Expert: Flawed corporate watchdog methods helped fuel economic crisis

Archaic corporate governing systems that failed to ferret out risky business deals helped stoke the nation's deepest financial meltdown since the Great Depression, a University of Illinois business law expert says.

Law professor Larry E. Ribstein argues the traditional, corporate-run firms that dominate the nation's Fortune 500 are ill equipped to prevent dicey management decisions that have choked credit markets, sparking a massive, taxpayer-financed Wall Street bailout.

But he says those problems could be averted by shifting to the partnership-style structure of hedge funds, private equity firms and other "uncorporate" businesses, which have better weathered the crisis through controls that include more closely tying managers' compensation to company financial fortunes.

"There's nothing like the fear that you yourself are going to lose money," said Ribstein, an authority on corporate and partnership law. "With corporations, everyone has long known that the oversight of managers is imperfect and it's always going to be."

Shareholders in traditional corporations have limited options to monitor powerful managers, said Ribstein, who wrote an article titled "Partnership Governance of Large Firms" that will appear in the University of Chicago Law Review. Even those scant alternatives, such as electing directors to oversee company operations, offer little direct control, he says.

"In corporations, boards of directors are supposed to be independent, which means that they don't really have strong incentives to pay a lot of attention to what's going on," Ribstein said. "They worry more about making some embarrassing mistake than trying to identify the fundamental problems that need to be fixed."

In contrast, he says, hedge funds and other "uncorporations" rely on incentives and discipline that essentially make managers partners in the operation and less likely to take needless risks that could ultimately cost both them and owners.

As a result, those partnership-based firms ducked miscalculations about the real estate market that sank traditional corporations such as Lehman Brothers and forced a $700 billion government bailout of others, Ribstein said.

He says the relative success of "uncorporate" firms during the nation's financial crisis earned a de facto government endorsement recently when the Federal Reserve relaxed restrictions prohibiting private equity firms from investing in banks.

"It was a desperation move by the Fed that was consistent with current economics, where the better governed firms are the ones with money," Ribstein said. "Whatever prejudice there was against private equity firms is diminishing. We can't afford to have prejudice against anyone who has money today."

Ribstein hopes the recent failure of corporate governing systems resurrects a
wake-up call for corporate America that was overlooked when the aftermath of Enron's collapse veered toward criminal charges rather than an investigation of internal problems.

"The Enron board was actually very sophisticated, but it turns out they didn't really understand what was happening in the company," Ribstein said. "And I think that we'll find that's true with the boards of the companies that are going bust today."

"There are now governance mechanisms demonstrated by hedge funds, private equity firms and others that are actually superior to the corporate form," he said. "And it's not just a matter of superiority. It's apparent that traditional corporate governance mechanisms just can't keep up with the modern world of finance."

Source: University of Illinois at Urbana-Champaign

Related stories:

Expert says layoffs could worsen economic woes
Widespread layoffs that stem corporate financial losses but leave workers out in the cold would deepen the looming recession that sparked them, a University of Illinois labor expert warns.
Study finds that corporate culture is most important factor in driving innovation
Innovation is integral to the growth, success and wealth of firms and nations. What predicts the increase of radical innovation, and the profits that often ensue, is a mystery most firms are trying to solve. The answer that trumps all others is closer to home than most probably realize. "Corporate culture is, above all, the most important factor in driving innovation," said Rajesh Chandy, a professor of marketing at the University of Minnesota's Carlson School of Management and a charter member of the U.S. Department of Commerce's Advisory Committee on Measuring Innovation in the 21st Century Economy.
Women's Gains in Politics Not Seen in Board Rooms, CEO Offices
(PhysOrg.com) -- Half of California's 400 largest public companies have no women in top executive offices, according to a study reported today by University of California, Davis, researchers. Almost half do not have a woman on the board of directors. Nearly a third -- including household names McAfee, Quicksilver and Hansen Natural -- do not have a woman in either a top executive post or on the governing board.
Democratic Party control could ban mandatory arbitration, UI expert says
Democratic Party control in Washington could restore lawsuits as an option for workers and consumers now forced to settle disputes through mandatory arbitration that gives employers and businesses an unfair edge, a University of Illinois labor law expert says.
What's in that stuff? Ask GoodGuide
(PhysOrg.com) -- As an academic researcher, Dara O’Rourke has spent more than a decade flying to far-flung corners of the world to suss out the impacts of global supply chains on workers and the environment. But it took his students — and his 3-year-old daughter — to bring home the pressing need for product information that helps everyday consumers do right by their families, their planet, and their personal convictions.
Email, Web surfing most popular personal uses for work PC
It probably wouldn't shock most bosses, but three out of four of their employees are using their work computers for email, shopping, surfing and other personal business, according to a survey released on Monday.
Green practices: When do corporations respond to stakeholders' pressure?
In a new study published in Strategic Management Journal, researchers explain when external stakeholders can effectively influence organizations to adopt greener management practices. In an effort to appease the demands of external stakeholders, supervisors of facilities appear to adopt management practices that are favorable to their professional network. As a result, competing firms may adopt very different environmental management practices according not only to the level of pressure exerted by external stakeholders but also to the internal structure of the organization.
Cisco makes push to become a truly global company
When Cisco Systems Chief Executive John Chambers dispatched top lieutenant Wim Elfrink to India nearly two years ago, the executive vice president's mother-in-law drew the only logical conclusion.

News discussion:

General Science news