Corporate Governance

Robert A. G. Monks, Nell Minow

• Publisher: Wiley
• Year: 2011
• ISBN:
  9780470972748
• Edition: 5
• Topic: Negocios y empresa
• Subtopic: Gobierno empresarial

In the wake of the recent global financial collapse the timely new edition of this successful text provides students and business professionals with a welcome update of the key issues facing managers, boards of directors, investors, and shareholders.

In addition to its authoritative overview of the history, the myth and the reality of corporate governance, this new edition has been updated to include:

• analysis of the financial crisis;
• the reasons for the global scale of the recession
• the failure of international risk management
• An overview of corporate governance guidelines and codes of practice;
• new cases.

Once again in the new edition of their textbook, Robert A. G. Monks and Nell Minow show clearly the role of corporate governance in making sure the right questions are asked and the necessary checks and balances in place to protect the long-term, sustainable value of the enterprise.

Features 18 case studies of institutions and corporations in crisis, and analyses the reasons for their fall (Cases include Lehman Brothers, General Motors, American Express, Time Warner, IBM and Premier Oil.)

Chapter 1

What is a Corporation?

Henry Ford once said, “A great business is really too big to be human.” Indeed, that is the purpose of the corporate structure, to transcend the ability and lifespan of any individual. It is also the challenge of the corporation. The efforts by humans in directing and controlling other humans, whether through democracy or fascism, whether by carrots or sticks, have been notoriously unsuccessful. Efforts by humans to control institutions are an even greater challenge.

The very elements of the corporate structure that have made it so robust – the limitation on liability, the “personhood” that can continue indefinitely – make it very difficult to impose limits to ensure that the corporation acts in a manner consistent with the overall public interest. The corporate structure creates both the motive and the opportunity for externalizing costs to benefit the insiders. As we will see, most of the problems and failures and obstacles we find in looking at corporate functioning from both a micro and macro perspective come from this seemingly intractable element of their existence. In other words, we must make sure that we have created a structure that is not just perpetual, but sustainable.

In this book, we will devote chapters to the three most significant forces governing the direction of corporations and trying to reduce agency costs and maximize sustainable value creation. They are management, shareholders, and boards of directors, all internal and structural. Throughout our examples we will also look at other significant forces like government/law, employees, competitors, suppliers, service providers, and other partners, as well as communities and customers. Key issues include how we establish goals, align incentives for corporate managers to reach those goals, measure performance to see how well they have done, and make whatever adjustments to the goals, the measurement, and the management itself to make sure that the aspirations and operations of the corporation result in sustainable, long-term value creation.

As a beginning we will focus on providing some context by discussing what the corporation is, what the corporate structure was created to accomplish and how those aspirations and structures have evolved. We will discuss the ways in which we do and do not establish, measure, direct, and encourage corporations and the people who govern them to behave in a way that promotes the best interests of society over the long term. We will also talk about the external actors and mechanisms for governing corporations, especially the government, but in this chapter and throughout this book we will also look at accountants, analysts, investment bankers, journalists, and others.

The house-of-cards collapse of every one of the gatekeepers established to provide independent oversight and assessment requires an examination of the ways they were ineffective or complicit in the string of corporate failures and catastrophes that began in 2002 and in the collapse of financial institutions triggered by subprime lending and derivatives in 2007.

We have a tendency to take the corporate structure for granted because it is so pervasive. But in order to understand how it works – and how it should work – we need to take a moment to look at how we got where we are, what it was intended to be, and how that compares with what we have. We will begin with a brief review of what the corporation is. Then, the rest of this chapter will focus on the key issues that put the key questions of corporate governance in context:

• How do we make sure that a corporation or the corporate structure in general adds the maximum value to society? How do we minimize corporations' ability to externalize the costs of their activities on to others? Constraints are generally imposed either by government through application and enforcement of legal standards by efficient application of market forces. Any study of corporate governance has to focus on various forms of oversight and gate-keeping effects of these constraints, how effective they are, and how well they support the twin goals of market efficiency and public policy.
• When the performance data show that the corporation is not meeting our goals, what is the best way to make the necessary changes and who is responsible for making that happen?

Throughout all business-related studies, we look at the ways we measure corporate performance. We will touch on that question again in this context, asking: What do we want and how do we determine whether we have achieved it? In the first set of twenty-first century corporate scandals, Enron, WorldCom, and others appeared to be outstanding performers due to a combination of accounting dodges and plain old-fashioned lying. Before that, Waste Management and Stone & Webster (see case studies) had massive restatements and “special charges.” In the dot.com collapse of the 1990s billions of dollars evaporated and in the financial meltdown of 2008 hundreds of trillions of dollars were “lost.” Where did this money go? Was the value shown on balance sheets ever really there?

Defining the Corporate Structure, Purpose, and Powers

The first challenge is defining what we mean by the corporation. There is a legal definition that covers the requirements for obtaining articles of incorporation and the obligations of the resulting entity. However, corporations always seem to have more vitality and more complexity than can be constrained by definitions or laws. They even seem to take on personalities that go far beyond the way we feel about their products. Think of the reputations of Apple, of Enron, of General Motors, of Google, of BP.

