By Colin Mayer, The Guardian, Friday, July 5, 2002
To many people, recent revelations in corporate America are illustrative of a corrupt system riddled with greed. The irony of this is that it was only a few months ago that the US systems of corporate governance, disclosure and accounting were held up as examples for the rest of the world. Policy-makers, practitioners and academics on both sides of the Atlantic went on global missions to preach the merits of the US market system.
The high proportion of non-executive directors and strong fiduciary responsibility of directors to shareholders in the US were regarded as examples of good corporate governance. Its systems of accounting and disclosure were thought to be tougher and better suited to the needs of investors than any other. Such was the strength of feeling that governments and international bodies were moving steadily towards the adoption of the US model.
A decade ago it was Japan whose financial system was regarded as particularly suited to good governance and the financing of corporations. A few years later, as the Japanese economy plunged into recession, this model was reassessed as plagued with crony capitalism.
Then it was the turn of Germany. Its banking system had the merits of the Japanese and banks again provided active corporate governance. But as the German economy began to stall during the 1990s, disillusionment set in. And so the US model rose to the fore.
What of the UK system? For the most part, the UK and US are lumped together as market-based systems to contrast them with continental and Far Eastern systems. But now that the US has stumbled, policymakers and practitioners in this country are rushing to distinguish the UK from the US. Could such corruption happen here? Of course, they admit. Is it as likely? Of course not, they say. Why? Because we do things differently. Our accounting systems are less rule-based and more pragmatic than those in the US.
While there may be some truth in this, it should not provide much comfort. It has happened here (remember Robert Maxwell?) and it will happen again when conditions are right. It is no accident that scandals materialize after periods of extraordinary corporate and economic performance - the Japanese bubble at the end of the 1980s and the US bubble at the end of the 1990s. The bubbles create expectations on the part of investors that managers feel compelled to sustain. They do this by investing in progressively riskier activities and borrowing to finance them. Once things start to go wrong they try to hide the problems, thereby compounding them. By the time they are revealed, they are of extraordinary proportions.
What lessons should we learn from this? The first one is that there is no single best system of corporate governance. All systems have inherent defects. That is an inevitable feature of the problem with which we are trying to grapple, namely how to get other people to manage our investments for us. Problems are less severe where firms are owned and controlled by their initial founders, and some people would like to see a return to the supposedly golden age of family ownership. But as firms develop, they need to raise external financing and broaden their ownership base. Incentives, boards of directors, shareholder activism are all suggested as remedies for the resulting corporate governance problems, but none is a perfect solution.
The second lesson is that different systems serve different functions. The US system should not be written off simply because there have been several prominent failures. It oversaw the financing and development of new technologies on a massive scale for more than a decade. Likewise, the Japanese system was associated with incredible growth. It is probably no coincidence that the market-oriented system of the US is associated with high technology, innovative investments and the Japanese with more traditional manufacturing investment. But what is suited to one economy at one stage of its development is quite different from another economy at a different stage.
The third lesson is that there will be regulatory and government responses. There are wide-ranging discussions and reforms in progress in Japan. There will be a great deal of critical analysis in the US. There is much that can and needs to be done by increasing the independence and accountability of directors and auditors.
But care is required. While action clearly needs to be taken, it will take time to determine precisely what it should be. Politicians and regulators should avoid acting in haste and repenting at leisure.
Colin Mayer is Peter Moores Professor of Management Studies at the Saïd Business School, University of Oxford, Contact Colin Meyer: firstname.lastname@example.org
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