'Good' Corporate Governance and the Unbent Spoon

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Whenever I critique efforts to legislate for proxy access or other measures designed to make corporate governance more democratic, I inevitably get attacked for being a shill for management.

A gentler form of that attack came recently from Nell Minow, board member of GovernanceMetrics International and a film critic for Belief.Net. (Full disclosure: that sounds like a pretty sweet combination of jobs to hold.)

In response to one of my semi-regular diatribes against shareholder democracy, Minow writes:

The only way to make sure that executives do not misappropriate the money provided by investors for their own benefit is to set up a system of accountability to shareholders. That system, an indispensable element of a robust and sustainable economy, includes the ability of shareholders to vote on critical areas of potential conflicts of interest, including the election of directors and executive compensation. The weakening of this kind of accountability was one important cause of the financial meltdown because compensation that was all upside and no downside, based on the quantity of transactions and not the quality of transactions, externalized the costs and the risks.

Let me make it clear that I think that management self-dealing is a real problem. In fact, I think the dominance of the corporate form of business organization may be on the wane because it turns out that agency costs are much higher than most people anticipated.

The acknowledgment of a problem, however, is not the same as the discovery of a solution. Just because we know that corporate boards are often captured by the executives, that compensation schemes are skewed to deliver outsized rewards based on temporary gains, and that executives often use accounting gimmickry to hide the true health of the company—just because we know all that, doesn’t mean we know how to fix it.

In fact, it might not be fixable at all. It may be that these are just costs associated with the corporate form. They can be weighed against the costs associated with other forms of business organizations—limited partnerships, LLCs, or whatever. Perhaps they can be reduced at the margin. But they are likely here forever.

What’s more, I’m not sure other forms of business organization will really address these problems. I suspect that many of those who specialize in corporate governance make the error of assuming that technical solutions are available to what are, at bottom, moral problems. A society that is growing more morally corrupt will have more moral corruption in its corporate management. At some level, governance may be irrelevant—the character of the people running the companies matters more.

The point of the article Minow was critiquing was to show that one method of attempting to address agency costs—setting up a system of accountability to shareholders—doesn’t do the job. It will simply empower special interest shareholders—unions, activist hedge funds, politically motivated investment vehicles—to cut deals with management that exploit the common diversified shareholder. It’s a recipe for further exploitation, rather than an escape. The agency costs just get worse.

She’s simply wrong on the facts. The corporations that scored the best on tests of “good governance” fared worse during the financial crisis.

Accountability to shareholders, alignment of financial interests of shareholders and management, and compensation in the form of options rather than cash were all features of Bear Stearns and Lehman Brothers. Accountability doesn’t lead to better run businesses.

This can be hard for corporate governance types to accept because they are spoon-benders—they believe that the application of intelligence and good will to the problems of corporate governance must affect the outcome. They cannot accept that the spoon won’t bend no matter how hard they want it to.


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