Enron & Henry Ford

Just as every cloud has a silver lining, so disasters always have a redeeming feature. Because of the Titanic , no major ship has struck an iceberg since. That most famous of disasters produced a slew of reforms, all of which made the sea a much safer place. Business and financial disasters, too, have led the way to fundamental reforms that made the capitalist system, as a whole, safer and more productive. The collapse of thousands of banks in the Great Depression resulted in a banking system in which not one depositor has lost a cent of insured funds since 1934. The failure of Samuel Insull’s overleveraged electricity empire in the early 1930s led directly to new rules governing holding companies.

Today’s ongoing Enron saga will undoubtedly lead to many new procedures for bookkeeping, auditing ethics and rules, offshore subsidiaries, and the ways in which Wall Street analyzes stock. The collapse of one of the largest American corporations will also, one hopes, result in thoroughgoing reforms in corporate governance. They are needed.

In theory the stockholders of a corporation elect a board of directors that in turn hires the management and evaluates its performance, rewarding it or firing it as needed. But because of one of the iron laws of human nature, that institutions tend to evolve in ways that favor their elites, many corporate boards today are, in fact, controlled by the management they are supposed to supervise. The chief executive is often the board chairman as well, as was the case with Enron, and frequently decides who else sits on the board. Thus the other members of the board are not about to criticize the chief executive freely. And, since it is the board of directors that sets the compensation of top management, it is small wonder that management salaries have escalated far faster than inflation or even corporate profits in recent years.

In effect, then, in many American corporations with widely dispersed stockholders, the top management has no boss. But everyone needs a boss, for the reason Lord Acton made clear more than a hundred years ago and, it seems, Enron has proved once again: Power corrupts, and absolute power corrupts absolutely.

There could be no better historical example of what happens when top management answers only to itself than the Ford Motor Company in the 1920s, as Peter Collier and David Horowitz make clear in their book The Fords: An American Epic . In that case, of course, it was not that management became unaccountable to stockholders; it was that Henry Ford and his son, Edsel, owned 100 percent of the stock.

The Ford Motor Company was founded in 1903. For capital, Henry Ford turned to Alexander Malcomson, a successful Detroit coal merchant. Together Ford and Malcomson held 51 percent of the stock; the rest belonged to such investors as John and Horace Dodge, who supplied such automotive components as engine blocks and transmissions (and who would later build their own line of cars).

The Ford company got off to a successful start, thanks to successes in automobile racing. But Malcomson wanted to concentrate on a larger model, the Model K, with six cylinders, aimed at the uppermiddle-class market. Ford would have none of it. “A car should not have any more cylinders than a cow has teats,” he proclaimed. Instead he wanted to make a plain car for the masses. “The way to make automobiles,” he told his attorney, “is to make one automobile like another automobile ... just as one pin is like another pin when it comes from a pin factory.” In July 1906 Ford and Malcomson parted company, Ford paying Malcomson $175,000 for his 25.5 percent interest in the business. Now, with 51 percent of the stock, Ford was in unquestioned control of the company.

And as the world knows, Ford was right. The Model T, introduced in October 1908, was an immediate success. Simple, rugged, and affordable, it caught the wave of rising enthusiasm for the new form of transportation and rode it to glory. And the Ford Motor Company became one of the great cash cows in the history of capitalism. In July 1909, the company paid out $1.7 million in dividends to its handful of investors and also distributed $1.9 million of new stock. A week later it declared an extra dividend of $600,000.

But while Henry Ford was deeply interested in endlessly refining the manufacturing process in order to lower the manufacturing cost and thus the sales price (he would introduce the revolutionary assembly line in 1913), he believed that the Model T was the answer to the nation’s automotive needs and always would be. In 1912, while he and his family toured the British Isles, Harold Wills, one of the company’s top executives, decided to surprise him with a new version of the T, to take advantage of rapidly evolving automotive technology. One employee thought the new version was “so much over the original it was like night and day.”

When Ford returned to Detroit, he went directly to the plant and quickly spotted it. He asked what it was.

“Well, Mr. Ford,” answered an employee, “that’s the new car.”

“Ford car?” he asked.

“Yes, sir.”

Ford looked at the car, circling it a couple of times. Then he attacked it. He ripped the driver’s side door off its hinges and then the passenger side door. He leaped onto the hood and kicked in the windshield. Clambering to the roof, he jumped up and down, staving it in. “We got the message,” one observer of this epic temper tantrum reported. “As far as he was concerned, the Model T was God and we were to put away false images.”

Again, Ford was right, at least for a while. The Model T, its price falling nearly continuously as economies of scale and ever-better manufacturing techniques reduced costs, soon captured nearly 60 percent of the burgeoning American automobile market. In 1915, the dividends declared by the Ford Motor Company, capitalized at less than $700,000 a decade earlier, amounted to an awesome $60 million.

By then Ford had plans for building what would be by far the largest industrial complex in the world, the River Rouge plant, where all the various parts of an automobile would be manufactured and assembled into finished vehicles in one vast operation. It would have 42,000 workers on 229 acres of floor space knitted together with 93 miles of railroad track. The Dodge brothers, who held 10 percent of the company, sued to prevent what they regarded as a monument to Ford’s megalomania. Ford lost in court but won the battle when he bought out the minority stockholders for $105 million. He and his son, Edsel, were now the sole owners of the largest automobile company on earth, and his dream of building the ultimate automobile plant at River Rouge soon became a reality.

By the beginning of the 1920s, more and more car buyers were seeking characteristics beyond basic transportation, such as status. But Henry Ford was convinced that the Model T was still the perfect automobile, and he simply ignored anything that indicated otherwise. No one, not even his own son, could change his mind. The Model T had always been the butt of affectionate jokes, but now the jokes began to take on an edge. (What does the Model T use for shock absorbers? The passengers.) Moreover, the sales of its closest competitor, the Chevrolet, were soaring, from 280,000 in 1924 to 730,000 in 1926. In 1923 Ford had 57 percent of the American market. Two years later it was down to 45 percent and dropping.

In 1926, with sales of the T plummeting, Ernest Kanzler, a Ford vice president, sent Henry Ford a memo arguing forcefully for designing a replacement for it. “That young man is getting too big for his britches,” responded Ford. He soon fired him. Edsel Ford, seeing disaster on its way, kept at his father to end production of the Model T, at no small cost to their personal relationship. Finally, after Henry Ford could no longer deny the evidence that was all around him, it was announced on May 24, 1927, that the Model T would be discontinued. Two days later the 15 millionth one—the record for a single model until 1972, when it was surpassed by the Volkswagen Beetle—rolled down the assembly line. But Henry still didn’t get it. “The only thing wrong with that car,” he said later, “was that people stopped buying it.”

The company shut down for months while its plants were retooled to produce the Model A. The American economy had a slight slowdown as people stopped buying cars, waiting to see what the Model A would be like. It sold well, but Ford was no longer the leader in the American automobile industry. General Motors now held that position, which it has maintained to this day.

As Henry Ford got older, crankier, and even less inclined to listen, the management of the Ford Motor Company, always erratic, became worse. Finally, in his eighties, his son dead, his legendary company a shambles, Ford relinquished control to his grandson Henry Ford II. It would take the latter years to restore what his grandfather, with no one to answer to but himself, had nearly destroyed.

Henry Ford almost ruined the Ford Motor Company because as the sole owner he didn’t need to listen to anybody. How the Enron story will play out is anyone’s guess at this point, but it is already clear that its management didn’t need to listen either. If any good for the American economy is to come out of the Enron debacle, corporate governance will have to change to ensure that the bosses at our great corporations have bosses.