An alternative model for setting and policing corporate governance standards - inspired by the FASB - is proposed
It is imperative to global competitiveness that we improve corporate governance. If we do not, we may fix all our present economic calamities only to, before long, have new ones erupt elsewhere.
Some of my fellow economists argue on principle against almost all government intervention. But this is wrong. Would they really advocate allowing corporate boards to vote to eliminate all fiduciary duty to shareholders? I hope not.
A fine line
Of course, government regulation is tricky, but a debate for or against misses the point. Firms and markets cannot function efficiently with too little or too much regulation. All markets require some rules and policing. What we need is a debate over the right kinds of regulations. We need regulations that are effective and inexpensive to implement, which is a difficult combination.
An example of what our political process usually comes up with is Sarbanes-Oxley; a knee-jerk reaction. SOX created massive compliance costs and few governance benefits. Its cost to benefit ratio was too high. Even with the best intent of our lawmakers, Congress is simply not capable of dealing with the dynamics of our markets and firms. If Congress were to legislate detailed corporate governance regulations, whether intentional or not, it is likely that our next corporate governance bill would be just another employment bill for lobbyists, lawyers and accountants, with black sheep managers running circles around the law’s intent.
So what should we do? One example of sound government regulation is the Financial Accounting Standards Board (FASB), the official government-endorsed institution in charge of US GAAP. FASB is not perfect, nor is it immune to political influence, but it is successful as its standards are even followed by firms that are not required to do so.
Setting a unified standard
I propose that we charter an equivalent official standards board that sets best practices for corporate governance; one definitive board, not twenty different commissions or think tanks trying to sell their corporate governance consulting services to the corporations that they rate. Like FASB, our governance board could rely on the expertise of its constituents from the corporate sector itself, from academia and from the consulting industry. Most importantly, it would be more insulated from the ‘scandal-du-jour’ and the political wrangling in Washington, enabling it to focus on its mission to set good governance standards.
Boards that follow the official standards should be afforded an additional layer of safe harbor protection against shareholder lawsuits. With some social pressure ‘to get on board,’ I believe that this voluntary system could nudge most US firms to adopt standards giving shareholders meaningful control to rein in poor CEOs, without imposing excessive costs on good CEOs. For example, the standards board might adopt a rule against staggered boards. Some firms may find the benefits of a staggered board outweigh its costs. If they keep it, the standards to which such a board’s behavior should be held in a shareholder lawsuit should then be higher. Even in our current system (that is, without an extra safe harbor for complying firms that I would advocate), the very fact that a board has not followed official best practice would expose its members to more legal risk.
We can argue about standards board recommendations, but we should not let that cloud the important issue: the creation of an institution that thinks about good, cost-effective corporate governance in an ongoing, expert fashion. It will not be perfect. There is no telling if it will err on the side of too little or too much governance regulation. But it is much more preferable to having corporate governance be made in Washington.
