Nothing in recent history has undermined investor confidence in corporate leaders, governance, and the capital markets more profoundly than the endless stream of stories about corporate failures and misdeeds, disclosure lapses, accounting irregularities, and, in the most disturbing instances, of outright fraud and crime. The unexpected revelations have caused steep declines not only in the prices of the stocks of the companies involved, but also in the market as a whole.
One fact has become all too obvious: the capital markets and individual investors have been gamed. The information needed to assess risk and performance intelligently and to make sound investment decisions has not been made available. Often disclosures were timed to further the interests of the very people charged with protecting the interests of investors—the management.
As a result, many have been hurt. Investment portfolios have been devastated. The savings that many placed in the stock market have been cut in half or more. Investors are reassessing their retirement plans, and those who invested heavily in their employer’s stock have seen their pensions shrivel to practically nothing. As companies scramble to maintain earnings growth, tens of thousands of workers have been laid off.
The processes designed to ensure that corporations are run to benefit shareholders rather than those in charge of managing the company have failed.
Calls for accountability, reform, and retribution have come from all fronts: investors, legislators, regulators, the press, and the general public. Most of the movement toward reform so far, however, has come in the form of rules and regulations. While these may contribute to the cure, they are generally narrow, shortsighted legislative and regulatory “fixes” that fail to attack the root causes of the problems facing investors and the capital market system—a systematic failure of checks and balances in corporate governance.
The processes designed to ensure that corporations are run to benefit shareholders rather than those in charge of managing the company have failed. A healthy, functioning checks and balances system is the responsibility of boards of directors, who serve as fiduciaries for shareholders. Fiduciary, a term used frequently throughout this book, is defined as “holding or held in trust.” A crisis of confidence exists now largely because investor trust has been broken by those who held it.
New rules introduced to solve the crisis in governance seem destined to produce less than satisfactory results and will almost surely lead to unintended consequences. The more specifically a rule is constructed, the more creative the ways around it become.
Unless individual corporate executives and directors significantly increase their commitment to principles of good corporate governance and live by those principles day to day, the legislated reforms will lead to more and more ineffective rules and a stalemate with angry investors. Under that scenario, it may become impossible for corporate executives and directors to sustain the highly productive free market system that has been tainted by excesses.