The variety of definitions set some parameters but are most useful in what they tell us about the assumptions and aspirations of the people who propose them. They remind us of the blind men who tried to describe an elephant – one feeling the tail and calling it a snake, one feeling the leg and calling it a tree, one feeling the side and calling it a wall, one feeling the tusk and calling it a spear. All definitions of the term corporation reflect the perspectives (and the biases) of the people writing the definitions.

Some lawyers and economists neutrally describe the corporation as simply “a nexus (bundle) of contracts,” arguing that the corporation is nothing more than the sum of all of the agreements leading to its creation.¹

Some speak of it with admiration. Ayn Rand wrote, “Capitalism demands the best of every man – his rationality – and rewards him accordingly. It leaves every man free to choose the work he likes, to specialize in it, to trade his product for the products of others, and to go as far on the road of achievement as his ability and ambition will carry him.” Historians John Mickelthwait and Adrian Wooldridge lauded the flexibility of the corporate form: “Nowadays, nobody finds it odd that, a century after its foundation, the Minnesota Mining and Manufacturing Company makes Post-it notes, or that the world's biggest mobile-phone company, Nokia, used to be in the paper business.”

Some are critical, like Joel Bakan, whose book and movie, The Corporation, diagnoses the corporation as pathological by matching its attributes to the standard medical literature's list of symptoms of a lack of moral conscience. In The Devil's Dictionary, the acerbic Ambrose Bierce says that a corporation is “An ingenious device for obtaining individual profit without individual responsibility.”

All of these definitions reflect the advantages and the risks from the corporation's key feature – its ability to draw resources from a variety of groups and establish and maintain its own persona separate from all of them. That goes back to the very origins of the word, from “corpus” or body, as in a body of people organized to act as one.

A purely descriptive definition would say that a corporation is a structure established by law to allow different parties to contribute capital, expertise, and labor for the maximum benefit of all of them. The investor gets the chance to participate in the profits of the enterprise without taking responsibility for the operations. The management gets the chance to run the company without taking the responsibility of personally providing the funds. In order to make both of these possible, the shareholders have limited liability and limited involvement in the company's affairs. That involvement includes, at least in theory, the right to elect directors and the fiduciary obligation of directors and management to protect their interests.

This independent entity must relate to a wide variety of “constituents,” including its directors, managers, employees, shareholders, customers, creditors, and suppliers, as well as the members of the community and the government. Each of these relationships itself has a variety of constituents, sometimes inherently contradictory. The corporation's obligations to its employees vary, for example, depending on the circumstances: whether it relates to them as members of a union or not, whether they are pension plan participants or not. Each of these relationships affects the direction and focus of the corporation. The study of corporate governance is the study of the connection of those relationships to the corporation and to one another.

Evolution of the Corporate Structure

While in law a corporation is, at least for some purposes, considered to be a fictional “person,” at its core each corporation is a structure, developed over time to respond to the need for more complex organizations to develop and manufacture and deliver more complex goods and services to a larger and more diverse range of customers. Its current form is the result of evolution through a Darwinian process in which each development made it stronger, more resilient, and more impervious to control by outsiders.

As we examine that evolutionary pattern, it will become clear that every change the corporate form has undergone has been directed toward the corporation's own perpetuation and growth. The advantages and disadvantages of this fact of business life are discussed throughout this book.

In their earliest Anglo-Saxon form, municipal and educational corporations were granted perpetual existence and control over their own functions as a way of insuring independence from the otherwise all-encompassing power of the king. By the seventeenth century, corporations were created by the state for specific purposes, like the settlement of India and the American colonies. Their effectiveness is credited as one of the principal explanations for Europe's half millennium domination of the globe. Limiting investors' liability to the amount they actually invested was a critical factor in attracting the necessary capital for this unprecedented achievement.²

Even as recently as 1932, US Supreme Court Justice Louis Brandeis argued for making sure that states conferred the privilege of the corporate structure only in those cases where it was consistent with public policy and welfare.

In the early days, there was a fear of some insidious menace inherent in large aggregations of capital, particularly when held by corporations. “So at first the corporate privilege was granted sparingly; and only when the grant seemed necessary in order to procure for the community some specific benefit otherwise unattainable. The later enactment of general corporation laws does not signify that the apprehension of corporate domination had been overcome.”³

Brandeis points out that the decision to remove the strict requirements imposed on corporations was not based on the legislators' “conviction that maintenance of these restrictions was undesirable in itself, but to the conviction that it was futile to insist on them; because local restriction would be circumvented by foreign incorporation.”⁴ In other words, the characteristics of the corporate form were so important to people in business that legislators recognized that they could not beat them, and therefore might as well join them, or at least permit and then tax them.

What made the corporate form so appealing, so essential? According to Dean Robert Clark of Harvard Law School, the four characteristics essential to the vitality and appeal of the corporate form are:

1. limited liability for investors;

2. free transferability of investor interests;

3. legal personality (entity-attributable powers, life span, and purpose); and

4. centralized management.⁵

He adds that three developments, starting in the late nineteenth century, made these attributes particularly important. The first was the need for firms far larger than had previously been the norm. Technological advances led to new economies of scale. For the first time it made sense to have firms of more than a dozen people, and suddenly there were companies employing hundreds, then thousands. The second was the accompanying need for ...