Good regulation reinforces market discipline
In March 2009, the Business Ethics Center of Jerusalem sponsored a major conference on the topic of “Ethics and governance in times of crisis.” There were panels and lectures on a wide variety of topics, but looking back on the conference I think that one question related to in virtually every session was, to what extent is more regulation the proper response to the crisis? While there was no consensus, I think that most participants would agree with the following statement: some additional regulation would be helpful, but not the micromanagement kind where the regulators get into your kischkes.
One point I want to emphasize is that believing there should have been more regulation before the crisis doesn’t mean that we need more now. Former Federal Reserve chairman Alan Greenspan acknowledged in his testimony in Congress that the extensive deregulation of the past decades was in hindsight a mistake, but in nearly the same breath stated that the lessons of the recent crash would do far more to correct the excesses than any regulation could. It would have been nice if a regulator had made us lock the barn door before the horse escaped, but now that we survey the situation his input is a bit superfluous.
Here are some consequences of ineffective, micro-managing regulation mentioned by conference participants:
Expensive: Professor Yosi Gross presented an estimate the Sarbanes Oxley governance regulations passed in response to the Enron scandal cost US corporations over a trillion dollars. (It is fair to mention that others challenge this figure, but no one disputes that it is a burdensome law.)
Counterproductive: Lawyer Ilana Bar suggested that legislation requiring directors to compare salaries of senior executives to those in comparable firms was responsible for actually aggravating the degree of salary competition. Others pointed out that Sarbanes Oxley caused many public companies to go private to avoid the onerous regulations. Dorit Selinger of Maalot stated that excessive regulation may take the pressure off companies to police themselves.
Superfluous: Migdal director Shlomo Hendel pointed out that requiring that boards review financial reports is hardly needed.
Easily evaded: You can’t put a cop on every corner, or a regulator in every cubicle. If the regulator tries to micromanage, the company will always be one step ahead.
Yet regulation, sometimes even extensive regulation, is still a necessity. The reason is simple: people always have a tendency to act in a way that is expedient, short-sighted, and sometimes just plain crooked if no is looking over their shoulder. Here are some worthy goals of regulation:
Transparency: Legal counsel to the Securities Authority Shoni Albeck explained that most of the new regulations the Authority wants to promulgate are not going to tell companies what to do, but they will ensure that the companies tell investors what they are doing. The pressure for good governance will come from the shareholders, not the regulator, but only if the regulator forces them to be transparent.
Honesty: After you compel disclosure, regulators should then make sure that people are doing what they say they’re doing. It’s disgraceful that no regulator discovered that for decades Bernie Madoff was not carrying out the trades he reported – something that was relatively simple to check.
Accountability: You don’t have to tell people what they do, but you can make them pay for their mistakes. Albeck stated that directors lose sleep worrying about lawsuits when they know they acted in a questionable fashion. Conversely, rewarding ethical conduct, for example the Federal Sentencing Guidelines which reduce fines for companies with effective ethics programs, can be effective.
Uniformity: Sometimes it doesn’t much matter what you do, as long as everybody does the same thing. When there is a need for standards, regulators can play an important role.
Market discipline alone is not going to make managers act in the best interest of shareholders and the public. Public oversight, in the form of regulation, is a vital necessity for market functioning. But regulation alone is also not going to do the job. The best combination is when regulation helps empower shareholders, by giving them knowledge about companies and power to hold their leadership accountable for lapses. The best regulation reinforces market discipline.