Preface

"Why did corporate governance checks and balances that served us reasonably well in the past break down? At root were soaring stock prices in the latter part of the 1990s that arguably engendered an outsized increase in opportunities for avarice. An infectious greed seemed to grip much of our business community."

”Alan Greenspan, Federal Reserve Chairman,
Speech to Congress, 16 July 2002

Chairman Greenspan's comments lead to some very intriguing questions. What are the corporate governance checks and balances that he is talking about? How and why did they fail us? Can this break down ever happen again?

Answering these questions is what this book is all about. We refer to the checks and balances as executive incentives and corporate monitors . Indeed, there are many participants in the corporate governance system. Although the corporate scandals take on specific names and faces (like Andrew Fastow, Martha Stewart, Enron, Arthur Andersen, and WorldCom), the problem actually involves a whole system that either allowed the misdeeds or failed to catch them.

It might be convenient to blame one group of people or another. For example, CEOs and other top executives have been blamed for being greedy. But they weren't the only ones who acted greedy. Many politicians and the media have blamed auditors . But they weren't the only ones who failed to monitor the companies. The problem was a breakdown of the system. For example, a board of directors, which was elected by the shareholders, gave the CEO and other executives stock options. This motivated them to maximize the stock price at a specific point when they could cash in the options for millions of dollars. The CEO then talked up his or her company to analysts. The captive analysts, impressed with the business, assigned a buy rating and hyped the stock. To meet the expectations, , the CEO demanded that the accounting department manufacture paper profits. Solutions also came from consultants and often involved investment bankers. These perilous actions were either okayed or overlooked by the corporate lawyers and the auditors. Any one of these groups could have put a stop to the shenanigans but didn't - why not? In this book, we thoroughly discuss the incentives, conflicts, and actions of each of the participants in the corporate system.

Some of the problems had been developing for many years . The Securities and Exchange Commission (SEC) knew about some of the problems but failed to act to stop them. Indeed, in the middle and late 1990s, the government enacted laws that reduced investor protection. When the scandals broke in 2001 and 2002, however, politicians were then lining up to speak against the "evil doers," the greedy corporate executives. A 180-degree turnaround . And, as if by script, they worked fast to enact new laws and to restore investor confidence. New laws were passed, but confidence hasn't been restored. Why not? Is it that the laws that were passed were not as effective as they could have been? People are naturally skeptical of these new laws, and their skepticism may not be unfounded as the participants in the corporate governance system are some of the largest donors to political campaigns . Auditing firms, investment banking firms, corporate lawyers and the public companies themselves donate tens of millions of dollars to both political parties per election cycle. Should we really believe that these politicians are turning their backs on them? This book exposes why many of the new laws and policies will only be marginally effective in improving the system.

We recognize that these new proposals are an important part of the process to restore investor confidence, but where these solutions fall short is its inability to recognize that the American corporate form of business is an integrated system with many parts . We should first realize, however, that this system has allowed the U.S. economy to become the largest and strongest in the world. Therefore, the basic system is a good one that deserves to be preserved, but it does have its problems that can be fixed. The best solutions do not over burden the basic system, nor overtax or unnecessarily scare the people. After all, we want our capitalist system to continue to churn out new jobs, wealth, and revenue far into the future. We propose some incentive-driven solutions that fit within the current system to make it better. Combining our incentives-driven solutions with the punishment and regulation-based solutions that have been proposed from the government should make the system not only whole again, but better.

If you own any stocks, either as an active investor or through your retirement savings, then this book was very much written for you. The group with the greatest interest in monitoring management is the shareholders themselves. The American investor has become disengaged from the company she or he owns. Investors have taken little interest in the inner workings of the corporation. If something about the company upsets you, you simply sell the stock and buy a different one. The dramatic decline in commission costs lends itself to this apathy. If shareholders do not take a stand for their own investment, why should executives, the board, or anyone else? Investors need to educate themselves on how this corporate system works and what their role should be. Being more knowledgeable about the system, its failures, and the solutions would also help investors regain some of the trust that was broken. This book aims to provide that education.

Finally, we believe that anyone who is interested in participating in the corporate system in the future (for example, business students) should read this book. To make sure that breakdowns like this are never to be experienced again, then the future participants of the system need to learn from the past.