No Corporate Oversight Necessary?

| Thu Jan. 12, 2006 7:02 PM EST

As short overviews of the problems with corporate governance in America go, you could do worse than Clive Crook's piece in this month's Atlantic. But after pointing out that shareholder oversight is often ridiculously lax, that many mangers and CEOs have had carte blanche to loot and pillage the companies they're supposed to be running, and that the "division of capitalism's spoils has become more lopsided in recent years," Crook strangely argues that we shouldn't worry too much:

Beyond [Sarbanes-Oxley], what [should be done]? "First, do no harm" is a good rule. Modern American capitalism has charges to answer, but it is best to keep a sense of proportion. The U.S. economy remains the most productive—and by almost any measure the most successful—in the world. …. America's economic pre-eminence must have something to do with its distinctive business model, the very model many people now question—which in different ways continues to reward success more generously and punish failure more brutally… than the milder systems to be found in, for instance, Europe and Japan.
And then says "it all comes down to traditional values," whatever that means. No major reforms necessary. The system that produced Enron and Tyco basically works and we should leave it in place.

But it's doubtful that "leaving well enough alone" is the best option. We don't even need to get into "business model" comparisons with Europe and Japan. (These things tend to go back and forth anyway—in the 1980s, it seemed like the bank-centered system of financing business as seen in, say, Germany, was the better model; nowadays the Anglo-Saxon "stock-market centered" model is held in higher regard. Perhaps in a few years the pendulum will swing back again. Who knows?) It's far more instructive to compare companies within the United States.

A 2003 Harvard University/Wharton School paper entitled "Corporate Governance and Equity Prices" ranked 1,500 companies in terms of management power, sorting firms into a Democracy Portfolio (firms in which shareholder rights were strongest) and a Dictatorship Portfolio (firms in which managers were subject to less oversight). Shockingly—or not—the democratic firms outperformed the dictatorship firms by 8.5 percentage points per year throughout the 1990s.

If you believe that's a good thing, then stronger corporate governance doesn't just make things "nicer" or "fairer" and stick it to "greedy" CEOs—it actually makes better economic sense in many cases. It's hard to believe, as Crook suggests, that "lower standards of corporate governance" is the price we simply must pay for high productivity growth in the United States. The two can go together.

Now obviously from a left-liberal perspective, reform is never as easy as simply making sure that shareholders—or the mutual funds that vote most of the proxies today—are exercising oversight. This country also went through a "shareholder revolution" in the 1980s, driven in part by public funds like CalPERS, that forced managers to focus heavily on short-term profit maximization, and what we got was a wave of useless mergers and endless "restructuring"—laying off workers, busting unions, slashing wages—that may or may not actually boost profits (it's surprisingly hard to tell) but is certainly a nightmare for everyone else. (Fun tidbit: A British Medical Journal study found that those workers who survived major "restructuring" campaigns vastly increased their risk of cardiovascular disease.) But it seems like somewhere along the line a decent balance can be struck, and we're almost certainly not at that point right now.

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