Financial Alchemy

Abstract

The Enron Era fiascos featured publicly traded companies experiencing simultaneous failures of all the critical pieces of their corporate governance system. Each of the monitors – boards, capital market servicers, and government regulators from several different agencies – failed. In previous chapters, we discussed how each monitor tends to fall victim to the incentive structure under which they operate. Our shorthand for this process is capture. Each monitor finds itself trying to compromise between a rigid standard of governance and accommodating to the wishes of its effective client, the very entity the monitor is appointed to oversee. A perplexing juxtaposition indeed for a watchman! Some observers might refer to the process simply as “influence,” rather than “capture,” but influence doesn’t provide the right nuance. Influence does not describe the extent to which monitors will bend their own principles of independent judgment to reach a more accommodating stance with their client. “Capture” does! We also use the qualifier “effective” to denote the actual entity to which the monitor addresses most of its effort. In the case of the board, the nominal client is the shareholder, but the effective client is the senior management (CEO/CFO) of the firm being monitored who has appointed the board member. Over a suitable period, management obtains a board with which it is comfortable, and the board over time becomes comfortable with its effective client, the senior managers.

“The hardest thing to judge is what level of risk is safe.”¹