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November 8, 2002

Corporate Governance Not The Only One Needing Reform

The ironies and contradictions in the notion that Congress can implement reform in corporate governance flow like water. The chairs of powerful committees, who receive millions in campaign contributions from the industries under their purview, lecture heads of accounting firms about conflicts of interest. The same senators and congressman who craft appropriations bills with billions of "off budget" and "emergency" spending items to get around spending caps are now looking down their noses at private sector gimmicks to make earnings look bigger than life. And quasi-governmental agencies, such as the home mortgage giant Fannie Mae, lobby to exempt themselves from disclosure requirements ordinary companies must comply with.

But the outcome of the recently concluded elections drives home a more fundamental parallel between the systems that govern politics and companies. Each must constantly struggle to ensure that what is best for the leadership is in fact best for those being led.

Step back a moment and consider, for example, the outcome of the electoral contests for the Indiana House of Representatives. To begin with, in 31 of the 100 House districts, there was only one candidate for office. Because of redistricting, only 55 of the 69 contested elections had an incumbent. Exactly two of those lost. Taken collectively, the incumbents tallied an unofficial 534,211 votes, or 68.5 percent of all those cast in contested elections around the state.

Even if you don't say that those reelected with no opposition got 100 percent of the vote, that's a landslide victory for the status quo. In a year that focused on the supposed drama of which party would control the House, the larger story is that for the vast majority of voters, there was no drama whatsoever.

Furthermore, there is also no question that this outcome is one that the sitting politicians of both major parties are extremely happy with. After all, the drawing of district boundaries, aided by sophisticated computer software that tracks voting records down to the city block, is conducted by the legislators themselves. The time-honored tradition of gerrymandering districts has gone high tech, and reduced the number of truly contested elections at many levels of government to a mere handful.

This is a classic outcome in what economists call the "principal-agent" dilemma that plagues both the public and the private sector. In this case we, the electorate at large, appoint our political leaders as our agents to manage our governmental affairs. But since we can only imperfectly observe the actions they take, they are free to pursue objectives that suit their own interests. We're interested in having leaders that respond to our needs. Politicians are interested, among other things, in a steady paycheck and a long career.

That's exactly the problem that has put corporate governance in everyone's crosshairs of late. Ironically, one of the practices that has come under the most fire -- stock options for top executives -- came to be widely accepted precisely because it was thought to put CEO's and stockholders' priorities in better harmony. After all, stockholders can't really know what kinds of day to day decisions the leaders that manage their companies are making. But if they're paid in company stock, which ultimately reflects the value of their efforts, they would by necessity look after stockholders' interests.

In truth, what happened in the 1990's in executive compensation was at best only a half-hearted attempt to implement this concept. At first, everyone accepted stock options with a wink and a nod, because their value only seemed to go up. When they came down things often got ugly, with many a board bending or breaking the rules to keep their executives' now-princely pay packages intact, effectively destroying the connections the system had put in place.

We cannot wish these sorts of dilemmas away. The best we can do is to manage them, by crafting laws and regulations that give our leaders the incentive to follow our wishes. Clearly, giving an electoral body the power to draw up the boundaries of it members' districts is not accomplishing this goal. It's time we modified the Indiana Constitution to make district boundaries an administrative, rather than nakedly political, task.

Link to this commentary: https://commentaries.cberdata.org/397/corporate-governance-not-the-only-one-needing-reform

Tags: election, economics


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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