vol. XV no. 3

				Calculating impact Rebello recently completed a study that tested general theories on the optimal structure of corporate boards. He found the most successful boards to be composed of outside directors where no one person dominated the decision-making process. These optimal boards chose true outsiders who held no conflict of interest with the company, and the outside directors held veto power on all decisions. "If you have truly independent directors, you are more likely to have good decisions," Rebello said of his research, currently under revision for publication. "Even if there is only one insider on the board but everyone knows that person's line, you're less likely to find good decision making." Rebello's colleague, Lalitha Naveen, believes the NYSE recommendations will reduce conflicts of interest inherent in the current system. The suggestions to limit director compensation for audit committee members as well as to prohibit relationships between auditors and their clients are positive moves, said Naveen. In Andersen's arrangement with Enron, for example, the external auditor was paid for consultancy and other non-audit services, creating a conflict of interest. The NYSE suggestion would prohibit such "relationships between auditors and their clients" that have the potential to affect fairness and objectivity of audits. "Similarly, Tyco, whose shares have fallen more than 70 percent in the last year, has been criticized for making huge payments to a former board member for advice on an acquisition," Naveen explained. "By requiring that committee members have no other affiliations with firms and by tightening the definition of independent director, the new requirements will reduce such conflicts of interest." Another guideline that will go a long way to improve corporate governance is the requirement for audit committee members to have financial management experience, according to Naveen. "O.J. Simpson might have been a great football player," she remarked, "but that doesn't qualify him to sit on the audit committee of Infinity Broadcasting, as he did in 1994." Still, many of the NYSE proposed guidelines will have only a marginal impact, predicts Kini, in part because many are already in place in the country's major companies. One recommendation that could have a larger impact is requiring nominating committees to consist entirely of outside directors. "This structure would reduce the CEO's impact on the selection of directors, thereby resulting in more independent board oversight. In addition, having auditing, nominating and compensation committees composed entirely of independent outside directors will go a long way toward improving governance." Kini expresses concern about two of the NYSE proposals, the first of which is a required cooling-off period for former employees. "The former CEO of a company knows a lot about that company, and losing this person's expertise might hurt the company." For example, one way of effecting a change in the operating and financial policies of a firm is by getting board representation through a proxy contest. In a proxy contest, a group of dissident shareholders solicit proxy votes from other shareholders with the goal of getting their slate of directors elected to the board. These dissident shareholder groups often contain former employees of the corporation who may know the company and how it works better than anyone. "We certainly do not want to inhibit this form of corporate discipline in any way," said Kini. Recommendations and reputations The proposed NYSE reforms may not go far enough, Rebello remarked, but they are a start. "Without some reform mandate, business may not get the best possible outcome. We need a watchdog to initiate a push." While the guidelines have the potential to "give a big boost to investor confidence," Naveen added that companies should go beyond these rules to ensure they act responsibly, adhere to a code of ethics and have the proper governance committees and organization in place. Based on his experience, Rebello has no doubt the market will rebound. As he saw while leading a team of research analysts for a brokerage and investment house in Asia during the Asian market crisis of the late 1990s, investors will return to the market when they believe there is money to be made. "Investors alternate between fear and greed. Eventually, their greed will overcome their fear." Reformed guidelines may have a modest impact on the recovery of investor confidence, but a bigger check on business may be the takeover market, noted Kini. "Takeovers are considered as a discipline mechanism of the last resort." Firms that don't function well are candidates for takeovers. While the 1990s saw a decrease in the frequency of hostile takeovers ­ partly due to more effective internal governance structures - takeovers could well become a disciplining force again amid today's corporate scandals. In the end, the biggest check is the threat of loss of reputation, Kini explained. "If Andersen taught us anything, it is that firms have a lot to lose if they damage their reputation capital. Because of a few shortsighted people, Andersen lost billions. We learned that even a hint of scandal can destroy a lot of value. It can damage a future stream of income so badly that a company can never fully recover." Top | Back See NYSE Guidelines, in brief.

Copyright © 2003 Robinson College of Business/Georgia State University.