Cyclical crises of corporate governance

Author: Paul W. McAfee (USA)
Publisher:
Publish Date: 2006-05-01
Features: During the period of no more than 12 months from 2001 to 2002, one-quarter of the largest American companies experienced a decline in current sales revenue or dim prospects for future income, leading to the stock prices of these companies dropping from an average of $50 to $1 or less. The GDP statistics—referred to by some sensationalist media as a "recession"—played a major role in this stock price slide, but the failure of the network services, information technology, and telecommunications industries to develop as expected was even more significant. Significant declines occurred in companies that supplied equipment to these industries; in these companies, over $1.5 trillion in shareholder value vanished. However, there is a more fundamental explanation for the stock price slide. The stock price decline of large, high-tech companies is said to be the result of rash, even fraudulent, strategies implemented by management. It was the imperfect corporate governance mechanisms that led to this problem. A management team presumed to be reliable turned into fraudulent or at least deceptive management for personal gain. In some cases, the perpetrators of fraud and deception extended to auditors, legal advisors, and the board of directors. But this does not mean that the board of directors universally engaged in unethical behavior; rather, it means that the board was unaware of the unethical behavior, the issue lies in the fact that the board should have known and should have had the information and knowledge to take measures to prevent self-dealing and subsequent declines in shareholder value. In media reports on the collapses of companies involved in scandals, Enron is often mentioned. Enron was the fifth-largest company in the U.S., with revenues exceeding $100 billion in the year before its bankruptcy. However, in the last quarter of 2001, Enron went bankrupt while losing 99% of its stock value. The full reasons for Enron's failure have been made public, from insider trading, fraudulent accounting, and excessive financial leverage to ambitious transactions in volatile energy markets and massive misinvestments in large-scale projects in Brazil and India. Although the reasons for Enron's failure have been made public, many people, including Congress, are still asking, "Where was the board, and why didn't the board management before it led Enron to bankruptcy?" The boards of Global Crossing, WorldCom, Lucent, Williams, DyneGY, K-Mart, and HealthSouth are also facing the same kind of questions. Business reports indicate that the collapses of these companies and subsequent stock price declines were due to the reckless, self-interested, or fraudulent behavior of management. However, by the time we wrote this book, it had become increasingly clear that a more comprehensive explanation based on governance failure might better account for the downturns of so many large companies during the recovery phase of the business cycle. We argue that many company boards are passive and/or overly accommodating to management decisions.