01 Oct 2002
A Purposeful Walk Down Wall Streetby Garry Emmons
Samuel L. Hayes, III (MBA '61, DBA '66), the Jacob H. Schiff Professor of
Investment Banking, Emeritus, is a widely recognized authority on capital markets,
Wall Street, and the corporate interface with the securities markets. He takes a
broad view of Wall Street's current troubles. The U.S. market is still the
most efficient in the world, he says. Over the longer term, one can buy
and hold investments and be confident that price disparities will smooth out with
time and be reflective of real value.
The author and coauthor of a number of books and many articles, Hayes has consulted
for corporations, financial institutions, and government agencies, including the
Justice Department, Treasury Department, the Federal Trade Commission, and the
Securities and Exchange Commission. He frequently comments in the news media on
matters relating to Wall Street and finance.
Hayes, who retired in 1998, was appointed to the HBS faculty in 1972. He taught in
the MBA, AMP, and OPM programs, and continues to teach in executive programs at HBS
and overseas. His current research focuses on Islamic banking and investment
practices, the subject of his seventh and latest book. Still active at HBS, Hayes
teaches in and runs the Executive Education offering Strategic Finance for Smaller
Businesses, serves on several committees, and is an advisor to the Dean. He also
teaches in and runs the two-week summer session Analytics, an offering for selected
entering MBA students who would benefit from practice in the use of statistical,
accounting, and financial analytic tools.
A resident of Westwood, Massachusetts, Hayes sits on four corporate boards, chairs
the investment committee at Swarthmore College (his alma mater), and is treasurer of
the New England Conservatory of Music. A longtime musician, Hayes plays the pipe
organ and cello, but only with family — a select group that consists
of his wife, Barbara, and their three daughters and two grandchildren.
What's behind the current crisis in U.S. financial markets?
Wall Street has always been a hornet's nest of potential conflicts of interest,
and we've seen companies stray over the edge of ethical impropriety before. This
time, however, the tendency to test the limits was exacerbated by the enormous surge
in stock values, profits, and economic activity during the 1990s. A lot was glossed
over or obscured by the stampede of the bulls.
I'm not at all surprised by the nature of the conflicts that have been revealed,
nor the areas in which abuses have taken place. These minefields have long been
apparent to industry participants. What I find sobering is that a number of firms have been unable to manage these well-known
conflicts in a responsible manner relative to the public and their own shareholders.
In my view, these are the most widespread allegations of wrongdoing on Wall Street
since World War II.
People got sloppy. People got greedy. Now we've got to tighten up.
What are some of the key actions that must be taken?
Heightened surveillance overall is essential. As for reforms, one step would be to
require that securities analysts be genuinely independent of the investment banking
side of the firms they work for. Profits on the investment banking side loom so large
that they're a siren song that's hard to resist.
Another crucial step would be to ensure that public accounting firms once again
become bona fide watchdogs. Too often, lucrative consulting contracts have caused
accounting firms to relax their auditing standards to placate management.
Self-regulation in the private sector requires truly independent and sharp-eyed
accounting firms — the alternative would be a disaster of bureaucratic gridlock
in the form of line-by-line audits by the federal government.
Can Wall Street's leaders restore trust in the markets' integrity?
Yes, I think they can. But they must exercise a truly long-term view of their
industry and not be seduced in the short term by the extreme competitiveness of the
investment banking and securities marketplace. I've seen firsthand how that
competitiveness can undermine the best intentions of high-ranking industry
In 1995, I served on a small blue-ribbon committee, established by then SEC chair
Arthur Levitt, to formulate best practices with regard to stockbrokers'
activities and compensation. These were not legislative remedies, they were
recommendations for voluntary standards of conduct, and all the big firms — and
their leaders — agreed to follow them. But it wasn't long before one firm
violated that understanding, and to avoid being put at a competitive disadvantage,
everybody else began ignoring the recommendations too.
From that experience and others, I know that intra-industry trust and effective
self-regulation can be fragile. That, of course, affects investor confidence.
Given that fragility, what rules and enforcement are appropriate?
The capital markets are so complex and fast-moving that their integrity must in the
end rely on self-regulation, rather than on day-to-day oversight by some government
bureaucracy. There's no way you can have meat inspectors stamping each
individual steer. The meat packers themselves must make sure that all the product
they sell is of good quality, as represented.
I believe the regulatory tools we have in place are enough. Considering its limited
resources, the SEC does a remarkable job: I'd favor increasing its budget and
the resources for its enforcement arm and making surprise inspections
much more frequent.
Those who violate the law or SEC rules should be punished severely. Using fines is
not sufficient. I think people have to go to jail.
Is the quarterly pressure on companies to report good results a factor in this
The focus on the short term has been a chronic plague on our financial system for
years. It's partly tied to the cadre of security analysts on Wall Street who are
influential in shaping the attitudes of institutional investors. When analysts
predict strong numbers for the next quarter and they don't materialize, they
often feel publicly embarrassed by their inaccuracy and take their anger out on the
subject company by reversing a previous buy recommendation. That causes
many institutional investors to run for the exits in anticipation of a precipitous
drop in the price of the shares, which could hurt their annual performance bonuses.
So you have a whole daisy chain of preoccupations that are short term in nature,
created in part by the institutionalization of the market and the growth in research
What can be done about that?
If I could do one thing, I would eliminate quarterly reports. While I think the best
market is a well-informed market, I believe we've created a short-term numbers
game that plays to the darker side of managerial action, and is a negative influence
on sound corporate strategy. Perhaps the reporting system should move to no more than
semiannual earnings releases.
Has too much corporate money in Washington contributed to this crisis?
It would be irresponsible for corporations not to strive to get their voices heard
where they perceive their well-being to be at stake. Having said that, to the extent
that this money has attempted to lessen regulatory oversight or mandated standards of
conduct, I think the private sector should now welcome steps that restore the trust
of investors and the general public.
What should business schools do?
We need to screen out any applicants whom we may suspect do not have an already
well-developed moral compass. While we should not have to point out to students what
is right and what is wrong, we can guide them through the
gray areas of decision-making. HBS puts these concerns front and center with the
ethics module and with its efforts to incorporate in all its offerings situations in
which ethical judgments are key.
— Garry Emmons