“Reports of my Death are Greatly Exaggerated”

Posted in Blog at 11:20 pm

John Richardson has published a thought-provoking piece entitled “Corporate Governance is Dead” on the Global Investment Watch website, www.globalinvestmentwatch.com.   While he raises many good points about the historical development of the modern governance movement, and demonstrates that it has indeed changed over the years, I disagree very strongly with his conclusion that it is now dead, and summarized my thoughts on the subject for a thread on the Yale Governance Forum.  For those who may not have seen it, I reproduce it here.

Many things have been declared ‘dead,’ based on recent experience.  For example, political conservatism in the U.S. was declared dead by the media and most commentators only two years ago; four years before that, liberalism was likewise ‘dead.’  In Europe, socialism was ‘dead’ in 1991; British-style liberal economics in 1997.  The best one can safely say, at least until the dusty coating of history has covered something to a reasonable depth, is that it seems to be ‘moribund.’

Before one declares something called corporate governance potentially in need of a priest to perform the Last Rites, one should define it carefully.  The Cadbury Report defined corporate governance as “the system by which corporations are directed and controlled,” a definition which is frequently employed by other authors.   I haven’t noticed the corporate mode of organization on the wane in our society, and I assume that most if not all of these entities are both directed and controlled, (although occasionally a specific situation gives one pause.)  Companies will continue to need advice in all related areas.  Clearly, the article on the death of corporate governance must be referring to something far more specific.

If the author means to say specifically that shareholder activism motivated by concerns about corporate governance is dead, one must assume either:  that the concerns which once motivated shareholders have been forever remediated, or that these concerns are no longer of interest to shareholders, and are unlikely ever to be of interest again.  I would submit that the first assumption is extremely unlikely, given that no one has succeeded in changing human nature in at least the 5,000 years of recorded history.  The second, if true, is only true so long as the the concerns underlying the first  remain in abeyance and/or fully discounted in share prices.

While there is some evidence, at least in the U.S. and the U.K., that these elements have been fairly well discounted over the past nine years, there is no reason to believe that this is the case because either (a) investors have become permanently more rational, or (b) managers and directors have become permanently less self-interested.  On the contrary, it has been demonstrated that the reason governance issues or the lack of same seem to have been discounted in share prices is because investors became expected to pay attention to them, due to the excess returns gained from paying attention to these issues during the preceding 15 years.  This was thanks to the efforts of corporate governance activists, of proxy advisors, and the occasional muckraking financial news item.  If governance activism is in fact temporarily moribund, then after a while investors will cease paying attention to it, just as at regular intervals they cease paying attention to book value, return on invested capital, or, in bear markets, growth potential.  This means that there would again be an excess return to be made from paying closer attention to these same governance issues:  board independence, transparency, protection from rent extraction, and fair treatment of minority shareholders.

It seems that what the author is decrying instead is the loss of missionary enthusiasm among the first generation of activists, and the decline of a rational link between the governance concerns of investors and the proper management of a business.  It is indeed arguable that the present governance ‘industry’ is a victim of its own successes:   there is increased emphasis upon compliance with increasingly minor infractions, the area has become bureaucratic and legalistic, divorced from investment concerns, exploited by some for purposes entirely contrary to the original intentions attending its foundation, and the whole subject has become overlaid with layers of complex regulation, particularly in the U.S.

However, the U.S. is not the whole world, the new regulations will not cover all possible attempts to circumvent them, the majority of the largest corporations are not the whole of all investible propositions, and investors may be counted upon to ignore or eventually forget all lessons not recently acquired from personal pain.  Corporate governance watchdogs will continue to be needed the same way that police will always be needed; because some individuals will try to cut corners no matter what the environment, and many more will begin to ignore or even participate in whatever is going on whenever it seems that is what most of their contemporaries are doing.

As Prof. Frentrop has demonstrated, governance activism goes back to the first corporation, the Dutch East India Company, and began as early as 1609.  It will be needed in some form as long as some people manage assets on behalf of others.

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