Governance Q&A
Q. The US is supposed to be the strongest, most transparent market in the world, with the best possible standards of corporate governance. But look what happened to Enron. Is this a setback to the whole governance movement?
A. Enron demonstrates the limits of what governance can accomplish by means of externally imposed standards. It appears there was fraud and criminal behavior going on at Enron, and no governance system can protect against that. That's a given.
Still, Enron represents a failure at every level of the US system of governance. First, it's a failure of disclosure. The US has very clear disclosure standards, but they were not met. That's both a regulatory and a governance failure. It was certainly a failure of auditors and accounting rules. It was Wall Street's failure too. When did you last hear analysts strongly recommending a stock and admitting in the same breath they didn't understand the company's financials? That's shocking and outrageous. It was also a failure of credit rating agencies. And, most disturbing, it was a failure of the strongest proponents of good governance - the shareholders themselves. Some institutional shareholders have revealed that they invested in Enron's off-balance sheet partnerships and had access to information about Enron that wasn't available to the public at the same time as they were heavily invested in Enron common stock. But somehow they did not recognize the conflict or the risks. They didn't put two and two together. Calpers deserves credit for its candor in raising this issue publicly.
Q. Aren't you forgetting the board of directors?
A. Of course it was a failure of directors, and it raises very difficult questions of how much we can rely on director oversight to prevent this type of disaster. Enron reveals deficiencies at every level of governance. All our checks and balances failed. But that doesn't mean these checks and balances shouldn't be there. It doesn't mean the effort to achieve good governance isn't worthwhile. We're not going to walk away from the governance achievements of the past 15 years, and we're not going to abandon our free market system of checks and balances.
Q. How can the US make sure another Enron doesn't happen?
A. Enron forces us to recognize that there's only so much we can do in imposing governance standards from outside. On the surface that board had good credentials. But what were their personal qualities? Were they willing to ask tough questions? What type of personal relationships did they have with the CEO and other senior management? Those are things you can't guarantee through independence guidelines and other standards that are measurable from outside. We need better ways to see and understand what really goes on in the boardroom. We need to be sure the elected representatives of the shareholders really have the qualities of character, the training and the expertise to do the job correctly.
It's also worth remembering that Enron happened at the end of a bubble market, and much of what was going on at Enron was going on throughout the market, and was in fact symptomatic of the bubble: businesses were being managed for the short-term financial results demanded by Wall Street, rather than for long-term financial strength.
Q. So where do we go from here?
A. We've got a lot of accounting issues to work on. The role of auditors is going to be substantially revamped. There are some disclosure issues, but we actually have very good disclosure requirements in the US. Unfortunately, the accounting system dictates what is material and needs to be disclosed, and this is largely where the failures must be corrected. The credit rating agencies have to take a hard look at what they do. Large institutional investors should examine the type of investments they make and how they coordinate their activities, and determine how to avoid the conflicts in using Wall Street tactics for portfolios governed by Erisa fiduciary standards.
Q. You have come to London to address the issue of cross-border proxy voting at the European Corporate Governance Service's inaugural conference. That's an issue that needs a hard look before shareholders can make themselves heard globally.
A. We have come through a period of focus on the theory of governance. That's very important because it establishes basic principles for how companies should be governed and what role shareholders should play.
Now we're moving into the next stage - putting theory into practice - and it's a lot harder to do. There's no global regulator to write a set of rules and oversee how companies are governed and how shareholder rights are protected. The old saying think globally, act locally is very appropriate here. Every country has its own culture, rules, laws, procedures and regulatory structure. There are universal principles all countries can accept - transparency and fairness - but it won't work just to say the US governance system is the right one and impose it everywhere. We must respect local arrangements while finding ways to build an efficient system of global communication and shareholder response.
So we're now undergoing a laborious process of figuring out how different local systems can work together and adapt to produce a global system without so many obstructions. We're at the nuts and bolts level, but it's the right place to start.