The Recurrent Crisis in Corporate Governance
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Paul W. MacAvoy , Ira M. Named one of the books of the year in the Economist : "A convincing explanation of why, despite all of the recent reforms in American corporate governance, there will probably be more firms that go the way of Enron. In addition to the ethics scandals that have plagued companies both new and established over the last three years, a number of over-diversified, over-staffed companies experienced failures that might have been avoided had there been proper oversight on the part of the board.
While reform of the governance system has received considerable attention from the press, business leaders, and politicians, there have been few analyses of what is really happening on a systemic level, and even fewer workable suggestions for reform.
The Recurrent Crisis in Corporate Governance provides an expert assessment of what went wrong on corporate boards and how to fix them. The book begins with both a legal and economic examination of corporate governance during the last three decades, including the broad issue of boards taking on responsibilities without being able to fulfill their obligations because of the lack of access to information and people within the corporation.
The authors then go on to show the correlation between strong board performance and strong company performance, make the case for separating the CEO and Chair positions, comment on the collapse of nine major corporations, including Global Crossing, K-Mart, Lucent, and Qwest, and provide suggestions on how boards can be more effective stewards of the shareholders' and public's trust. The Current Crisis. The Emergence and Development of the Governance Problem. Conglomeration as an example of managerial selfinterest. Description Desc.
He is the author of twenty books and numerous journal articles focusing on government regulation of the structure and conduct of the corporation. Ira M. Named by The Economist as one of six "best books" in economics and business for Table of Contents. More in Business—Management and Leadership. Milstein, Holly, and Grapsas , January. In broad terms, they fall into three categories: a to make decisions, b to monitor corporate activity, and c to advise management. The key issue here is deciding which board posture is appropriate at what time.
While the law, corporate bylaws, and other documents frame many of the decisions a board must make, such as appointing a CEO or approving the financials, they do not provide much guidance with respect to the most important decision a board must make—when must board oversight become active intervention? For example, when should a board step in and remove the current CEO? When should directors veto a major capital appropriation or strategic move?
Lists never can fully capture the complexity and intricacies of the governance function because they do not consider the specific challenges associated with different governance scenarios. In particular, the precise role of a board will vary depending on the nature of the company, industry, and competitive situation and the presence or absence of special circumstances, such as a hostile takeover bid or a corporate crisis, among other factors.
The challenges faced by small, private, or closely held companies are not the same as those of larger, public corporations. In addition to their traditional fiduciary role, directors in small companies often are key advisers in strategic planning, raising, and allocating capital, human resources planning, and sometimes even performance appraisal. In large public corporations, directors are focused more on exercising oversight than on planning, on capital allocation and control rather than on the raising of capital, and on management development and succession activities rather than on broader human resources responsibilities.
Public company ownership patterns are not homogeneous either, and different ownership structures may call for different governance approaches. The first, and most common, board situation is one in which a corporation has no controlling shareholder. In that case, directors should behave as if there is a single absentee owner whose long-term interests they serve. A primary responsibility for the board in this scenario is to appoint and, if necessary, change management, just as an intelligent owner would do if he were present.
The recurrent crisis in corporate governance
If he is successful, the board will have the muscle to make the appropriate change. He should then feel free to make his views known to the absentee owners. Directors seldom do that, of course. The temperament of many directors would in fact be incompatible with critical behavior of that sort. But I see nothing improper in such actions, assuming the issues are serious. Naturally, the complaining director can expect a vigorous rebuttal from the unpersuaded directors, a prospect that should discourage the dissenter from pursuing trivial or non-rational causes.
Buffett, annual letter to Berkshire Hathaway shareholders The second situation occurs when the controlling owner is also the manager. At some companies, such as Google, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In these situations, the board does not act as an agent between owners and management, and directors cannot affect change except through persuasion.
Therefore, if the owner or manager is mediocre—or worse, is overreaching—there is little a director can do about it except object. And if there is no change and the matter is sufficiently serious, the outside directors should resign. Buffett The third public corporation governance situation occurs when there is a controlling owner who is not involved in management. This case, examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially value-creating position. If they become unhappy with either the competence or integrity of the manager, they can go directly to the owner who may also be on the board and make their views known.
This situation helps an outside director, since he need make his case only to a single, presumably interested owner who can immediately make a change if the argument is persuasive. Even so, the dissatisfied director has only that single course of action. If he remains unsatisfied about a critical matter, he has no choice but to resign. It will also be readily apparent that the role of the board will vary depending on the size of the company, the industries it serves, and the competitive challenges it faces.
Global corporations face different challenges from domestic ones; the issues in regulated industries are different from those in technology or service industries, and high growth scenarios make different demands on boards than more mature ones.
The recurrent crisis in corporate governance | Awards & Grants
Finally, in times of turbulence or rapid change in the industry, boards often are called on to play a more active, strategic role than in calmer times. Special events or opportunities, such as takeovers, mergers, and acquisitions, fall into this category. Company crises can take on many different forms—defective products, hostile takeovers, executive misconduct, natural disasters that threaten operations, and many more.
But, as boards know very well, they all have one thing in common: They threaten the stock price and sometimes the continued existence of the company. Some examples follow:. Jones Beyond implementing reforms and best practices Methods or techniques of running a corporation or business to realize superior results. Rubber-stamping decisions, populating boards with friends of the CEO, and convening board meetings on the golf course are out; engagement, transparency, independence, knowing the company inside and out, and adding value are in.
This all sounds good. There is a real danger, however, that the rise in shareholder activism, the new regulatory environment, and related social factors are pushing boards toward micromanagement and meddling. This issue is troubling, and clear evidence that the important differences that separate governance from management —critical to effective governance—are still not sufficiently well understood by directors, executives, regulators, and the popular press alike.
The key issues are how and to whom boards add value. Carver , November , pp.
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Specifically, the potential of directors to add value is all too often framed in terms of their ability to add value to management by giving advice on issues such as strategy, choice of markets, and other factors of corporate success. While this may be valuable, it obscures the primary role of the board to govern, the purpose of which is to add value to shareholders and other stakeholders.
John Carver, well-known governance consultant and author, does not mince words:. Governance is an extension of ownership, not of operations. Directors must be more allied with shareholders than with managers. Their mentality, their language, their concerns, their skills, their choice of interactions are subsets of ownership, not of management. Carver , November , p. A greater arms-length relationship between management and the board, therefore, is both desirable and unavoidable. Recent governance reforms focused on creating greater independence and minimizing managerial excess while enhancing executive accountability have already created greater tension in the relationship between management and the board.
The Sarbanes-Oxley Act, for example, effectively asks boards to substitute verification for trust. This is not necessarily bad because trust and verification are not necessarily incompatible. In fact, we need both. But we should also realize that effective governance is about striking a reasonable accommodation between verification and trust—not about elevating one over the other.
The history of human nature shows that adversarial relationships can create their own pathologies of miscommunication and mismanaged expectations with respect to risk and reward.
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This makes defining the trade-offs that shape effective governance so difficult. Is better governance defined primarily by the active prevention of abuse?
Or by the active promotion of risk taking and profitability? The quick and easy answer is that it should mean all of those things. However, as recurrent crises in corporate governance around the world have shown, it is hard to do even one of those things consistently well.