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 / Spring 2010 / Issue 58(originally published by Booz & Company)


Welcome, “Stateholder”

The failures within the corporate sector (such as Enron and Tyco) are well known, but the extent of the government’s failure to properly supervise the financial sector is still underreported. Regulators allowed managers to pursue higher returns without properly adjusting for the risk incurred or setting appropriate prices, and in some cases they were simply inattentive: Bernard Madoff’s Ponzi scheme should become a topic in any security regulatory agency’s induction program for new recruits, a case study for business schools, and a semester-long course in law schools. It is simply unfathomable that Madoff was able to perpetrate such a level of fraud for so many years.

Many regulators — and the board directors they oversaw — apparently did not understand the risks that banks were taking in their borrowing and lending practices. Nor did the regulators make managers accountable for results by forcing reductions in commissions and bonuses, or aligning such bonuses more closely with delivered results (as is the case in commodities trading). At no other time in history has so much been paid in short-term commissions in the face of such medium- and long-term value destruction.

An essential tenet of capitalist systems should never be forgotten: Markets and their actors need to continuously earn the public’s trust to operate in the public interest. The ultimate accountability for the financial system rests with government. Someone needs to monitor the system not only to identify bubbles but also to pierce them as early as possible. Governments are uniquely well suited to manage this task; no other single actor has the requisite systemic interest.

Let us underline how difficult the task of reforming government practice is, however: We have just emerged from a long period of market deregulation and government dis-intervention. Rather than letting the pendulum now swing excessively to the side of overregulation (as it has in the past), we should find a proper balance by agreeing on a clear vision of the new order, and then taking multiple small steps to achieve it.

This is far from current practice. Consider, for example, the European Union. The economic crisis of 2008–09 has provided a unique opportunity for European governments to tackle reform together and steer the system with a common approach. After all, it’s only logical to assume that the countries of the E.U. should act in concert to prevent bubbles that affect its currency. Yet there has been no single concrete action in this regard. Instead, European governments have largely acted independently from one another, protecting their own national interests.

2. Hold boards responsible. The market for corporate control is quite different from the market for goods and services. If a buyer is displeased with the goods or services provided by a supplier, the response is easy and immediate: Buy from someone else. Shareholders can also easily disengage when the prospects of investment returns deteriorate. But when a corporation becomes insolvent, it may very well not recover at all. And that can irreversibly damage communities, employees, business partners, and the regions and nations that governments are elected to serve.

The central justification of stateholder governance is to take control of corporate destinies so that if a company goes south, there is a reasonable promise of its returning north at some point, when it can continue its journey without direct state guidance. When and to what extent government should intervene by taking equity positions will always be a delicate question, as there will always be tension between intervening and letting the corporation die or restructure on its own. Governance will remain a complex act, distinct from execution and distinct from regulation and policymaking. But just as corporate boards can temporarily intervene in corporate execution (for example, when nonexecutive board members become managers), so can governments temporarily intervene in the governance of private corporations by taking stakes in them.

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