Academic journal article Journal of Corporation Law

Corporate Governance: Still Broke, No Fix in Sight

Academic journal article Journal of Corporation Law

Corporate Governance: Still Broke, No Fix in Sight

Article excerpt

I. INTRODUCTION

Dissatisfaction with the governance of public companies is as old as the public company itself, but public concern about corporate governance is spasmodic. When the stock market booms, as in the 1990s, investors are merrily engrossed counting their profits and don't fret about governance. When stocks crash amid an epidemic of corporate scandals, as in 2001, public fury erupts and demands change. To calm the storm, Congress, the securities and Exchange Commission (sec), and the stock exchanges make elaborate pretenses to effect bold solutions. With luck, stock prices revive and investors relax until the next crash. By then, the old troupe of legislators and regulators has been replaced by a new cast.

The crash and scandals of 2001 show that prior reforms did not cure the ills of corporate governance, and there is little reason to think that the recent spate of reforms will be any more effective. Despite a partial recovery of stock prices, many symptoms of the underlying disease persist, including excessive executive compensation, empire building by managements, and entrenchment of incumbents against unwanted takeovers. Unfortunately, investors seem to have been mollified by the recent reforms, and even these inadequate measures may be emasculated by the management lobby.

The fundamental problem of corporate governance remains what it has always been: the separation of ownership and control. No reform can succeed unless it overcomes this contradiction. Corporate executives are determined to preserve their privileges and a number of scholars deny this claim; in effect, these Panglosses consider the status quo the best of all possible worlds. Others recognize that corporate governance is broken and that initiatives recently instituted or proposed are inadequate. Several have proposed changes, some of which would be beneficial, but none promises to eliminate the separation of ownership and control.

The stakes in the corporate governance conflict are high. The loss in equity values from separation of ownership and control is hard to gauge but certainly amount to trillions of dollars. ' This waste discourages public ownership. Robert Monks estimates that excessive executive compensation alone effectively imposes a 10% tax on shareholders and that this cost is spurring investors to flee into private equity.2 The losses borne by employees and customers are even harder to calculate. However, employment and wages tend to grow faster and prices tend to be lower at more profitable firms, so the costs of inefficient corporate governance to these other constituencies are certainly substantial.

The problems of corporate governance should not be overstated:

Despite the alleged flaws in its governance system, the U.S. economy has performed very well, both on an absolute basis and particularly relative to other countries. U.S. productivity gains in the past decade have been exceptional, and the U.S. stock market has consistently outperformed other world indices over the last two decades, including the period since the scandals broke. In other words, the broad evidence is not consistent with a failed system. If anything, it suggests a system that is well above average.3

Nonetheless, we should not be complacent. The threat to the American economy from poor corporate governance is greater now than ever. Formerly, capital flows were obstructed by national barriers, and only a few industrialized countries offered an attractive investment climate. Financial markets are now global and many formerly undeveloped third-world nations compete for capital. If American companies are wasteful, investors will ship their money elsewhere, with dire consequences to employment and economic growth in America.

Part II of this article describes the corporate governance debate. Part III explains why the separation of ownership and control is the problem of corporate governance and why past reforms have failed. …

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