Wall Street seems to have pronounced the death knell of
capitalism. It has fallen victim to the worst form of crony
capitalism of which it used to blame the Asian economies.
Never before has the downward-slide been so persistent,
so long and so sharp. Every measure that the US government
is taking to prop up the market or the dollar seems to be
working otherwise. The slide continued unabated even when
President Bush was exhorting US business in Alabama to boost
the confidence in the US economy and the dollar. The disease
has caught up with Europe as well and no doubt is going
to afflict, the rest of the world. Dollar’s weakness is
not a good sign for the exporting countries of Asia and
the region’s fragile economic recovery.
The strange thing about the latest stock market collapse
is that it has not nose dived because of Japanese dropping
the atom bomb on Pearl Harbour or Saddam Hussain’s attack
on Kuwait or the Twin Tower attacks of 9/11. Americans have
simply lost faith in the ability of their iconic enterprises
to return their savings. The accounting frauds committed
by the likes of Enron, World.com, Global Crossing, Tyco,
Adelphia, Qwest, Dynergy, Xerox and the list goes on, have
brought home to average investor that the earnings these
companies disclose cannot be trusted. Nearly 1000 US companies
have had to restate their earnings since 1997 and many more
are under investigation. It is not that the fancy accounting
tricks were only confined to Andersen who has been convicted
in a Texas court of obstructing justice. Some of the big
names of Wall Street such as Merryll Lynch have been found
guilty and fined for publishing deliberately misleading
research and ignoring egregious conflicts of interest.
While India and other developing countries are fortunate
in not having been infected with this problem to such an
extent, may be they did not pay heed to the World Bank advice
of using American model and use American audit firms, their
penchant for inflating profits and earnings is no less.
A recent study by India’s credit rating agency CRISIL stated
that 139 companies including infotech giant WIPRO, and star
companies such as TISCO, NOCIL and SPIC had resorted to
creative accounting and inflated their asset base in 2000-2001.
It is not the first time that the stock market has crashed
or we have seen the emergence of ugly head of corporate
greed. The history of capitalism is replete with examples
of similar excesses starting with the affair of the tulips
in Holland and the South Sea Bubble. The general assumption
is that like the previous market collapses, the current
crisis will spur reforms, make corporates more ethical and
help market emerge stronger than before. President Bush
has already called on stock exchanges to require companies
to appoint majority of independent directors and audit and
remuneration committees to be all independent. There is
,of course nothing new in his proposals. All this has been
an integral part of corporate governance folklore which
the Washington based secretariat of the World Bank and Paris
based OECD Secretariat are assiduously lecturing the emerging
markets about. It is assumed that rationalization of the
markets; stricter punishments for defaulters, curbing the
stock options, banning of consultancy by auditors, bringing
more independent directors, increasing transparency of accounts
and making auditors independent will bring back sanity to
the markets.
The tragedy is that all this has been said before and
time and time again. It is the implementation of all this
which is fraught with egregious problems. Lord Young, the
president of UK’s Institute of Directors has already lambasted
the institution of independent directors and called for
the abolition of the non executive posts. He argued that
relying on part time outsiders who barely spend 15 hours
a year to police boardrooms was naïve and dangerous
non-sense. Paul Sarbanes, the US Senator has introduced
a bill to set up an independent body to supervise the accounting
profession, which is likely to become law despite opposition
by professionals. Again will this help? Remember, Andersen,
auditor to both Enron and World.com had already separated
from its consultancy, now called Accenture. The remaining
Big-four still have to do it.
The malaise in the governance of corporations is far deeper
than what appears on the surface. Capitalism, it has now
emerged, is far more deeply flawed than our analyses suggest.
By feeding on ruthless competition and promoting a culture
of winner takes all, capitalism has spawned virulent individualism
which has grossly discounted the value system based on ethics.
Corporates still use moral language but they do not believe
it has any objective foundation. Like George Bush they tell
other corporates Do as I tell you, not as I do. Naturally
nobody listens.
With growing dominance of the markets and emphasis on immediate
gain people’s behavior is guided almost exclusively by prudential
and not moral consideration. They obey the rules, remain
within the law, follow the norms, respect values only if
they calculate that these will benefit them personally.
