GOVERNANCE REFORMS FAIL

We need principled corporate directors and executives to build ethical cultures and improve corporate governance.

key benefit gained by companies garnering such awards is, supposedly, an improved reputation with investors and other financiers.

As a result, companies also expect that their share prices will improve and that they will have easier access to global funds.

But we should be careful to take such awards with a grain of salt. Businesses have always tried to project a good image to the public. Why should it be any different when it comes to corporate governance? In fact, with so much at stake, the bigger companies will have to earn such recognition, if only to appear on a par with the rest. The question will always be whether the substance matches the public claims. Let’s not forget that Enron had a 64- page Code of Ethics.

What about the stick?

This is usually a regulatory rule with a sanction for noncompliance. For what good is a regulation without teeth, right? Regulators, to be sure, can’t be blamed for tightening the screws on corporations after each wave of scandals.

The public’s need for reassurance often combines the tendency of politicians and government agencies to assert their mandates while gaining visibility points. And new and far-reaching corporate governance rules have come fast and furious after Enron and the global financial crisis. These rules cover required disclosures, qualifications of directors, independent directors, external auditors, compliance officers, corporate governance manuals, executive compensation, and risk management, among others.

These have resulted, however, in some companies’ viewing good governance as simply a compliance exercise or “check-the-box game.” The US Justice department has voiced concerns that the corporate governance rules and the resulting compliance systems have encouraged companies to adhere to the letter but not to the spirit of the law.

The real problem with carrotand-stick approaches is that they are merely external mechanisms to promoting good corporate governance. They do not tend to strengthen the ethical culture of companies. In fact, when used alone, external mechanisms weaken the moral judgment of corporate leaders and even undermine their ethical cultures. Board directors and executives learn to focus on appearance over substance by outsourcing their consciences to lawyers and accountants and their public communications to PR firms. Unfortunately, these service providers tend to view governance through the lenses of their own codes and practices, and not through principles of sound and ethical corporate management.

We need principled corporate directors and executives to build ethical corporate cultures in order to improve corporate governance practices. Without this, carrots and sticks produce morally stunted corporations that look good on paper and that can avoid punishments but actually sow the seeds of malpractice that produce tomorrow’s scandals.