Governing the Modern Corporation: Capital Markets, Corporate Control and Economic Performance

Governing the Modern Corporation: Capital Markets, Corporate Control and Economic Performance

Governing the Modern Corporation: Capital Markets, Corporate Control and Economic Performance

Governing the Modern Corporation: Capital Markets, Corporate Control and Economic Performance

Synopsis

Nearly seventy years after the last great stock market bubble and crash, another bubble emerged and burst, despite a thick layer of regulation designed since the 1930s to prevent such things. This time the bubble was enormous, reflecting nearly twenty years of double-digit stock market growth,and its bursting had painful consequence. The search for culprits soon began, and many were discovered, including not only a number of overreaching corporations, but also their auditors, investment bankers, lawyers and indeed, their investors. In Governing the Modern Corporation, Smith and Walteranalyze the structure of market capitalism to see what went wrong. They begin by examining the developments that have made modern financial markets--now capitalized globally at about $70 trillion--so enormous, so volatile and such a source of wealth (and temptation) for all players. Then they report on the evolving role and function of the business corporation,the duties of its officers and directors and the power of its Chief Executive Officer who seeks to manage the company to achieve as favorable a stock price as possible. They next turn to the investing market itself, which comprises mainly financial institutions that own about two-thirds of all American stocks and trade about 90% of these stocks. These investors are well informed, highly trained professionals capable of making intelligent investment decisions onbehalf of their clients, yet the best and brightest ultimately succumbed to the bubble and failed to carry out an appropriate governance role. In what follows, the roles and business practices of the principal financial intermediaries--notably auditors and bankers--are examined in detail. All, corporations, investors and intermediaries, are found to have been infected by deep-seated conflicts of interest, which add significant agencycosts to the free-market system. The imperfect, politicized role of the regulators is also explored, with disappointing results. The entire system is seen to have been compromised by a variety of bacteria that crept in, little by little, over the years and were virtually invisible during the bubbleyears. These issues are now being addressed, in part by new regulation, in part by prosecutions and class action lawsuits, and in part by market forces responding to revelations of misconduct. But the authors note that all of the market's professional players--executives, investors, experts andintermediaries themselves--carry fiduciary obligations to the shareholders, clients, and investors whom they represent. More has to be done to find ways for these fiduciaries to be held accountable for the correct discharge of their duties.

Excerpt

The corporate and financial scandals of the late 1990s and early 2000s in the United States have elicited a broad range of reactions. "A few bad apples," said some, "that have distorted the picture of the world's best performing economic and financial system." "An unfortunate legacy of the greatest financial bubble in history," said others. Still others suggested that the conduct of major American corporations revealed fundamental weaknesses at the heart of the free market system—flaws that have always lurked just below the surface of the country's overly triumphal, self-absorbed capitalist approach to economic organization.

The truth surely contains elements of each. What is certain is that the faith most people had in the integrity and discipline of marketbased finance and capital deployment was severely shaken. the magnitude of the losses and the extent to which these losses reached ordinary citizens, along with the cynical disregard by senior business and financial leaders of legal or ethical constraints pressed home a need for reform. a sense of public outrage developed that motivated government officials and regulators to move quickly to "restore confidence" in the markets and prosecute some of the most visible offenders.

Before the 1930s, neither government regulators nor the courts had much of a role in enforcing checks and balances in the U.S. economic and financial system. Boards of directors were appointed by knowledgeable investors and constrained by fiduciary duties. the boards would select people to manage their firms and achieve the objectives the board had established. If they failed, they could expect to be replaced. Such enlightened self-interest might not be a sufficient restraint on management under some circumstances, so both companies and investors could be expected to exercise discipline upon each other. Powerful figures in business and finance sought the support of banks, insurance companies and other investors, who in general would avoid . . .

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