I can’t think of anybody who was satisfied with the way in which the consequences of the financial crisis of 2008 have been handled. There have been some indictments but always against very minor figures, and no prosecutions have been directed toward the major players in any of the large institutions.
Who takes responsibility?
This is in contrast to prior disasters in American history when we saw the Pujo Commission and later the Pecora Commission. Government then was determined to investigate what brought about the problems, find out who was at fault and then brought prosecution against those people. Nothing like this happened this time. Oh, there was the Financial Crisis Inquiry Commission but by the time they completed their investigation Congress had already taken what little action they were going to – which is to say nothing came of it. Senator Levin has probably made the best effort to address the root of the problems but Washington seems to have little interest in doing anything about them.
In the end, no one wants to bring a criminal case against a corporation. The memory of the Arthur Anderson case is still strong in people’s minds when thinking about this. The unintended consequences of criminal charges in that case led to one of the country’s largest and most prestigious accounting firms to go out of business. Except in the most extreme cases, it doesn’t do anyone any good to drive a company out of business, and so there has been an aversion to charging corporations with crimes.
Business as usual...
Take, for example, British Petroleum which is involved in an enormous amount of private liability on account of the spills in the Gulf, and in the case of BP, if they were found guilty of a crime they wouldn’t be eligible any longer to bid for drilling on U.S. government property. Well as a matter of national policy, do we really want to eliminate one of the major players to drill on government property? On the other hand, BP is a habitual offender and never seems to address the persistent problems that led to loss of life and environment disaster. But we haven’t figured out a way to deal with these issues as a country either. What’s the best way to address corporate crime and negligence without undermining our economy?
Without addressing that question, we’ve allowed the situation to carry on in a sort of limbo so that corporations pay fines but don’t have to admit wrongdoing or change the way they do business. In fact, many corporations have enough cash reserves on hand that they factor in potential fines. Not only does the system have no teeth, it’s tantamount to a licensing scheme.
Why doesn't the captain go down with the ship?
Little attention is paid to the people making the decisions at the head of the corporations. They alone are responsible for the (sometimes repeated) offenses, and yet the financial burden is borne by the shareholders. Bonuses and salaries are paid to top management regardless of company performance. Even when a CEO is fired, more often than not he or she has craftily arranged a golden parachute and walks away with a fortune.
When the government imposes a fine, the intention is to reduce the book value of the stock which is to the detriment of the shareholders -- and nobody else. They end up in the disagreeable position of having their cash reserves depleted and having been misled by executives. We see a vast discrepancy between salaries for corporate managers and their personal risk. We’re told that they warrant outrageous compensation because of the risks they take. What risks? No responsibility for corporate misdeeds or failure is carried by executives. Their contracts remove all personal and financial risk. No, all financial burdens fall to the shareholders.
So, here’s a question: Why shouldn’t fines be paid out of executive bonuses & board of director’s fee? Once that amount is met then any amount over and above could be paid out of shareholders’ equity. Obviously there would be consequences -- I’m sure compensation consultants, lawyers and mangers would find a way to wrap that bonus money into regular salaries. For the time being, though, it would be an interesting and useful way of addressing a problem. I mean, if an executive knows he or she will be held personally, financially liable then wouldn’t they less likely to break the law? If a director knows there are ramifications wouldn’t they be more likely to take their oversight duties seriously?
Shareholders have no say in the day to day decisions of a company – and I don’t think they should. But why are they the ones who foot the bill for corporate malfeasance? Some of the so-called negligence or mistakes are barely disguised “business as usual” tactics exercised by executives. We see this all across the corporate spectrum but it’s been especially notable in the pharmaceutical industry. For example, Abbot Industries paid a fine of over $1 billion last year for “for illegal marketing practices, including promoting prescription drugs for uses not approved by the FDA, paying financial inducements to increase sales and engaging in practices that pose grave danger to patients’ health and lives.”
Collecting fines out of executive bonuses could have two very desirable effects: it would send a message to the management that this is not acceptable corporate behavior and they, as the decision makers, are responsible for fines; and that shareholders will not bear the financial burden of executive negligence or misdeeds. This could create an attention to obedience with law that is obviously lacking now.
Corporate crime as a breach of fiduciary duty.
And, it would resolve a clear default of fiduciary duty. When executives repeatedly sanction corporate negligence or crime they leave shareholders to pick up the tab for the fines. How does that square with an obligation to provide shareholders with the best possible returns? All the recent talk about corporate need to pay no taxes or as few taxes as possible because they are obligated by fiduciary duty to shareholders is bunk. Corporations would be much closer to fulfilling fiduciary duty if they didn’t break laws and incur fines. If they’re looking to meet fiduciary obligations, they should follow this simple solution: don’t break the law and avoid paying fines with cash reserves.
Read more blog posts on corporate governance at the Robert A.G. Monks blog.
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