the auto industry (Kathy Barks Hoffman, "Michigan Jobless Rate up to 7%," Associated Press, August 16, 2006). Still, with General Motors losing $8.6 billion in 2005 (Bill Vlasic and Brett Clanton, "Simply Staggering," Detroit News, January 27, 2006) and Ford Motor Company announcing in August 2006 that it would cut production by 21%—with plant closings, layoffs, and pay and benefit cuts also planned (Joann Muller, "Ford Motor: It Only Gets Uglier," August 18, 2006, http://www.forbes.com/markets/2006/08/18/ford-output-update-cz_jm_0818output.html)—the regional economy was not expected to recover quickly or easily.

BUSINESS AND POLITICS

Large companies often have strong ties to the government. They have the resources to be able to donate millions of dollars to political campaigns to elect sympathetic lawmakers and to otherwise encourage the passage of pro-business legislation. Likewise, lawmakers, eager to have companies locate facilities in their constituencies to boost local economies, may support policies that favor business interests to the detriment of other programs. Members of Congress may be more inclined to pass pro-business laws if their region has benefited from a large corporation's presence, or if they or their party have received campaign contributions from such a company. This raises concerns that big businesses may be able to convince the government to favor their interests at the expense of the interests of other businesses, or even the population as a whole.

ECONOMIC PERFORMANCE

The businesses of America produce goods and provide services that are purchased by consumers. Consumption of business output is the major driving force behind the nation's GDP growth.

The U.S. Department of Commerce's Bureau of Economic Analysis (BEA) compiles data on the contributions made to GDP by various industries. One measure of output is called "real value added." This is defined as gross output minus the consumption of intermediate inputs. For example, the real value added to the economy by a manufacturer is calculated using the market value of the goods sold minus the cost of producing the goods.

Figure 6.1 shows the BEA breakdown of GDP growth per year by industry category for 2002 through 2005 and averaged over the period of 1995 through 2000. In 2005 the nation's GDP increased by 3.5%. Service-providing businesses grew by 4.1%, while goods-producing businesses had a 2.6% increase. As detailed in Table 6.2, the growth in the service-providing industry during 2005 was due to strong performance by information services (with a 7.4% increase) and professional, scientific, and technical services (with a 7% increase). The leading performers in the goods-producing sector were manufacturing (particularly the manufacture of computer and electronic products) and construction. Growth in these industries offset declines suffered in mining and agriculture businesses.

Table 6.2 indicates the incredibly strong growth during the late 1990s of a business sector the BEA calls information-communications-technology-producing industries. These are businesses that produce computers and electronic products, publish software and other materials, and provide services related to information and data processing and computer systems design. This sector had an annual growth rate of 22.1% between 1995 and 2000. After a downturn in 2002 the sector rebounded, experiencing growth rates of 6.7% in 2003, 12.9% in 2004, and 11.9% in 2005, according to the BEA.

Agriculture

The U.S. Department of Agriculture's National Agricultural Statistics Service (NASS) performs a Census of Agriculture every five years. The most recent census was conducted in 2002. According to the results, there were just over two million farms and ranches operating in 2002. The NASS defines a farm/ranch as an establishment from which at least $1,000 in agricultural products is produced or sold (or normally would be produced or sold) during a year (http://www.nass.usda.gov/census/census02/quickfacts/index.htm). Although less than 10% of farm/ranch establishments were owned by corporations or business partnerships in 2002, these farms accounted for nearly half of all sales and government payments.

As indicated in Table 6.3, the number of farms in America declined dramatically during the twentieth century, from 5.7 million in 1900 to 2.1 million in 2000. Likewise farming's share of the nation's workforce decreased from 41% to only 2%. However, the average farm size increased from 146 acres to 441 acres. This growth, combined with advances in agricultural science and technology, has resulted in an increase in farm output, even as farming's contribution to the nation's GDP has diminished. (See Figure 6.2 for a comparison of these measures between 1950 and 2000).

As shown in Table 6.2, the agriculture, forestry, fishing, and hunting sector experienced a downturn during 2005; real value added declined by 4.4%. This follows several years of positive moderate growth.

Nonagricultural Businesses

Table 6.4 shows results from the 2002 Economic Census performed by the U.S. Census Bureau. The agency conducts an economic census every five years. The table provides an economic overview of nonagricultural industry sectors with employee payrolls. The sectors are listed from largest to smallest in terms of value of sales, receipts, or shipments. Also included for each sector are the number of establishments, number of paid employees, and annual payroll.

