System failure, system renewal.

• Author: Weidenbaum, Murray L.
• Position: Governance Leadership

How should the interests of the public be protected in a governance environment dominated neither by sinners nor saints? And, how can that protection be made available in a manner that does minimum damage to the private enterprise system? It's a tall order, but specific courses of action are clear.

CORPORATE GOVERNANCE in the United States is facing a variety of external pressures for change, many of them involving a larger governmental presence in internal business decision-making. The three most obvious sources of those pressures are (1) the downturn in the American economy in 2001, (2) the terrorist attacks of September 11, 2001, and their aftermath, and (3) the widespread public criticism of business practices resulting from the Enron bankruptcy. The third of these factors is likely to generate the most severe and lasting impacts on corporate governance.

The first adverse factor, the decline in U.S. gross domestic product, is likely to be the most ephemeral. Yet, the lingering effects of recessions invariably reduce public confidence in the private enterprise system, making it easier for the advocates of additional government intervention to gain support for their case. Thus, the coincidence of the economic downturn with the other two events is an unfortunate bit of timing.

The second factor, especially the comprehensive national response to the rise of international terrorist activities, has generated a longer-term expansion of the role of government in day-to-day business operations. The common characteristics of the great bulk of these interventions -- be they tougher anti-money laundering rules or more extensive inspections of imports or more detailed investigations of employees and customers -- is to increase the overhead costs of doing business in the United States and, to some degree, to reduce the discretion available to business managers.

Nevertheless, the need for these antiterrorist efforts is widely supported in the business community as by the public in general. Thus, we can expect business managers to respond to this second factor in the same general way that they deal with any new major element of expense. They improvise, innovate, and otherwise attempt to achieve the new objectives with minimum cost and disruptions to the enterprise.

The most troubling questions

It is the third category of public challenges to corporate governance -- those resulting from the widespread reports of corporate mismanagement and worse -- that are likely to have the most serious and lasting impacts on the conduct of the business of U.S. corporations. Numerous issues have been raised in the national media as well as in a flurry of Congressional investigations. The following appear to be the most troubling questions:

1. Have the accounting firms lost their independence and integrity in the effort to expand the scope of their operations and the profits that they receive?

2. Are lawyers failing to alert their corporate clients to the perils of using clever ways of cutting corners in meeting the requirements of law and regulation?

3. Have the boards of directors of corporations been unable to keep up with the intricacies of business finance and thus have they not adequately performed their critical role of overseers of management?

4. More specifically, have the audit committees failed in their function of providing the fiscal conscience of the corporation?

5. Has the effort to get top management to think like shareholders -- especially by using options as a major portion of compensation -- backfired?

6. Is there in effect a double standard in much of American business: Are rank-and-file employees expected to meet higher levels of integrity and ethical behavior than top management?

   These are loaded questions which the typical honest American business manager must resent having to hear, much less answer. Surely, that was my personal response as a corporate director. Nevertheless, these questions -- and many others in the same vein -- reflect the growing public dissatisfaction with the state of corporate governance in the United States. The underlying resentments are not new, but they may have been submerged when the stock market was booming. The less favorable stockholder experiences of more recent times has brought these long simmering concerns to the surface.

   Lessons from the past

   It seems almost inevitable that the widespread damage done to employees and investors by the Enron bankruptcy and a few similar episodes will produce a new wave of government regulation of business. Under the circumstances, attention is warranted to ways that will help policymakers in writing constructive laws and regulations. Some lessons from past efforts to regulate business would seem to be a useful starting point. For example, despite all the talk about "deregulation," the fact is that the great variety, as well as complexity, of the existing array of regulation is awesome.

   Anyone who has any doubts on that score should examine the many volumes of the Code of Federal Regulations. Better yet, just try to read one of the daily issues of the Federal Register. It is an eye opener just to see the number and variety of governmental regulations that are issued in a single day. It is not merely a matter of diminishing returns (i.e, very modest benefits) from this process. The most relevant "lesson" is that so often regulatory power is exercised in a manner that generates unexpected -- and frequently counterproductive -- results. A cogent case in point is the rise of the 401(k) "retirement" plans that are receiving much attention (see sidebar, "The Best Is the Enemy of the Good").

   What changes should be made?

   It likely is an exercise in wishful thinking to expect that, before it acts, Congress will carefully survey the true condition of corporate governance in the U.S. As someone who has served on a number of corporate boards of directors for over a quarter of a century, I personally am struck by the variety of circumstances that exist.

   Surely, many companies are well managed. Their senior executives, boards, and outside legal and accounting firms all do the conscientious and honest job that is expected of them. Yet, as recent events have made clear, such a benign situation is hardly a universal experience. How should the interests of the public be protected in an environment dominated neither by sinners nor saints? And, how can that protection be made available in a manner that does minimum damage to the private enterprise system that generates such great magnitudes of goods and services, employment, income, wealth, innovation, and progress?

   Achieving those multiple objectives is, to put it mildly, a tall order. It surely requires some modesty in recommending specific courses of action. The sensible place to begin may be the questions that were posed earlier. Let us see how responding to each of these questions may generate a useful agenda for reforming corporate governance in the United States.

1. Refocus the role of the accounting firms

   Former SEC chairman Roderick Hills recently told the Senate Banking Committee, "It is increasingly clear that the accounting profession is not able consistently to resist management pressures to permit...