The special report on corporate governance in yesterday's WSJ (sub. req'd) included an interesting article by Phyllis Plitch entitled A Piece of the Action: Corporate governance is hot -- and there's no shortage of companies promising to help:
With corporate governance showing no signs of fading as a hot business buzzword as executives scramble to meet new regulations, companies of all kinds and sizes are trying to get a piece of the action. "This looks like the first widespread new potential to sell software and services to the whole economy since the dot-com bust three years ago," says Lane Leskela, research director at Gartner Inc. Mr. Leskela says he found at least 50 high-tech vendors marketing services related to the Sarbanes-Oxley Act of 2002, the legal centerpiece of sweeping reforms aimed at preventing corporate malfeasance. The businesses, he says, range "from the usual suspects all the way down to companies no one has really heard of before." ...
To critics, however, the onslaught of "you must hire us" pitches can scare companies into thinking they have no choice but to pony up big bucks. Some promotions "seem designed to put the fear of God in companies -- that complying is so difficult, you can't possibly do it without expensive and extensive outside help," says Beth Young, senior research associate at the Corporate Library, an independent research firm and corporate watchdog. "It's making people extremely paranoid about the requirements and what it takes to comply."
Well, that's just great. As an investor, I don't want my portfolio companies spending a dollar on "good corporate governance" unless doing so adds at least a buck to the bottom line. I don't have any voice in how much to spend on corporate governance, however. The board of directors and top management make that decision (as they should, of course). Unfortunately for the bottom line, however, directors and management have a strong incentive to over-invest in corporate governance consultants and so on.
Why? The answer lies in the incentive structures of the relevant players. Who pays the bill if a director is found liable for breaching his federal or state duties? The director. if the director has adequately processed decisions and consulted with advisors, will the director be held liable? Unlikely. Who pays the bill for hiring corporate governance consultants, lawyers, investment bankers and so on to advise the board? The corporation and, ultimately, the shareholders. Suppose you were faced with potentially catastrophic losses, for which somebody offered to sell you an insurance policy. Better still, you don't have to pay the premiums, someone else will do so. Buying the policy therefore doesn't cost you anything. Would not you buy it? isn't that exactly the choice we're giving directors and senior managers?
Corporate governance reforms have thus given us the corporate governance racket. We know that these reforms have significantly raised the regulatory burden on Corporate America. Will we get a commensurate bang for our buck? Regular readers know that I'm very skeptical. What I've tried to show here is even modest reforms can result in costs that outweigh their benefits so long as those upon whom the reforms impose new liabilities control the purse strings.
