Risk & Compliance

Forum: Seven Panaceas, One Solution

It's time for institutional investors to step up as change agents.
Robert A.G. MonksJuly 1, 1998

Many methods of ensuring corporate accountability have been advanced during the past 200 years, but seven have achieved prominence. Taken alone, each method is more a panacea than a true cure. Indeed, too often the presence of only one of these deterrents to bad behavior brings a false–and dangerous– sense of comfort.

1. The CEO philosopher-king. This is the oldest and most deeply ingrained notion of corporate accountability, and it persists to this day around the globe. CEOs today exercise near-monarchic powers. With our acquiescence, they are free to advance their own interests in compensation–even to the point of harming the interests of shareholders and the general public.

2. Chartering. This says if state or federal charters set proper limits, then the corporation can serve the common good. But the facts prove otherwise. Chartering jurisdictions merely “race to the bottom” as they lower standards of public accountability to attract corporations. Further enfeebling the effectiveness of charters has been the growth of the multinational corporation.

3. Independent directors. Certainly directors without business ties to a company are more independent than those with such ties. Yet true independence remains elusive. How can an individual selected for a well-paying and prestigious job be expected to stand in judgment of those who accorded him this position? Only men and women of the highest character can do this, but the best solutions cannot depend on character alone.

4. Well-structured boards. Alas, this notion too proves questionable. If we cannot count on all our independent directors to be truly independent, then the amount or quality of structure is moot.

5. Independent experts. This popular view, proffered by (you guessed it) such experts as Peter Drucker, holds that corporations need only the proper independent experts to review and bless the balancing of public and private interests. The experience with “experts,” however, is disheartening. The tendency to generate opinions satisfactory to present and prospective customers is strong.

6. The free press. The truth shall set you free; journalists tell the truth and publishers publish it; therefore, the free press is the ultimate check on corporate actions. Yet we must ask just exactly how free publishers are to publish all the news that is fit to print, when such a large percentage of their revenues derive from advertising.

7. Multiple external constraints. This idea was advanced more than 15 years ago by noted corporate governance attorney Ira Millstein. He described not only the effects of chartering on corporate decision making but also the economic constraints of competition and law, the impact of tax and regulation, and the influence of social values. He hoped that this ensemble could rein in corporate power. This is the best general model advanced to date, but it still falls short of a full solution.

Taken together, these seven methods can go a long way to improving the governance of corporations. But ultimately, they must fall short. While worthy both individually and collectively, they do not constitute an effective force inclining congruency of corporate and public interest.

Thus, CEOs have been able to philosophize their way into wealth while selling off corporate birthrights. The standards of charters degenerate over time. Sham elections continue, and fallible experts say what their clients want to hear. The press is hailed as a force for freedom, even as advertising money mutes its voice. And with all of these forces at work, the natural mechanisms of legal, economic, and social constraints weaken.

There is really only one party that is sufficiently independent, informed, motivated, and empowered to make firms accountable for their actions. That party is the institutional investor. Its trustees are charged to manage assets exclusively in the interest of beneficiaries–and as a class, institutional investors own a majority of the outstanding stock of publicly traded U.S. companies. It’s time for these investors to begin fulfilling their roles as true agents of change.

Robert A.G. Monks is a founder and principal of Lens Inc. This article is adapted from his latest book, The Emperor’s Nightingale, which examines corporate governance from the perspective of complexity theory.