Better values for better governance

Secretary-General of the OECD

We are inundated these days with concerns about corporate governance. Corporate executives are under attack and major auditing firms are worried, as well they might be in the wake of the demise of one of their giants, Arthur Andersen. Enron, WorldCom, Tyco – what should our reaction be to these extraordinary and outrageous breaches of faith with shareholders andemployees?

To begin, we must make a few distinctions which seem to be lost in this flood of revelation. There may indeed be some criminal behaviour in a number of these sad stories. The law will be brought to bear in such cases and justice will hopefully be served. But there are also indications that even in the absence of criminal behaviour, some corporate managers have ceased to see themselves as stewards of other people’s money. Rather, they prefer to see themselves as partners entitled to huge “entrepreneurial” rewards for doing what they are already extremely well paid to do.

We read much about rewriting rules to contain corporate abuses. But is a thicker rule book really the answer?

In the case of public companies with widely held shares, the temptation of managers to “take advantage” is enormous. We have witnessed the consequences. Is it conscionable that top executives can earn as much as 400 times the salaries of the plant floor workers? William McDonough, president of the New York Federal Reserve Board, raised this point in a speech on the anniversary of 11 September. What corporate manager is really worth that? Frankly, none. Let us remember that the CEO of a large public company is fundamentally a manager, surfing on the assets of others, happy to catch the upside of the business cycle, but not happy with the downside, and thus often seeking to re-base their stock options or other perks.

Will regulations change these attitudes? No. It is corporate culture, and the incentives that shape that culture, which must change. Top managers of widely held companies are in effect accountable to no one. In reality, it is these managers who usually name the directors. These in turn are then only too happy to support those who appoint them, rather than the shareholders who in theory they represent, but only in theory. Senior managers have an obvious incentive to put other CEOs on their remuneration committees, not critical, independent directors. Hence “you scratch my back, I scratch yours” becomes the basis for ratcheting up executive remuneration to levels far beyond the dreams of avarice.

Meanwhile, the major shareholders – the pension funds, the insurance companies, and so forth – too often do not play the role they should. Why? Perhaps because they can always vote by selling their shares, which is a lot less messy than sitting on boards and overseeing management. These large institutional shareholders potentially have enormous clout, but they have not exercised it very effectively to discipline top management. Perhaps now this will change and the large institutional shareholders of public companies will finally start to act like “owners”.

There is one important caveat to all this. It concerns the entrepreneurs of this world who, from scratch, and often risking everything they have, manage to create enormous wealth for others, and for themselves. Good for them; that is the risk and reward principle that has made entrepreneurial capitalism, as opposed to bureaucratic capitalism, such a potent force for creating mass prosperity. But those who seek to become billionaires through the management of other people’s ideas and money are another matter.

Let us be clear about the real issue. Where corporate behaviour involves criminal activity, we have judicial systems to deal with that. But today, the vast majority of the excesses of the corporate executive class really have nothing to do with criminal activity. The more fundamental problem has to do with a breakdown of traditional capitalism which has seen the role of the owners of capital undermined through diffusion of interest, leaving no one to speak clearly and forcefully for the shareholders.

I have been troubled by these developments for many years. As a former board member of a major corporation myself, I have concluded that the malaise in much of corporate governance today has even deeper roots than the all too frequent lack of adequate shareholder oversight. Somehow we have come increasingly to substitute rules for values. We now look first of all to see if something is legal – satisfying the letter of the law, not necessarily its spirit.

Certainly we need rules to provide the framework for behaviour and ultimately to constrain those who would take advantage. But do we want a world based on rules or a world based on values? Rules will always have loopholes, and there will always be those who will spend their time trying to wriggle through them. This thinking appears to have invaded much of the corporate world.

Are our students today learning values or learning rules? I hope both, but with a good dose of the former. Because any set of rules alone, disconnected from the values which those rules are ultimately meant to reflect, is like a body without a soul.

©OECD Observer No. 234, October 2002 

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