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4.3 Synthesis: What Is the State of U.S. Corporate Governance?
Has investor confidence been restored? Were the various regulatory changes effective? How sound is the American corporate governance today? As we begin to answer these questions, it is important to note that the U.S. corporate governance system has been roundly criticized and the subject of vigorous debate for many years. In 1932 Berle and Means warned that changes in ownership patterns would foreshadow “governance co-opted by management”; Mace has likened boards to “ornaments on a Christmas tree”; Drucker said boards “do not function”; while Gillies proclaimed that “boards have been largely irrelevant throughout most of the twentieth century.”Berle and Means (1932), p. 62; Mace (1971), p. 3; Drucker (1974), p. 628; and Gillies (1992), p. 3. A widely read book by Lorsch and MacIver has the colorful title Pawns or Potentates.Lorsch and MacIver (1989). Perhaps the most cynical observation comes from an anonymous executive quoted by Leighton and Thain (1997): “Our board is like a bunch of ants… on top of a big log carried by a turbulent current swiftly down a river. The ants think they are steering the log.”Leighton and Thain (1997), p. 51.
Robert Monks, pioneer among shareholder activists, founder of Institutional Shareholder Services (ISS), and well-known author on corporate governance–related subjects, recently expressed his skepticism this way:
There is almost universal agreement that corporate governance in America is failing. There was a large window of opportunity following public revulsion with the scandals of the 1990s. That energy has dissipated and virtually no “real” reform has occurred. We are in the “worst of times”—unignorable evidence of governance failure persists from the comic criminal of Health Care South to the nearly noble Royal Dutch Shell; equally unignorable is the failure on all sides to come up with credible improvement. Instead, companies complain of the cost of compliance with new laws and threaten to tie up proposals in appellate court litigation; reformers complain of the failure of new initiatives.Monks (2005, March), p. 108.
Similarly, appearance and reality are conspicuously at variance with respect to recent governance “reforms.” So much attention has been paid to such widely discussed “apparent” reforms as the NYSE listing requirements and Sarbanes Oxley (“SOX”) that observers fail to note the fundamental difference between process and substance. Business leaders exacerbate the problem by polluting public dialogue with complaints of “governance fatigue.” In reality, only a cynic or an incurable optimist could detect real reform in recent enactments.Monks (2005, March), p. 109.
I have recently argued that most of the observed problems of governance failure arise out of the excessive power lodged in the Chief Executive Officers. Persons having power are reluctant to give it up. This is the problem, and this is the challenge. Governance is stuck in the mode of confrontation between owners and managers and the managers have won. The informing energy of business is greed; solutions that are not based in economic incentives will certainly fail. Reform proposals will be credible only to the extent they make desired action profitable. Nothing by way of change will happen unless the various corporate constituencies can achieve profits through compliance.Monks (2005, March), p. 109.
Real change, Monks (2005) argues, should focus on making shareholder responsibility a reality by removing the “many biases in the current legal/regulatory/institutional structure of governance.” Monks makes a number of intriguing, sometimes politically controversial and challenging, proposals, such as placing a tax incentive on term ownership to encourage long-term holding of securities and discourage “churning,” increasing the role of shareholders in the nomination of directors to achieve true director independence, and splitting outstanding common equity into two classes—“ownership” and “trading” shares—to more meaningfully engage institutional owners in the governance process. Calling CEO compensation the “smoking gun” of governance failure, he also urges the restoration of CEO pay to credible levels, even if this means changing existing agreements.Monks (2005, March), p. 110.
Despite all this skepticism, a reasonable argument can be made that the broad evidence is not consistent with a failed U.S. system. On the whole, the U.S. economy and stock market have performed well, both on an absolute basis and relative to other countries over the past 2 decades, even after the scandals broke. And while parts of the U.S. corporate governance system clearly failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. On balance, most of the reforms that have been enacted are welcomed. Along with other increasingly common board features—periodic self-evaluation, for example, and requiring that directors own a significant amount of company stock—they have, by and large, had a positive effect on governance and, indirectly, on company performance. This is not to deny that significant issues persist, however.
Perhaps the most visible and contentious unsolved problem is runaway executive compensation. A growing number of investors and directors, upset with absolute levels of pay and with forms of compensation that are not aligned with long-term corporate performance, want concrete change. Shareholder activists are pushing additional reforms. They continue to press, for example, for the right of shareholders to directly nominate and elect directors rather than work with the slate recommended by the board’s nominating committee. Another proposal asks that shareholder resolutions receiving majority support become binding upon boards and that shareholder votes on merger proposals be made mandatory. Support for these further proposals has been lukewarm, however, because they tend to undermine rather than strengthen the role of the board.
Others complain that the recent wave of reforms has been too narrow in focus—exclusively aimed at the immediate interests of shareholders—and has not addressed or even seriously contemplated the broader set of stakeholder concerns and societal pressures that is emerging on issues, such as companies’ growing political influence, sustainable business practices, and various dimensions of corporate social responsibility.25. In academic terms, reforms enacted to date can be characterized as being primarily focused on addressing the so-called agency problem—the innate conflict that exists between owners (investors) and management, even though managers ostensibly act in the shareholders’ interests. For more on this issue, see Chapter 3 "The Board of Directors: Role and Composition".
Finally, there is a growing concern that the recent wholesale adoption of new rules and processes may have had a number of unanticipated, unintended, negative consequences. Regulation is, and always will be, an extremely blunt instrument for solving complex problems, and impacts different companies in different ways. Many smaller companies, for example, are struggling to cope with the additional regulatory burden and comply with the new law. In recognition of this fact, proposals allowing smaller companies to scale back or postpone compliance with some of the provisions in the Sarbanes-Oxley are now under active consideration.