Carrots for Good Governance

Abstract

There is no doubt that compensation incentives for managers that are unduly focused on contemporaneous results create inherent conflict and a potential for corporate misgovernance. This is especially true when boards fail to exercise skillful discipline of management, particularly with regard to risks undertaken by corporate managers. Under these conditions, shareholder property can be placed at risk without the knowledge of shareholders. Corporate governance can also be undermined by capital market servicers whose personal interests compromise the stewardship that their institutions should display. As their key personnel strive for increased fees and rapid promotion motivated by their own performance pay systems, capital market servicers can be negligent with regard to the risks of their clients. Account officers of these capital market servicers, therefore, also are in a position to create “agency” problems for their own companies. Negligent acquiescence of client financial results can confer a misleading seal of approval by the underwriter that is in turn transmitted to the public market. The ultimate chain of a financial tragedy is made up of many such links.

“I have always thought that if … even in the very presence of dizzily spiraling [stock] prices, we had all continuously repeated, “two and two still make four,” much of the evil might have been averted,” Bernard Baruch, as quoted by Andrew Tobias (1980, “Foreword” to McKay 1841).