Wholesale trade had $4.6 trillion in sales, receipts, or shipments during 2002. Wholesalers buy large quantities of finished goods from manufacturers and sell the goods in smaller lots to businesses engaged in retail trade. Retailers then offer the goods for sale to consumers at an increased price. There were more than one million retail establishments operating in 2002. While the traditional notion of a retail establishment includes at least one store location, many retailers operate via the Internet and/or catalog sales, instead of or in addition to their physical locations.

The manufacturing sector had the highest annual payroll in 2002 at $576 billion. Nearly 14.7 million people were employed in this sector, the second-highest number of the sectors listed. The health care and social assistance sector was the top employer with just over fifteen million paid employees.

Corporate Profits

One of the economic indicators tracked by the BEA is called corporate profits. This is a measure of the income generated by corporations from the current production of goods and services. Because only current production is counted, corporate profits do not include capital gains, such as inventory profits.

Table 6.5 lists the corporate profits by industry for the years 2003 through 2005 and the change from 2004 to 2005. Corporate profits totaled almost $1.4 trillion in 2005, up by $190 billion from 2004. Domestic industries accounted for $1.1 trillion, or 85%, of the total in 2005. These values include adjustments for inventory valuation and capital consumption (depreciation).

Among domestic industries, corporations engaged in financial services had the highest corporate profits in 2005. These businesses had profits of $347 billion (including only the inventory valuation adjustment). Similarly, the manufacturing sector had corporate profits of nearly $208 billion during 2005. Corporate profits were positive for all subsectors but one—the manufacture of motor vehicles, bodies and trailers, and parts.

Figure 6.3 shows the percentage change in year-over-year growth in corporate profits for the second quarter of 2002 through the first quarter of 2006. Corporate profits for first-quarter 2006 were up nearly 24% compared with the first quarter of 2005. This was the highest one-year growth rate recorded since 2002.

Industry Outlook

Table 6.6 is a list of the industries expected to undergo the greatest growth or decline in output through 2014. The list was compiled by the Bureau of Labor Statistics (BLS). The BLS expects phenomenal growth from businesses engaged in the manufacture of computers and peripheral equipment. This business is expected to increase its output by nearly $1.2 trillion between 2004 and 2014. Strong performance is also expected from the wholesale trade industry, with an increase of more than $840 billion predicted over the same time period.

Industries expected to suffer declining output include tobacco manufacturers, natural gas distributors, and manufacturers of certain apparel items.

FEDERAL REGULATION OF BUSINESS

Historically, U.S. economic philosophy has been to let the market operate with a minimum of government interference. This does not mean, however, that American businesses go unregulated. Many local, state, and federal laws exist to protect the public and the economy from dangerous, unfair, or fraudulent activities by businesses. Major federal programs that oversee business activities are described below:

• Federal Trade Commission (FTC)—Created in 1914 with the passage of the Federal Trade Commission Act. Originally intended to combat the rise of business monopolies, the FTC grew to become the U.S. government's consumer protection agency, addressing consumer issues such as identity theft, false advertising, telemarketing and Internet scams, and anticompetition moves by businesses.
• Consumer Product Safety Commission (CPSC)—Established in 1973 to protect the American public from unreasonable risks of serious injury or death from consumer products. Through a combination of voluntary and mandatory safety standards, the CPSC tries to prevent dangerous products from entering the market. If a product is found to be dangerous after it has already been sold to consumers, the CPSC has the duty to inform the public and the power to force a recall of the product if it is deemed necessary.
• Equal Employment Opportunity Commission (EEOC)—Established in 1965, the EEOC is the primary federal agency responsible for preventing discrimination in the workplace. Its original purpose was to investigate violations of the Civil Rights Act of 1964, which prohibited discrimination in the workplace on the basis of race, color, national origin, sex, and religion. Over the years its powers have been expanded and it has been given responsibility to enforce other antidiscrimination laws.
• Employment Standards Administration (ESA)—One of the largest branches of the Department of Labor, the ESA is charged with enforcing a wide variety of labor laws dealing with minimum wage requirements, overtime pay standards, child labor protections, and unpaid leaves of absence. It also provides oversight of federal contractors with regards to employment issues.

