Leadership in Challenging Times

In New York City on December 2, executives, board directors, institutional investors, regulators and others gathered for the Directorship Boardroom and Economic Leadership Forum “The Way Forward: Leadership in Challenging Times.” The annual event recognizes the Directorship 100, a list of the most influential people on corporate governance and in the boardroom, and included day-long panel discussions, workgroups and peer group exchanges that focused on the financial crisis, the new Administration and Congress, and the forthcoming proxy season. (For a post on this Blog about the Directorship 100, see here). Speakers included Congressman Barney Frank, former Congressman Michael Oxley, Vanguard founder John Bogle, former SEC Chairmen William Donaldson and Harvey Pitt and — from Harvard Law School — professor Lucian Bebchuk and Delaware vice-chancellor Leo Strine, Jr., who serves as a visiting professor and a senior fellow of the Corporate Governance Program.

Two panel discussions and the keynote address attracted intense interest. The first panel discussion, involving William Donaldson, Martin Lipton, Harvey Pitt, and Leo Strine and moderated by The New York Times’ Andrew Ross Sorkin, considered the outlook for regulation, legislation, and litigation. None of the panelists disputed the need for financial regulatory reform. Pitt was the most specific about the reforms required. Regulatory reform was required quickly as the current system was badly broken and threatened freedoms we cherish, Pitt said during the panel discussion and an earlier session. He recommended reforms to clarify the scope of each regulator’s authority so that when problems arose regulators would know with certainty whether they could respond and others could identify the regulator that could act – and act dispositively. To provide transparent, fully informed markets, he encouraged regulators to compel the disclosure of information about all financial markets. This could be done in the short term. In the longer term, he recommended the consolidation of federal regulators into the Federal Reserve and a single other regulator, saying that the Treasury’s Blueprint for a Modernized Financial Regulatory Structure should be considered only the beginning of the analysis that was required.

In discussing the role the board of directors could play in regulatory reforms, Lipton cautioned against looking to the board to do what it was incapable of doing and noted that many independent directors lacked in-depth knowledge of their company’s business. He compared this situation unfavorably with boards in earlier decades that had often included the company’s investment banker and commercial banker – people who understood the business and could engage in a robust exchange with other board members.

Donaldson took the position that directors have taken their job more seriously since the passage of the Sarbanes-Oxley act and asserted that investor protection should not be overlooked in any financial regulatory reforms. Strine agreed that boards have become much more responsive to stockholder demands in recent years, including demands by activist investors that companies take more risks to generate very high profits. He noted that strong safety and regulation was more, not less important, when stockholder voice was potent, especially given that institutional investors who represent long-term stockholders have generally failed to make monitoring for excessive risk and leverage a centerpiece of their activism.

Lipton also discussed the need for regulators to understand the products and transactions they regulate. Today, professionals with PhDs often design complex financial instruments and if regulators are to regulate them, they will need to understand the instruments properly. Regulatory design needed to reflect this reality.

The second panel discussion, involving Professor Lucian Bebchuk and former Congressman Michael Oxley and moderated by The Wall Street Journal’s Alan Murray, considered how the credit crisis can be expected to affect corporate governance. Mr. Oxley contrasted the current regulatory environment with the conditions prevailing when the Sarbanes Oxley legislation was adopted, commenting that the current crisis could not be characterized as a scandal involving criminal misconduct. He doubted that criminal behavior would be found to have contributed to the crisis and said we would likely find that bad decisions had been made by good people. Lucian Bebchuk suggested that flawed compensation practices have been an important driver of the short-term outlook of corporate managers that contributed to the current crisis, and described how compensation packages can be redesigned to provide managers with incentives to maximize long-term shareholder value.

In his keynote address, Congressman Frank gave his own assessment of the financial crisis and discussed Congress’ likely response. He characterized the financial crisis as a failure of techniques to constrain risks in the securitization of assets. Explaining how regulation had failed to keep pace with financial innovation, Frank said the challenge now for Congress was to legislate to retain the benefits of securitization while mitigating its risks. Congressman Frank canvassed numerous possible regulatory reforms regarding securitization for Congress to consider, including mandating increased disclosure standards, altering compensation arrangements of participants in the chain of securitization, and requiring participants to retain some risk rather than distributing all of it.

In other comments, Frank expressed a concern that, given that banks now have ample capital, the continued difficulty of getting credit might reflect banks’ rational assessment that operating firms will not be able to repay funds lent to them. He also questioned the rationale for current remuneration practices of executives receiving large bonuses for doing their jobs well. Other professionals, such as dentists, he said, don’t receive financial incentives to align their interests with those of their patients, and he asked why directors needed the promise of great financial rewards for good performance. On the reform front, Congressman Frank expressed support for proposals to allow shareholders to set broad policy of corporations and said that Congress will likely consider say-on-pay reforms and giving shareholders access to the corporate ballot.