THE STATE OF U.S. CORPORATE GOVERNANCE: WHAT'S RIGHT AND WHAT'S WRONG?

Authors

  • Bengt Holmstrom,

    1. Paul A. Samuelson Professor of Economics at MIT's Sloan School of Management and a Research Associate of the National Bureau of Economic Research.
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  • Steven N. Kaplan

    1. Neubauer Family Professor of Entrepreneurship and Finance, at the University of Chicago's Graduate School of Business. He is also a Research Associate of the National Bureau of Economic Research.*
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  • *

    Warren Batts, Don Chew, Art Kelly, Rick Melcher, Andrew Nussbaum, and Per Stromberg provided helpful comments. Address correspondence to Steven Kaplan, Graduate School of Business, The University of Chicago, 1101 East 58th Street, Chicago, IL 60637 or e-mail at steven.kaplan@gsb.uchicago.edu Part of this article draws on our earlier article, “Corporate Governance and Takeovers in the U.S.: Making Sense of the '80s and '90s,” Journal of Economic Perspectives (Spring 2001), pp. 121–144.

Abstract

Largely as a result of failures at Enron, WorldCom, Tyco, and other prominent American companies, U.S. corporate governance practices have come under attack. These much publicized failures and the resulting popular outcry have served as catalysts for legislative and regulatory changes that include the Sarbanes-Oxley Act of 2002 and new governance guidelines from the NYSE and NASDAQ. But is the U.S. corporate governance system really as bad as critics suggest? And will the recent legislative and regulatory changes lead to a more effective system?

The authors begin by noting that the broad evidence is not consistent with a failed U.S. governance system. During the past two decades, the U.S. economy and stock market have performed well both on an absolute basis and relative to other countries, even in the wake of the corporate scandals in 2001. Moreover, the most notable changes in U.S. corporate governance in the 1980s and 1990s-including the institutionalization of U.S. share-holders and the dramatic increase in equity-based pay-have served mainly (though not always) to strengthen the accountability of U.S. managers to their shareholders.

The authors' message, then, is that while parts of the U.S. corporate governance system gave way under the exceptional strain created by the bull market of the 1990s, the overall system-which includes corrective market forces as well as oversight by the public and government-has reacted quickly and decisively to address its weaknesses. The net effect of the recent legislative and regulatory changes has been to make a good governance system an even better one. But, as the authors caution, perhaps the greatest risk now facing the U.S. financial market system (of which corporate governance is a critical part) is that of overregulation.

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