In an address at the Stern School of Business in New York on March 26, Alan Greenspan, not for the first and hopefully not for the last time, gave a clear and sensible analysis of an important and pressing problem. He was addressing the need to restore public trust in corporate governance in the aftermath of Enron and Global Crossing. He suggested that the basis for reliable governance is either ‘the current CEO-dominant paradigm’ or ‘the only credible alternative is for large – primarily institutional – shareholders to exert far more control over corporate affairs than they appear to be willing to exercise.’ He chooses the benevolent despot: ‘It seems clear that if the CEO chooses to govern in the interests of shareholders, he or she can, by example and through oversight, induce corporate colleagues and outside auditors to behave in ways that produce de facto governance that matches the de jure shareholder-led model.’
Greenspan is in a unique position. In his 75th year, the Fed chairman is seeking no favor from anyone. He is largely immune to the subtle and not so subtle influences of the corpocracy that is Washington, DC. It is hard to name another leader with such credibility in matters financial. So it falls on him to expose the convenient lie of governance based on ‘independent’ directors. This fiction has been convenient to everyone – the government can pretend there is a functional system, until a crisis like Enron shrieks that the emperor has no clothes. Individual directors are glad to be overpaid and overvalued. CEOs are thrilled to function as dictators while having available the myth of accountability to an ‘independent’ board. As Greenspan puts it from an economist’s perspective, the system has survived – ‘For the most part, despite providing limited incentives for board members to safeguard shareholder interests, this paradigm has worked.’
If only men were angels. But they’re not, and CEOs are no exception. Why should trustees, of all legal owners, be permitted by simple fiat to purge themselves of tiresome responsibility? As Adolph Berle said some 65 years ago, ‘If a horse dies, does not its owner have the obligation to bury it?’ Further, it is clear this disinterest of institutions to act as owners is largely based on their conflicts of interest. Institutional owners are preponderantly financial conglomerates whose financing interests with corporations are apparently of greater value than functioning as trustee for their pension plans. And yet the law of trusts is clear. Any conflict of interest must be resolved in favor of the beneficiary. Government at all levels in the UK and the US has failed to enforce this plain requirement of basic law.
The way the majority ownership of US and UK companies is held by trust institution was not an ineluctable product of history. The government, in providing retirement income and safe mutual fund investing, created these institutions. It characterized them as trusts and thereby gave assurance to beneficiaries that their assets would be protected by, among other things, freedom from trustee conflict of interests. The unintended consequence of well-intended government action is the neutering of the majority owners of publicly traded companies. The ‘market’ of ownership has thus been corrupted. Even the most rabid libertarian would not quarrel with government undoing consequences created uniquely by government. Simply, trust responsibilities must be enforced. The UK has faced up to this problem by adopting the proposals of the Myners Report.
Happily, Greenspan’s remarks were delivered only days following SEC chairman Harvey Pitt’s assurance that the law would henceforth be enforced and money managers should view their corporate proxy votes as a fiduciary duty. In as much as the Department of Labor has long opined that employee benefit plan trustees have an identical obligation, we now have formal assurance that the institutional reluctance of pension plans and mutual funds to which Greenspan pays such deference will no longer be tolerated.
The importance and value of shareholder involvement has been demonstrated dramatically in recent times in the cases of Salomon Brothers and Waste Management. In the first case, ‘owner’ Warren Buffett took direct control and successfully negotiated with the government the continued ‘parole’ of the company, and ultimately realized substantial profits for all shareholders. In the latter case, ‘owner’ Ralph Whitworth of Relational Investors took on the chairmanship in order to direct the recovery from massive accounting frauds. The continuing shareholders of Waste Management have profited. Contrast the situation characterized by governance based on ‘active owners’ with the total losses for outsiders in Enron and Global Crossing.
Chairman Greenspan has identified the real alternatives. He has politely but firmly repudiated the conventional governance wisdom of the past 20 years. He has given us much to think about.
Robert Monks is a leading shareholder activist.