• The Environmental Protection Agency (EPA)—Develops and enforces federal environmental regulations. The EPA keeps track of industrial pollutants and regularly updates its compliance codes for individual sectors and industries.
• The Food and Drug Administration (FDA)—Works to ensure that the food, drugs, and cosmetics sold in the United States are safe and effective. It establishes safety and sanitation standards for manufacturers of these goods, as well as quality standards that the goods themselves must meet. FDA scientists must prove that certain products, especially drugs, are safe and effective before they can be sold in the United States, and it can force products off the market if they are later discovered to be dangerous. In addition, the FDA ensures that the labeling of food, drugs, and cosmetics is complete and truthful.
• The Occupational Safety and Health Administration (OSHA)—Establishes and enforces workplace safety standards. One or more OSHA standards covers almost every workplace in the United States.

Other Agencies

Besides the organizations listed above, there are a number of other government agencies that regulate specific industries or aspects of the economy. Some of them are well known, while many others may be virtually unknown to people outside the fields they regulate. A few examples are:

• The Federal Communications Commission (FCC) regulates the telecommunications industry, including all television, radio, satellite, cable, and wire services in the United States and its territories.
• The Federal Energy Regulatory Commission (FERC) regulates the national transmission network for oil, natural gas, and electricity.

• The Federal Maritime Commission regulates the waterborne foreign commerce of the United States.
• The National Highway Traffic Safety Administration regulates automobile design and safety.
• The Office of Surface Mining regulates surface coal mining.
• The Securities and Exchange Commission (SEC) regulates the stock market.

Government Regulation and Deregulation

Since the late 1970s the federal and many state governments have lessened their restrictions on certain industries. Called deregulation, this process allows industries to set their own standards and control their own systems of pricing and other business functions. For example, beginning in 1938 the airline industry was regulated by a federal body called the Civil Aeronautics Board (CAB), which controlled airlines' schedules, flying routes, and prices. In order to stimulate competition in the industry, Congress passed the Airline Deregulation Act (PL 95-504) in 1978. The industry experienced a flood of new airlines offering low fares to compete with the established airlines. Although deregulation has actually caused some problems with larger airlines having too much control (or monopolizing) the industry and with overly crowded flight routes, most economists agree that the end result has been an air transportation system that offers some of the lowest costs and safest flights in its one-hundred-year history. Other industries that have experienced some degree of deregulation include electric utilities, telephone services, trucking, railroads, and banking.

MARKET POWER—MONOPOLIES AND MONOPSONIES

One of the foundations of a capitalistic economy is competition. Competition for customers among sellers theoretically ensures that buyers receive the lowest price. If an industry becomes dominated by one seller, lack of competition allows that entity to set prices in the market-place—a situation known as monopolization. The federal government has long fought against monopolization in most U.S. industries. In 1890 the U.S. Congress passed the Sherman Antitrust Act to strengthen competitive forces in the economy. Section 2 of the law states: "Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony."

A monopsony is a different situation, in which the power lies with one buyer. This arrangement can occur if one company wields enormous power over the suppliers in that industry. Lack of other customers forces the suppliers to meet the price and quota demands of the monopsonist. Monopsony is an obscure economic concept to most Americans. But changing market forces in the retail industry are drawing attention to the possible existence and consequences of monopsony in some business sectors.

The Microsoft Monopoly?

In 1993 the Department of Justice began an investigation of software company Microsoft based on allegations that the company was engaging in unfair competition. Microsoft's Windows program already dominated the operating systems market. By bundling Web browsers and other applications with Windows, Microsoft made it difficult for other companies to compete in the market for these other applications as well.

In 1994 Microsoft reached an agreement with the Department of Justice, and the company agreed to stop bundling other products with Windows. In 1998 Microsoft was accused of violating its agreement, and the Department of Justice and the attorneys general of twenty states brought an antitrust suit against it. Microsoft reached a settlement in the case but still faced a number of class-action lawsuits. (A class-action lawsuit is one that is filed by a large group of people, all of whom accuse a single company of engaging in the same illegal acts against them.)

During the 2000s Microsoft fought and lost antitrust cases brought against it in Japan, South Korea, and Europe. In 2004 a European court ordered Microsoft to pay a fine of $613 million for violating the European Union's competition law. The company was also ordered to offer for sale a modified version of Windows that does not include a media player and to share certain communications protocols with competitors. In July 2006 the European Commission levied a $357 million fine against Microsoft for failing to fully comply with the 2004 ruling. Microsoft immediately appealed the fine, claiming that it has acted in good faith to meet the requirements imposed by the European Commission in 2004.

The Wal-Mart Monopsony?

