Can Trust in Corporate Governance Be Restored?

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The headline in The New York Times story from the World Economic Forum read: "Leaders in Davos Admit Drop in Trust."


No kidding! 

After poor business decision-making in the financial sector was a primary cause of the Great Recession, and after years of board and management mistakes leading to the bankruptcies of industrial icons GM and Chrysler, the business community today faces a crisis of confidence in its own ranks and in broader society. Regard for corporations is at a historic lows

Many are asking: how can corporations govern themselves more effectively---and truly be held accountable?

I found this Times story of special moment because the Committee for Economic Development just a few days ago published a Policy Brief in which I tried to suggest a way forward. It was entitled: "Restoring Trust in Corporate Governance: The Six Essential Tasks of Boards of Directors and Business Leaders." 

Necessary public policy debates are taking place all across the globe on new regulations to ensure the safety and soundness of the financial sector and to improve the governance of all publicly-held corporations (with focus on an enhanced shareholder role and mandated disclosure about compensation and risk processes).

But, regardless of regulatory outcomes, the destiny of public corporations will still turn on the complex decisions made by business leaders and boards of directors.

In my view, to meet the legitimate criticisms of business decision-making, corporations must first redefine their mission---and the role of the board and CEO. 

To summarize a much longer discussion, they must clearly and explicitly redefine the purpose of the corporation as creation of long term economic value through sustained economic performance, sound risk management and high integrity.

In particular, business leaders must forge a sound balance between necessary risk-taking (creativity and innovation) and required risk-management (financial and operational discipline). They must fuse this high performance with high integrity. High integrity means a commitment to law, ethics and values in order to attain affirmative benefits in the company, the marketplace and global society but also to reduce legal, ethical, reputational, public policy and country risk. 

The past emphasis on short-term maximization of shareholder value must be significantly reduced. 

The Policy Brief then argues for five other essential tasks built on the imperatives of sustained performance, sound risk management and high integrity: revamped leadership training; a refocused CEO selection process; a restatement of operational goals across performance, risk and integrity dimensions; a revision of compensation that holds back or pays out a significant portion of pay as objectives are met, exceeded or missed; and a re-alignment of board oversight to focus on critical operational and compensation goals. 

In my view, only if these six, closely connected tasks are carried out with focused intensity is it possible for trust to be restored. But there are many obstacles to prevent this from happening such as the short-termism of many institutional investors; a "money happy" labor market for business talent which will frustrate compensation regimes paying out over time and for performance, and problems in meaningful board oversight of management. 

There is, thus, certainly reason for substantial doubts whether the "practical ideal" I suggest can be realized. For example, with the separation of ownership (shareholders) and control (managers), the theory was that the boards would represent the shareholders and control the management. Unfortunately, too often the practice has been that management controls the board (and, today, there is no one "shareholder" as various types of "shareholders" have myriad conflicting objectives and strategies).

Nonetheless, although other accountability mechanisms such as regulation may, limit private discretion in order to accomplish public goals, private decision-making by boards and business leaders still must drive corporations.  This is where ultimate accountability will always lie, however uncertain and problematic. 

And, for those skeptical about corporate governance, there is the answer of self-interest. With business facing a crisis in confidence about governance and accountability, it is, I believe, in the demonstrable interest of corporate leaders (and capitalism itself) truly to address legitimate criticisms, to provide a clear, credible and powerful private sector response and, as one alternative, to consider using the "actionable framework" of the six essential tasks.

                                                     * * * * * 

For those interested in reading more, go to the website of the Harvard Law School Forum on Corporate Governance and Financial Regulation to find both a longer summary of the argument and the Policy Brief itself.

Photo credit: Joe Raedle/Getty Images

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Presented by

Ben W. Heineman Jr.

Ben Heineman Jr. is is a senior fellow at the Belfer Center for Science and International Affairs, in Harvard's Kennedy School of Government, and at the Harvard Law School's Program on Corporate Governance. He is the author of High Performance with High Integrity.

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