The slow demise of the U.S. car industry over decades and the spectacular collapse of the U.S. financial system have a lot in common. Both implosions are the result of poor management: shortsighted incompetence in the car industry and reckless risk-taking in the financial sector. Where was the oversight? And what could be a better indictment of the incentives in our system than the fact that even the executives who made the most egregious calamitous decisions are all walking away as rich men, while many of their shareholders have been wiped out?

(The Corporate Library reports that Richard Fuld, the person primarily responsible for the destruction of Lehman Brothers (and clearly among the most incompetent CEOs of all time), was the 13th highest CEO in 2007, with $71.92 million in compensation in 2007, including more than $40 million in value from realized stock options. The third highest-paid executive on the list was Angelo Mozilo, former CEO of Countrywide Financial Corp., which collapsed on its subprime loans. His total actual compensation for 2007 was $124.69 million. Bank of America had to pay him another hundred million dollars to make him disappear. It took government intervention to stop the CEOs of Fannie and Freddie from receiving $25 million in parachutes. The list of scandalous pay and no board supervision goes on and on.)

The fact is that our US corporate governance system is dysfunctional. The most important feature of a governance system is its ability to limit the power of those CEOs—the black sheep if you will—who are inclined to break it. Therefore, the only effective mechanisms are those that are external to the firm — those that cannot be dismantled by bad CEOs: management’s fiduciary duty, the requirement to hold an annual meeting, the possibility of an external takeover (at least before Delaware gave management the poison pill and staggered boards to prevent them), the negative publicity surrounding excessive salaries. In contrast, internal governance mechanisms, such as the power of the Chairman’s board to fire the CEO, are seldom effective. Any bad CEO worth his salt will have worked hard to make this extremely difficult.

It is imperative to our global competitiveness that we improve our corporate governance system. If we do not, we may fix all our present economic calamities only to have new ones erupt elsewhere before long.

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