493. Mark J. Roe, The Inevitable Instability of American Corporate Governance, 09/2004; subsequently published as Chapter 1 of Restoring Trust in American Business, J.W. Lorsch, Leslie Berlowitz & Andy Zelleke (eds.), (Cambridge: MIT Press, 2005), 9-33.
Abstract: American corporate governance faces two core instabilities. The first is the separation of ownership from control—distant and diffuse stockholders own, while concentrated management controls—a separation that creates not only great efficiencies but also big recurring breakdowns. In every decade since World War II, we’ve faced a fundamental large firm problem. Each emanated from this fundamental instability. We will not stabilize, once-and-for-all, this instability because some form of separation is necessary for large firms, because it provides large efficiencies, and because once we resolve one derivative problem, another will in time arise. The Enron-type scandals are just the latest manifestation of the core fissure in the large American public firm.
The second instability arises from our decentralized and porous regulatory system. Decentralization has key advantages—such as flexibility, specialization, and multiple informational channels—but with the advantages come costs in porosity. Our decentralized regulatory system leaves each regulator with weaknesses. Most importantly, they are not fully independent from the regulated. The regulated entities often deter the incompletely independent regulated from acting. The regulated can induce political authorities to deny the regulator enough power to act, they can get Congress to cut the regulator’s funding, they can fight the potential regulations in courts and Congress, and they can weaken the quality of the regulation that they face. The Enron-class scandals illustrate this regulatory instability of American corporate governance well. Thus one structural response to the first fissure—separation and managers without immediate bosses—would be to facilitate gatekeeping, via strong boards that check managers, via strong shareholders with the motivation to channel managers toward profitability, via powerfully independent, professionally-driven accountants who verify managers’ “report card,” and so on. Some of these gatekeeping functions arise from contract, best practice, and the natural path of the market. Many are facilitated by regulation, but here the regulated—often managers themselves—can affect the regulatory outcomes, often weakening it. Some regulation that does occur arises when public outrage is sufficiently high that the regulation is more brittle and less supple than would be ideal.
Neither of these instabilities can be solved once-and-for-all, so that we can put it behind us. Instead, we resolve the local and immediate problem, move on, and in time face a new problem emanating from one or both of these core instabilities. We muddle through; we don’t solve, because we can’t.