During the early 2000s the mega-retailer Wal-Mart became the subject of much media attention for its business practices. In November 2003 the Los Angeles Times published a three-part series on Wal-Mart. Part two, titled "Scouring the Globe to Give Shoppers an $8.63 Polo Shirt" (by Nancy Cleeland, Evelyn Iritani, and Tyler Marshall), describes the relentless push at Wal-Mart for suppliers to lower costs. One textile producer summed up Wal-Mart's power: "They control so much of retail that they can put someone into business or take someone out of business if they choose to."

In November 2004 the Public Broadcasting System (PBS) series Frontline aired an episode titled "Is Wal-Mart Good for America?" The show traces the rise of Wal-Mart as a major force in the retail industry and describes the power that the company developed over its suppliers. One commentator noted, "Wal-Mart used its buying power and its information about consumer buying habits to force vendors into squeezing their costs and keeping their profit margins low. Over time, some suppliers—especially middle-sized and smaller firms—were bankrupted" (Sam Hornblower, "Always Low Prices").

At that time Wal-Mart employed 1.2 million employees and served one hundred million shoppers per week at more than three thousand stores around the country. The company had sales of $256 billion in 2003 and accounted for approximately 8% of total U.S. retail sales (excluding automobiles).

Wal-Mart's relatively small share of retail sales is one factor that helps the company avoid antitrust charges. A December 2003 article by New York Times columnist Steve Lohr asserts that Wal-Mart's emphasis on low prices to consumers is another factor ("Discount Nation: Is Wal-Mart Good for America?"). This view is shared by Washington Post columnist Peter J. Solomon. In the March 2004 article "A Lesson from Wal-Mart," Solomon notes that "federal regulators have refrained from pursuing monopsony antitrust action against Wal-Mart for putting the squeeze on its suppliers, because of the price benefits to consumers."

CORPORATE BEHAVIOR AND RESPONSIBILITY

Businesses play a vital role in the economic well-being of the United States. In addition to economic performance, Americans also expect businesses to behave in a legally and socially responsible manner. There is no public or political consensus on the exact social responsibilities of businesses. But it is recognized that the decisions and practices of company officials, particularly of large corporations, affect not only employees and investors but also the communities in which businesses are located. Fraud and corruption at the corporate level can adversely impact large numbers of people. Likewise, poor performance by businesses in meeting environmental, health, or consumer-protection standards has detrimental effects on society at large.

Corporate Scandals

ENRON

Based in Houston, Texas, Enron was an international broker of commodities such as natural gas, water, coal, and steel. In August 2000 Enron's stock rose to an all-time high of $90 per share. But the company was incurring more and more debt because its contracts outstripped its ability to deliver. To hide its liabilities, Enron created a web of partnerships; the idea was to transfer debt so it would not show on the company's books. Enron's accounting firm, Arthur Andersen, helped the company hide its debts and shredded key documents. With debts transferred to other entities, Arthur Andersen and Enron could overstate the value of the company, and its stock continued to perform well.

Enron eventually had to pay the debts either with cash or with stock, which would create a huge loss that the company could not hide. Enron Vice President Sherron Watkins discovered the accounting discrepancy in the summer of 2001, becoming the key whistleblower when she sent a memo about the problem to CEO Kenneth Lay. In October 2001 Enron announced part of the loss—$638 million in the third quarter of 2001, with a loss in shareholder equity of $1.2 billion—and its stock price plummeted. The company announced that it was being investigated by the SEC for possible conflicts of interest with its many partnerships. In November 2001 Enron stock dropped to less than a dollar per share, and in December the company filed for bankruptcy. Four thousand employees were laid off at that time.

Shortly before announcing the income overstatement, Enron executives took two additional steps. First, some of them sold their stock so they could get their money out before the stock lost all its value. Second, the company imposed a freeze on employee sales of the stock shares in their 401(k) plans. So when the news broke and employees tried to sell their stock to save what they could of their retirement savings funds, they found that they were stuck with worthless stock in a bankrupt company. Thousands of people lost their jobs, along with their health care, retirement funds, and, in many cases, life savings. While investors both in and outside the company lost tens of billions of dollars, Enron wrote $55 million in bonus checks for company executives the day before it declared bankruptcy.

In 2002 Enron's accounting firm, Arthur Andersen, was found guilty of obstruction of justice charges; two years later the company also lost its appeal of the original ruling.

In December 2005 former accounting officer Richard Causey pleaded guilty to securities fraud and agreed to cooperate with authorities in exchange for a plea deal providing a five- to seven-year prison term and a $1.25 million fine. In May 2006, after a lengthy trial, former CEO Jeffrey Skilling and Enron founder Kenneth Lay were found guilty on various counts of fraud and conspiracy. Lay died six weeks later from a heart attack. Skilling was scheduled to be sentenced in October 2006. Dozens of other people were charged in the Enron scandal; a complete list is published by the Houston Chronicle ("The Fall of Enron," 2006, http://www.chron.com/news/specials/enron/background.html#scorecard).