They do not accept the validity of moral discipline if it
runs counter to their personal objectives. In a policy driven
by competitiveness and aimed to enhance the authority of
markets, individual action has little to do with ethical
behavior.
The rational market participant is supposed to treat everyone
and everything as a means to serve his/her ends. The imperative
is simply to achieve the greatest possible satisfaction
of our personal preferences. So what is wrong in the CEO
paying himself astronomical salary and bonus, while he is
sacking the workers in the name of cost cutting and downsizing?.
Why should the independent director ask awkward questions
on company accounts or CEOs pay hike? He gets only a fraction
of his remuneration from the company in director fees -
a lot more comes from the consultancy services provided
by his / her private company. Similarly what is wrong in
auditing companies flogging their other services to the
clients?. The fact is that you get ahead as an independent
director or an auditor by billing large fees and not by
blowing the whistle. As Mike Rake, the international chairman
of KPMG now admits, having a $3 million audit fee and $
100m non-audit services fee just does not meet the perception
test. It is not for nothing that auditing firms advertise
themselves all-purpose solution providers. Here is an example
from Ernst & Young’s website :
"Our 84,000 people in more then 130 countries
worldwide can implement a broad array of solutions in audit,
tax, corporate finance, transactions, online security, enterprise
risk management, the valuation of intangibles, and other
critical business-performance issues."
Would you ever rely on a food inspector who also sells
catering services to the kitchen he / she inspects?
Lester Thurow wrote, nearly 40 years ago, in The Future
of Capitalism that, ‘Paradoxically, at precisely the time
when capitalism finds itself with no social competitors
- its former competitors, socialism or communism, having
died - it will have to undergo a profound metamorphosis’.
It is time we began the process to bring about this profound
metamorphosis.
The centrality of corporate governance lies in its emphasis
on transparency. It is far easy to say but most difficult
to implement. You cannot obtain transparency if investors
expect double digit profits in each quarter. In our rapidly
changing economy variations are an integral part of business.
So why are we defensive about shortfalls?. We practice the
three types of truths we all know - first truth is what
we tell others; the second truth is what we tell ourselves
but do not tell others. The third truth is what we do not
even tell ourselves. The malaise in corporate governance
is so deep rooted that we do not even tell ourselves that
it exists. This is why it has to make its presence felt
every so often by market collapses causing pain and suffering
to poor shareholders for no fault of theirs.
It is curious that each time we are confronted with market
collapse our immediate response is to tighten the rules
and revise the codes little realizing that corporate discipline
is not something that can be achieved simply by revising
codes or adding new ones. The very people who are crying
for retribution were part of procession of cheerleaders
of Kenneth Lays and Bernie Ebbers. They are the ones who
stoked the fires of impossible expectations with, what The
Economist says, an unfailing supply of hero worship, with
their idiosyncratic maxim that you either get it or don’t
get it. Investors were so inebriated with irrational exuberance
that they almost willed the companies to tell lies.
One of the problems of the modern economics is that we
have no perfect business models. We often aim at fastly
moving targets and are bound to have a few misses. We are
oblivious to the fact that failure is also value adding,
that failure is the precursor of success and that no success
has ever been achieved without failure. In a relationship
based on trust and transparency, failure is an investment
and would need to be capitalized and not expensed. Hundreds
of Silicon Valley companies have demonstrated that failure
is a badge of honour, that people should be rewarded for
good tries.
As humans, we recognize that we reach perfection by learning
from mistakes. So why do we hesitate in owning our mistakes
and sharing them with our colleagues in the board &
the shareholders? We are on a journey of continuous improvement
where everyday I am doing better & better.
Transparency calls for sharing of mistakes with your board
and shareholders. Their real concern is not that you did
not achieve the double digit earnings-growth, but what are
you doing about it and where is your plan of action for
the next quarter. Investors are looking for management with
their eyes on the ball who may lose a game but can demonstrate
a compelling strategy that will finally win the match.
In any event market capitalization today is not determined
by quarterly profits or earnings. Study after study has
indicated that buyers are thronging to companies which have
societal, environmental and social messages. So why inflate
earnings and risk the wrath when you are exposed?. Think
how it would spoil your reputation the very key to market
capitalisation.
