The Corporate Scandals and American Capitalism
Stelzer, Irwin M., The Public Interest
FOR a century, regulation by government and modesty on the part of business leaders have guided efforts to preserve and improve the capitalist system. The phrase "There oughta be a law" captures the spirit of that impulse, and experience has largely vindicated its worth. In the latter part of the nineteenth century, when the country risked having its key industries fall to monopolists or cartels, Congress enacted antitrust laws that in no small way helped to preserve competitive markets in the United States. These laws also affirmed the idea that social mobility should not be unreasonably restricted in the American economy.
The trading excesses of the 1920s and the Great Depression also led to legislation that helped to preserve capitalism. This time, new laws, established under the New Deal, created rules of the road for the myriad institutions that would be known famously to future generations as Wall Street. Under the new rules, those seeking to raise money from the public were required to reveal details of their business plans and practices truthfully; those trading securities would have to treat all buyers and sellers alike; and the stock exchanges would thenceforth be required to monitor members to prevent abuses.
Operating properly, of course, free markets would in the long run make it difficult and costly for businesses and entrepreneurs in search of capital to transgress. But even those who abhor government regulation must concede that the key policy goal of these regulations--to reduce the information asymmetry that gives the seeker of capital an advantage over the investor--is legitimate. And the conduct of corporate America and of the financiers who make it possible have more or less conformed to the strictures imposed by the New Deal reformers.
Recently, though, a spate of what have come to be called corporate scandals has attracted the attention of the media and of government. The scandals--which included the collapse of Enron and other major corporations, revelations that securities analysts hyped stocks to help their investment-banking colleagues get lucrative assignments (small investor be damned), and revelations that CEO-friendly corporate compensation committees often awarded executives pay packages that were inscrutable and not necessarily related to any measure of performance--revealed several old and some new flaws in the American system of market capitalism. "There oughta be a law" was once again heard in our land. The result was the Sarbanes-Oxley Act of 2002, "the most important securities legislation since the original federal securities laws of the 1930s," according to Securities and Exchange Commission (SEC) chairman William Donaldson. The act aims to improve the accuracy and reliability of corporate disclosures by, among other things, requiring corporate chief executives to certify, personally, the accuracy of their companies' financial statements. Have this statute, the accompanying actions by enforcement authorities, and the wave of self-created corporate governance reforms proven to be as effective as their twentieth-century forebears were?
The arguments against the latest changes can be put simply. The first is that new laws are not needed; existing statutes are adequate to clean up any excesses. The second is that new governance requirements are simply too costly: More audits are expensive, as are the increasing presence of lawyers in board rooms and the higher fees required to induce competent people to serve on boards. Third, it is argued, increased fears of transgressing vague new rules heighten risk-aversion among managers and corporate boards, threatening the pace of innovation, discouraging efficiency-inducing corporate mergers (if such there be), and causing a general wariness to act. Finally, literally hundreds of empirical studies dating to the 1960s have found little direct relationship between board composition and day-to-day financial performance. …