by Danielle Collazo, Featured Contributor
RETROSPECTIVE revisions to corporate law can protect stakeholders from a repeat incident, which parties affected by white collar crimes may feel is “a day late and a dollar short.” It would be much more beneficial for federal agencies to prevent fraud before it occurs by implementing prospective modeling. Throughout latter half of the 20th century and into the 2000s, corporate governance laws has been added/revised retrospectively, prompted by calls for change after a major incident when it becomes apparent that the current standards are inadequate. One piece of legislation that would minimize the number of corporate crime incidents going forward would be the requirement of separate individuals holding the positions of CEO and Chairman of the Board, which would increase the objectivity of corporate governance. When an unethical Chairman is also the CEO of a corporation, pushback on illegal activity is unlikely to occur as the dual-role leader holds a monopoly of influence on corporate governance.
History of Corporate Governance
The concept of corporate governance, or balancing the power between stakeholders and executive management of public companies, began to gain traction in the latter half of the 1980s, despite decades of widespread theories by management scholars about the dangers of imbalanced corporate power. In the 1930s, Adolf Berle, author of The Modern Corporation and Private Property, predicted that the escalation of corporate executives utilizing their power for personal gain would create an imbalanced chain of command in corporate America. However, in the period following World War II, strict regulations for corporations during this were not seen as a top priority as the country enjoyed a prosperous economic time.
The emergence of corporate governance was brought up by the SEC in the 1970s in response to scandals such as Penn Central, when proof of need for greater accountability by corporate leaders was apparent. However, legislative action surrounding these warnings lagged, as corporate governance was still just a theory at the time. In the late 1970s, SEC Chairman Harry Williams and federal working groups made recommendations for reshaping relevant federal legislation with dismal success. The encouragement of a free market in the Reagan administration is considered a major contributing factor for overlooking the warning signs scholars presented during the 1970s on the abuse of power executives would continue to exhibit.
The 1990s presented small signs of realignment of corporate power in terms of increased power by shareholders, widespread activism for corporate governance, and more pension funds; however, managers still fought to retain the level of power they had in past decades over their corporations. Corporate executives relinquished a portion of their power to shareholders and directors in latter half of the 1990s, increasing the influence of shareholders. The emergence of investor relations coupled with the pressures of short-term performance that shareholders impose on directors reshaped corporate values, whereby managers started to directly correlate success with shareholder satisfaction. This new measuring tool decreased focus on long-term company goals and shaped the mindset for which led to the scandals the world would see in the next decade, with Enron being the ultimate call for reevaluating the synergies of management, directors, and shareholders. With 20/20 hindsight, federal officials established new financial reporting controls including SOX and the Basel Accord and later ramped up enforcement of the FCPA in response to widespread global bribery scandals.
Roles in Corporate Governance
Governance of corporations is created by the Board, which is responsible for establishing a framework to outline governing policies. The Board of Directors self-appoints its officers and supervises operations from a macro level, as the Board’s selection of key executive leadership are responsible for carrying out day-to-day operations. Executive leadership holds the responsibility for executing the company’s overall vision and values by communicating the big picture to employees, creating a healthy corporate culture, and working with management to develop a top-notch leadership team.
Together, the Board and executive team, as well as other stakeholders, create a corporate governance system. Compliance with laws and strong ethical values are essential for successful governance, as this committee is responsible for ensuring the direction the entire corporation will go. Since the role of the Board is to ensure leaders are ethical, an unethical Chairman of the Board diminishes the opportunity for illegal practices to be stopped, and may even inflate the capacity in which unethical practices are used, as there would be no force to stop the activity.
The world has already witnessed on more than one occasion that when one individual is allowed dual powers, oversight is weakened and the ease of committing corporate fraud is increased. When examining three major scandals, namely, Enron, JPMorgan, and MF Global, one key commonality is that one person held the position of both CEO and Chairman of the Board. In line with many other federal “solutions” that attempt to control the effect of a particular problem, increased financial reporting regulations fail to offer a solution for eliminating corrupt leadership, the underlying cause of burdensome regulatory requirements. Instead, SOX and Basel, while justified in necessity, are absent of a solution for creating organic ethics and values in an organization.
Organic corporate values are grown within a corporation, by leadership at the top, which, when contaminated with an unethical dual-position leader, are impossible to achieve. Separation of power between the two positions facilitates internal checks and balances within the corporate governance system that enables corporations to extract unethical leaders and prevent unlawful activity.
Kenneth Lay was charged with “abusing his powerful position as Chairman of the Board and CEO” of Enron, according to a 2002 FBI Press Release. With his dual power, Lay held the ability to influence the Board in activities such as lifting the company’s code of ethics to allow Enron’s CFO to create partnerships that concealed the corporation’s true debt. Had Lay only held the position of CEO, an ethical, objective board would never have approved such a red-flag action, and instead provided uninfluenced guidance on how to handle the corporation’s declining revenue in a compliant, ethical way.
Another dual Chairman and CEO role that resulted in a failed company was John Corzine at MF Global. As MF Global’s liquidity plummeted, before its eventual dissolvence, CEO and Chairman Jon Corzine stated that the company was taking measures to decrease its market exposure, when in actuality it was increasing its already vulnerable position by purchasing stake in very high-risk markets, as well as disclosing less debt than it actually had. According to Reuters, a source that worked with MF Global stated that the Board was intimidated by Corzine and “just gave in to his demands.” Had another individual held the Chairman role, that person would have been equally as accountable as Corzine for the company’s actions and could have intervened Corzine’s unethical practices.
At JPMorgan, institutional shareholders did call for more oversight of Jamie Dimon, arguing that a CEO and Chairman role eliminates the board’s ability to “maintain an objective view” of the CEO’s performance, thereby creating a conflict of interest in oversight of the executive team (Prial, 2013). Surprisingly, only 32% of shareholders voted to separate the roles of CEO and Chairman for JPMorgan in 2013, despite the oversight concerns and the company having paid out around $30 billion in fines since 2009 under Dimon’s reign.
The conflict of interest and unethical pandemic that can spread between Boards and executives in which there is a corrupt leader with the final say in both parties is a great concern that needs to be addressed to facilitate organic change within corporations. With a division of powers, a CEO would bring issues to the Board’s attention, and in turn the Chairman would consult with ethical, external audit teams to develop remediations, while maintaining corporate integrity and transparent communication with stakeholders. When one individual monopolizes power over both parties, they retain complete control over all company activity as well as the flow of information, which has largely been a contributing factor to corporate scandals over the past decade. Harry Truman once said “a person who is fundamentally honest doesn’t need a code of ethics,” which is why in place of excessive, complicated reporting processes, federal legislation needs to begin implementing laws that position corporations to maintain integrity within corporate governance structures.
Prial, D. (2013, May 21). Dimon Retains Dual Roles at J.P. Morgan | Fox Business. Retrieved from http://www.foxbusiness.com/news/2013/05/21/jpmorgan-investors-on-edge-over-vote-on-dimon-what-if-win/