We must realize that knowledge economy behaves differently
from capital economy. Success in the knowledge economy requires
boards to change their industrial age paradigms. Far more
value is added by promoting the concept of sharing than
competing. Sharing adds value to both sides because knowledge
unlike capital is not limited by tangible assets which can
be used only for one purpose. Knowledge is a fluid tangible
asset that can be transferred at little cost. But sharing
cannot take place without trust and trust can come only
through transparency.
The problem of the American system is that it is skewed
heavily in favour of shareholders. The practice of corporate
governance was aimed to give the CEO unfettered authority
to hire, fire and reward in the name of creating wealth
for shareholders and to mitigate principal agent problem.
In practice most CEOs use this authority to reward themselves
with huge pay hikes and vast bonuses by inflating earnings.
This was largely an American disease. But of late European
CEOs are also copying their US counter parts in this respect
and awarding themselves hefty rises. Prudential shareholders
had a hard job in preventing their boss to award himself
bonuses worth £900,000. While CEO’s salary in US quadrupled
in 1990s, the employees salaries only increased by 3%. Such
actions take away employees confidence in management. Governance
that says shareholders should get most benefits and does
not care about employees who dedicate their lives for corporation
is not governance but corporate greed.
In their book, The Stakeholder Corporation published in
1997, Wheeler and Silanpaa have asserted that during most
of the 20th century in the UK and USA, stakeholder inclusive
enterprises fared better than shareholders - first companies.
Stakeholder inclusive corporations invariably lead to better
long term business performance.
More and more people today, individuals and groups expect
a business organization to adopt a triple bottomline approach,
be economically viable while becoming, environmentally and
socially responsible. They also expect the business to be
inclusive and ethical. Kenichi Ohmae argued in The Borderless
World: Power and Strategy in the interlinked Economy that:
A corporation is a social institution whose responsibilities
extend far beyond the well being of its equity owners to
giving security and a good life to its employees, dealers,
customers, vendors and subcontractors. Their whole life
hinges on the well being of the corporations.
Peter Drucker, in his now classic The Concept of the Corporation,
said over 50 years ago that what is needed in a redefining
of the corporation as a social institution is an integration
of the worker as a partner in the industrial system and
as a citizen in society. Yet most corporate governance definitions
even today do not include employees as the beneficiary of
the corporate rewards in the same way as shareholders.
If the capitalism is to survive, if it is to create wealth,
it is absolutely essential that it adopts an inclusive approach
to make it sustainable in the long haul. It must incorporate
the social and environmental agenda, not as add-ons to a
company’s economic activities but as an essential and integral,
part of business strategy and its processes, to reflect
the rapidly changing post-industrial economy.
The ultimate aim of good corporate governance must be to
make corporations good corporate citizens. Corporate citizenship
calls for creating value for the society as a whole and
goes well beyond corporate social responsibility or corporate
philanthropy. The transformation is achieved by following
the 11 point agenda.
Sustainability
Corporate governance must recognize that at the heart of
successful business there needs to be a promise of long
term prosperity for all its constituents. Corporates must
move away short term approaches and link all their actions
to long term horizons.
A triple bottom line
Good corporate governance recognizes that a business has
social, cultural and environmental responsibilities to the
community in which it seeks a license to operate, as well
as economic and financial responsibilities to its shareholders.
Corporate citizenship is about business redefining the way
in which a company focuses on a triple bottom line approach
that brings financial rewards while meeting social and environmental
obligations.
Making a difference
Business’s foremost purpose is to make a difference in society.
It is more than philanthropy and beyond corporate social
responsibility. Corporations must refit themselves into
businesses which provide services the society needs rather
than create artificial demand for obsolete products or services.
Employee and stakeholder empowerment
Corporate citizenship seeks to ensure that every one associated
with the corporation is empowered to be able to contribute
creatively an proactively. It must recognize that people
want to become involved and it is for the Corporation to
innovate strategies to make it happen.
Transparency
No teamwork is possible without trust and transparency.
