Holding Corporate Officers and Directors Accountable for Failures of Corporate Governance

The following post comes to us from Greg M. Zipes, a trial attorney with the United States Department of Justice. This post is based on his article Ties that Bind: Codes of Conduct that Require Automatic Reductions to the Pay of Directors, Officers, and Their Advisors for Failures of Corporate Governance that was recently published in the Journal of Business and Securities Law. All comments are in Mr. Zipes’ individual capacity and do not reflect the views of the Department of Justice.

Executives and directors at large corporations rarely face personal liability for failures of oversight that lead to large penalties or losses to their companies. As outlined in my recent article, the American consumer can help provide a solution to this lack of accountability.

I propose that corporate executives and directors sign binding codes of conduct requiring them to uphold specific standards within their corporations. They would agree to specific, transparent reductions in compensation if they fail to live up to these standards. This proposal does not rely on the altruism of these corporate heads to sign. Rather, it assumes that those consumers, dismayed by corporate excesses, will direct at least a portion of their business towards those companies with executives who are willing to put their compensation on the line.

Compensation packages for top managers appropriately reward those who create a lawful and innovative work environment. As a result, these executives may receive bonuses even if they had no hand in the development of a product generating significant profits. The same principle of accountability should apply in a permissive environment where improper conduct is rife.

One binding code of conduct would require an executive or director to forgo 25 percent of his or her gross compensation for three years if the corporation pleads guilty to a criminal count, the company is fined more than $10 million, or an employee of the company (while acting in his/her corporate capacity) is found guilty for losses of more than $10 million.

It is easy to determine whether the code applies. A corporation pleads guilty for some pervasive wrongdoing, such as money-laundering or unsafe working conditions, and the code applies. The company pollutes a local stream and incurs an EPA fine of over $10 million dollars, and the code applies. The company engages in Medicaid fraud above the threshold and the code applies.

Once the code’s requirements are met, the reductions are likewise easy to calculate. The code looks at gross compensation of top management. With the assumption that executives and directors pay taxes at a 50 percent rate, the proposed reductions still leave money in their pockets, just substantially less, as is appropriate.

Publicity is key to the implementation of binding codes. Consumers must know who signed the binding codes and guide their business accordingly. Consumers should have a neutral, easily accessible and reputable source that lists recommended binding codes of conduct and corporations that comply with these standards. In keeping with the market-based approach, a private organization should be created. It will manage the website and publicize the codes of conduct.

In the highly competitive retail world, companies are always looking for ways to distinguish themselves from the crowd. In the same way some consumers buy eco-friendly products or shop at chain stores known to pay their employees above market-wages, some consumers will flock to a company with an executive who has signed the binding codes.

The codes do not require total changes in shopping habits by consumers—simply enough of a change that gets the attention of the corporations. Even if only five percent of consumers or investors shift their business to companies with executives willing to sign, corporations will have to take notice. As more customers move their business, more corporate agents will face increased pressure to climb on board and adopt the binding codes.

The strict liability aspect has several advantages for corporations. For better or worse, the matter is put behind them without endless litigation over the intent or knowledge of the executives and directors. Top management can stay focused on the core mission of the corporation. This strict liability concept likewise solves a dilemma for independent directors who do wish to change corporate behavior but worry about their fiduciary duties to maximize corporate revenues. These directors will have a fiduciary duty to require executives to sign codes if corporate revenues drop due to a failure by the executives to sign.

Of course, the point of the proposal is to improve corporate governance as well as to provide an outlet for public dismay. An executive or director, knowing his or her compensation is at stake, will redouble efforts to ensure the company does not break the law or incur penalties as result of corporate improprieties. Ideally, no corporate agent will actually suffer reductions in compensation. In fact, lenders and investors typically appreciate good governance and should reward these companies with lower borrowing costs and higher stock prices. Good corporate governance is typically good business.

The full article is available for download here.


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