WORLDCOM

In 2002 the federal government began investigating the accounting practices of WorldCom, the second-largest long-distance telephone company in the United States and the world's largest Internet service provider. Eventually, an $11 billion scandal was uncovered. The company filed for bankruptcy—the largest such filing in U.S. history to date. The stock held by investors was worthless, and thousands of former employees lost their jobs, pensions, benefits, and severance pay.

Company executives were indicted on fraud charges; several agreed to testify against former CEO Bernard J. Ebbers in exchange for lighter sentences. In March 2005 Ebbers was convicted of all nine charges against him. He received a sentence of twenty-five years in prison.

TYCO

In 2002 Tyco International Ltd. became embroiled in a series of scandals centered on the company's CEO, L. Dennis Kozlowski, and its CFO, Mark Swartz. Both men resigned and were sued by Tyco in connection with $600 million in loans, salary, and fringe benefits they allegedly took from the company without board approval. The government indicted the men for grand larceny and securities fraud, among other criminal charges.

Kozlowski and Swartz were first tried in September 2003. Particularly at issue during the trial was Kozlow-ski's extravagant lifestyle. Prosecutors told of Kozlowski throwing his wife a $2.1 million birthday party paid for in part by Tyco, living in a $19 million Manhattan duplex bought for him by the company, and purchasing a $6,000 shower curtain, all while Tyco investors lost millions because of his stock manipulations. The case was declared a mistrial in April 2004 when a juror, suspected of communicating with defense attorneys, was named in the media and subsequently received threatening letters and phone calls. In 2005 the men were retried, found guilty, and sentenced to up to twenty-five years in prison.

Big Tobacco—An Industry under Attack

In the 1990s many state governments brought lawsuits against the nation's major tobacco firms to recoup taxpayer money spent treating sick smokers under state Medicaid programs. In 1998 a settlement was reached in which the companies affected agreed to pay a total of $246 billion spread amongst the governments of all fifty states. The payments are to be made over a twenty-five-year period. The settlement also required the tobacco companies to change their advertising methods and reduce their political lobbying efforts.

In 1999 the federal government filed its own lawsuit (United States v. Philip Morris) against the tobacco companies alleging that the defendants had engaged in a decades-long scheme to "defraud the American public" regarding the safety of cigarette smoking. The case centered on internal documents obtained from tobacco companies that seemed to demonstrate that the companies were well aware that nicotine was addictive and cigarette smoking caused lung cancer. The trial began in 2004 and lasted for nine months. As of July 2006, the federal judge who presided over the case had not given a ruling on the findings. But rulings by other courts during 2005 mean that the government cannot pursue a $280 billion penalty that it was seeking from the tobacco companies.

The lawsuits represent an unusual occurrence in American history, because the government has brought financial pressure on an entire industry. Rising costs of doing business in an unfavorable climate have led tobacco companies to raise prices. Figure 6.4 compares the consumer price index (CPI) for all items and for tobacco products between 1991 and 2005. Price inflation for tobacco products has outpaced the general inflation rate over this period, particularly since 1999. On the flip side of the supply-demand relationship, consumption of cigarettes has dropped dramatically. This is likely due to a combination of price pressure and greater public awareness about the dangers of smoking. As shown in Figure 6.5, total U.S. consumption of cigarettes peaked in the 1980s at around 640 billion cigarettes per year. Since then, consumption has plummeted; only 378 billion cigarettes were purchased in 2005, based on preliminary estimates.

Public Perception of Big Business

In June 2006 the Gallup Organization conducted a poll to gauge public confidence in various institutions. As shown in Figure 6.6, the military garnered the highest rating, with 73% of those asked expressing a great deal or quite a lot of confidence in the military. Big business received a much lower rating. Only 18% of respondents had a great deal or quite a lot of confidence in big business.

An earlier Gallup poll conducted in February and March of 2006 found that 65% of respondents felt that major corporations should have less influence in the United States. This value is up from 52% who felt that way in January 2001. Nearly three-quarters of those asked said that big business has "too much influence" over the decisions made by the administration of President George W. Bush (Big Business, The Gallup Organization, http://poll.gallup.com/content/default.aspx?ci=5248&pg=1&VERSION=p).