Following on a thread that involved earlier posts here and here, Professor Ribstein expands in this post on his proposal for reforming corporate governance:
My solution to the problems of corporate governance is to put pressure on managers to distribute excess cash by increasing owner distribution and liquidation rights. Ironically, it is the corporate form’s elimination of these partnership-type rights that Margaret Blair argues made modern business possible. I dispute that proposition here. In that article I also argue that thick sophisticated markets have made the giant corporation no longer as important as it once was.
You might well ask, if this is such a good idea, why haven?t we seen more of it ? e.g., partnership type provisions in corporate charters that mandate distributions? Why not more publicly traded LLCs?
My explanation is that the corporate tax and the ?double? tax imposed on corporate distributions reduce owners’ incentives to insist on distributions even if requiring distributions would efficiently reduce managerial agency costs, and therefore be value-increasing in the absence of this tax. So I propose eliminating the bias favoring retained earnings inherent in the our current tax system. Firms would then be freer to move toward more efficient governance forms.
Professor Ribstein’s focus on the detrimental effects of the double taxation of corporate profits raises an interesting incongruity of the related political issue.
The anti-business crowd rails against removal of the double taxation of corporate profits as an unfair concession to the rich capitalist roaders. However, the retention of corporate profits contributes to corporate blunders (such as HP’s acquisition of Compaq) and Enron-type scandals, which the anti-business forces attempt to remedy through bigger government — that is, shareholder lawsuits in the civil justice system, criminalization of questionable corporate actions in the criminal justice system, and greater governmental control in the regulatory system (i.e., Sarbox).
Thus, the anti-business crowd’s opposition to removal of the double taxation on corporate profits has the unintended consequence of promoting bigger businesses and bigger business blunders that, in turn, require bigger government to control. I’m not sure where the anti-business forces want to go with all of this, but my sense is that “bigger in everything” is not the destination that they have in mind.
Also, check out Professor Bainbridge’s additional cogent thoughts in this post on corporate governance issues, and also Professor Ribstein’s follow up post. Likewise, Professor Bainbridge passes along this site where you can download the papers presented at a conference over the weekend that addressed these and other corporate governance issues. These are great resources.
I enjoy your thought provoking blog, but i hardly believe that the retention of corporate profits contributes to such blunders as the HP-Compaq deal or the Enron-type scandals. The former was caused by simply poor strategic management skills, the latter by a serious lack of personal ethics as well as by a board of directors that failed to do its duty. The SEC is also to blame as it has been woefully remiss in exercising its oversight and enforcement obligations.
Any corporation can buy its own shares back in the open market to return value to the shareholders. Granted, the double taxation issue still exists in the form of capital gains tax, but only for those shareholders that wish to recognize the gain. A dividend, on the other hand, forces all shareholders to recognize the income.
If the SEC would start performing its oversight and enforcement function, making corporate criminals believe there was a high probability of being punished, the risk/reward calculation would change and we would probably see fewer corporate insiders trying their little stunts.
Double taxation isn’t behind Enron-type scandals. The low probability of getting caught and a lack of personal ethics is to blame.
Charles, I actually agree with much of what you say, although I think you underestimate the effect of retention of corporate profits has on the power of the imperial CEO in the modern corporation. But certainly you are right that complacent boards have much to do with the Enron-type scandals, and there is no question that poor strategic planning contributed to the HP-Compaq mess.
However, as Professor Ribstein has pointed out, is it really realistic for a board (or the SEC for that matter) to be in a position of exercising any meaningful oversight control over a complicated corporation that retains earnings and is ruled by an imperial CEO? For all its faults, the Enron board had some impressive people on it. Presumably, at least some of them were attempting to do the right thing. My sense is that the model under which they were operating made the right thing a very difficult thing to achieve.
The mere existence of the ‘imperial CEO’ is a issue of accountability (or lack thereof). If the CEO is imperial, it is because he is not accountable to anyone to any significant degree.
Accountability and oversight are concepts that mirror each other. If the CEO is not being held accountable, the board is failing at its oversight function.
Some continue to ascribe to the theory that corporate boards exist to assist the CEO in executing his business plan and not necessarily to second guess the CEO or to oversee the actions of the CEO. This view holds that the oversight function belongs to the shareholders. Regardless of which structure is employed by a given corporation, two things are true. one is that stupid business deecisions will never eliminated, regardless of who is in charge of providing oversight (HP-Compaq) and that corrupt individuals will be corrupt and they will find ways to mislead the directors, the shareholders and the SEC, so no amount of oversight will eliminate corrpution (Enron).
The imperial CEO exists because shareholders have failed to either exercise oversight or have failed to ensure directors assume the oversight function. just as voters often get the government they deserve, shareholders usually get the corporate governance they deserve.
As far as the Enron board was concerned, they might have been impressive people in one sense, but they were not impressive corporate directors. Just last week, I read the Skilling indictment and then read the Enron 10k’s. After reading how the Whitewing, Raptor, etc deals were presented in the anuual reports, I was appalled.
The reason John Olson shied away from rating Enron was that he couldn’t understand what the heck the disclosures were describing. In reality, the board couldn’t have understood the disclosures, either. No one can understand them because they were designed to obfuscate. Yet, the board signed off on the reports.
Personally, I would love it if Pres. Bush would name Spitzer as the head of the SEC. Let him re-vamp how the commission performs its oversight and enforcement functions. A strong, reform minded individual with political ambitions seeking to build his reputation. Set him loose and demand substative reform.
I personally know of at least one instance where a major corporation has filed false Sarbox certifications to hide the fact that they are hiding tens of millions of dollars in liabilities from their financial statements. When I threatened to make an issue of it to regulators, their attornies laughed at me. I have written to the SEC annd nothing has happened. I have written to Michael Oxley personally and nothing has happened.
Companies know that the Sarbox fad is much like the CB radio craze or that of putting pictures of lost kids on milk cartons. Its just a fad. Once the initial feel-good phase is over, it will be business as usual. The SEC doesn’t want to enforce Sarbox. In many instances, they aren’t enforcing it now.
CEO’s know this. keep a low profile for now, act like you’re doing a lot and then go back to doing what you were doing earlier. This is why we have imperial CEO’s. In truth, they know the odds of anyone doing anything substantive about it are slim.
Reflections on corporate governance scholarship, or Groundhog Day, or on rereading Henry Manne
This was a very interesting conference featuring many leading corporate scholars, with many good thoughts.