Corporate governance II
In my previous blog I suggested that directors be exempt from shareholder lawsuits. There are two reasons for my view.
First, directors have to take their jobs seriously and devote the time and effort required to do their best. Being a director canot be a part-time vocation. Directors must have the competence and accept the responsibility to perform the five major tasks I set out in that blog. They should not hire others to do their work and hide behind the recommendations of external advisors.
Second, we must do away with the myth that directors represent the interests of the shareholders of their respective companies.
The directors (all of them quite impressive on paper) of a number of global financial institutions – Bears Stern, Lehman, FannieMae, FreddieMac, Citigroup, Merrill Lynch, AIG, CIBC, Royal Bank of Scotland, all the banks in Iceland, etc. – did not learn any lessons from the Enron flameout. This time round the failure by directors to supervise senior management and their proclivity to take risks with other people’s money posed a much greater risk to the global financial system and world economies.
As both Enron and the current financial crisis demonstrate, corporate governance matters only because there is a critical externality between the quality of governance and the confidence of investors in the integrity and fairness of the equity markets as a whole, and in the credibility and survivability of financial institutions.
If the fallout from Enron had been concentrated to the shareholders of Enron, the losses would have been substantial. But the aggregate losses were much larger because of the negative spillovers into the stock markets and the U.S. economy. The situation is even worse this time with the lack of good governance in the financial sector. We have been brought to the brink of an economic disaster.
So, whom do boards represent? Everyone who invests in the equity markets, not just those who invest in a board’s particular company. Thus, boards must have a much broader perspective than just their respective companies when performing their jobs. What might appear to be against the interests of their particular shareholders (e.g. reporting fraud by the CEO to the security regulators in order to avoid a shareholder lawsuit), might actually be in the best interests of all shareholders and the economy at large. Similarly with executive compensation.