Corporate Governance: Don't Rush Reforms

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James Wolfensohn concluded when he was president of the World Bank that "the governance of companies is more important for world economic growth than the government of countries." Simply put, well-governed companies deliver better results.

a corporate-governance free-for-all?

We have seen a steady stream of corporate-governance reform proposals in the last several years. Some are worthy, some are bad, and a few are distinctly misguided. While many of these proposals focus on increased shareholder influence over corporate policy, many focus on political "hot button" issues such as social responsibility, global warming, government influence, and political contributions.

As we consider various proposals and their proponents, a few observations become increasingly clear. First, corporate governance is now merely a catchphrase used to promote and justify a relatively broad range of restrictions and requirements on the U.S. private sector. Second, the constituencies that are staking a claim to the "corporate-governance" turf are extraordinarily diverse, with varied agendas. Whether we agree or disagree with their proposals or subscribe to their agendas is largely irrelevant.

So another round of corporate-governance reform is likely inevitable. It has long been the premise of American capitalism that profit and return on investment to shareholders are the primary indicators of the success of a business enterprise. Guided by this thesis, corporate-governance mechanisms have been, and should be, designed to increase the likelihood that the corporation will create value for its owners.

Strong corporate governance is essential to achieving shareholder value and sustainable economic growth. To be effective, a balance must be found that gives weight to the legitimate interests of all stakeholders. Few businesses can achieve long-term profitability and growth if they are at war with their employees, consistently violate the law, or are in conflict with the communities in which they operate. This does not mean that the employees, the government, or local communities necessarily have a formal role to play inside the boardroom. Rather, the board of directors needs to take into account the interests of these constituencies and achieve a balance which will likely create long-term growth for the corporation.

shareholder value and economic growth

Certain basic elements of corporate governance appear to work across industries, geographies, and circumstances. The independence of a majority of the board and accurate, transparent public disclosure are key in almost all circumstances. If a majority of the directors of the board of a public company is independent and faces no impediments to making fully informed and disinterested decisions regarding the company, the best possible results are likely to be achieved. An independent board of directors—coupled with accurate, clear, public disclosure—has consistently provided shareholders with the most effective protections.

To implement changes that go beyond the basic principles that have worked so well would risk losing focus on the role of corporate governance and indeed, the role of the corporation in our society. The farther corporate governance strays from these core principles, the less likely it is that directors and the corporations they oversee will be able to achieve their fundamental mandate of increasing value for shareholders and providing economic growth for society as a whole.

Corporate-governance reform is coming, but any "reform" that fails to recognize the ideals that have made American capitalism the global symbol for prosperity and wealth creation will most certainly fail. As any doctor will caution, the first rule is do no harm. We can only hope that legislators, regulators, and shareholders remember that rule.

Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

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