Business must be truthful in disclosing not only its financial
statements but also the way in which decisions are arrived
at. It must also share its responses to environmental and
social consensus with its shareholders.
Equity
Transparency means sharing not only successes but also failures.
Such sharing is not possible unless financial rewards are
distributed equitably. The benefits must be divided not
among the few but many. Creation of wealth must aim at removing
inequalities and inequities.
Accountability, probity and integrity
Corporate citizenship is about improved accountability,
probity and integrity. The business must aim to bring benefit
to all and demonstrate it through regular audits of the
organisation’s financial, environmental, social and economic
processes.
Inclusivity
Corporate citizenship is about employee and stakeholder-inclusivity.
Stakeholder inclusion requires a long-term, and continuous
relationship to be developed with all stakeholders both
inside and outside the corporation.
Diversity
Diversity has been regarded as dysfunctional throughout
our economic history. It is extremely valuable in the board.
It is only through the clashing of opposite ideas that the
true reality emerges and real progress takes place. A lot
of our national ills can be solved only if we recognize
that its is the difference and not conformity that makes
harmonious society.
Engagement
Corporate citizenship is about engaging with changing and
diverse cultures - corporate, government, community and
individual - in order to achieve sustainable social, environmental
and economic success.
Dialogue
Open dialogue is at the heart of corporate citizenship.
With wrenching change taking place all around us the corporation
has to develop systems of regular communication within the
board & between the board, shareholders, management,
government, employees, custom, suppliers and the civil society.
It is through this dialogue that the corporation will communicate
its values, vision, mission and goals and share their financial,
environmental and social numbers at regular intervals. It
must demonstrate corporation’s commitment to all it’s constituents
viz. the board of directors, management, employees, shareholders,
the government and the other stakeholders and the civil
society. Corporations must clarify that they are not only
creating value for the corporations but making significant
impact on the society by reshaping community values, attitudes
and cultures.
Corporate scandals and the consequent collapses have a
lethal effect on the poor and the old. Not only these destroy
their life’s savings and reduces them to penury they take
away their confidence in the markets itself. They have no
hope to make good their loss. It is a great national loss.
We have to do something, therefore, to prevent them happening
again. But revising codes of corporate governance is certainly
not the answer. We have a great capacity to beat the codes.
Andersen have asserted all along that whatever they did
at ENRON or WORLD.COM was within the law and thousands of
firms do the same. Again nothing that President Bush has
said in the aftermath of so many accounting scandals is
new. Plastering over the capitalism’s cracks simply won’t
work. It needs a systemic change which will come only by
looking inside and not from outside. It is we who have to
change our paradigm from individualism to integration, from
tangibles to intangibles, from capital to knowledge, from
objects to relationship, from parts to the whole, from domination
to partnership, from structures to process, from short termism
to long termism, from growth to sustainability, from confrontation
to collaboration and from covering up failures to owning
them up.
As we move into the 21st century there is a growing recognition
that the ultimate goal of economic effort ought to be to
improve the quality of life. Money is not a measure of all
things that make us happy and markets are not the best mechanism
to enhance human happiness. Indeed, if completely unfettered,
they can do the opposite by encouraging selfish behaviour.
Our focus should not be only on financial capital but also
the human capital, intellectual capital and environmental
capital. Good Corporate Governance must aim on maximising
the value of all capital.
It is unfortunate that our economic structures are built
on an inaccurate view of the human pscyche. Scientists have
recently discovered that the small, brave act of cooperating
with one another, of choosing trust over cynicism, generosity
over meanness, altruism over selfishness makes the brain
light up with quiet joy. Experiments conducted on young
women engaged in cooperative effort showed that longer they
engaged in cooperative strategies, stronger were the blood
flows to the pathways of pleasure. Obviously our effort
should be to increase opportunities of cooperation and down
play unbridled competition.
We need to think of business designs that go beyond the
externalities of quarterly profits and provide intrinsic
worth and meaning to shareholders while making corporations
focus on the larger picture and helping to relish the joy
of making a difference. Alas, it may take many more scandals
to move to such a radical solution but since the alternative
is so grave it might be worthwhile to steer the debate in
this direction.
