Since Enron, Little Has Changed - 8 Dec 2008

Since Enron, Little Has Changed

This post was co-authored with Malcolm Salter, the James J. Hill Professor Emeritus at Harvard Business School.

Enron’s demise in 2001 and the collapse of some of our most
prominent financial institutions this fall share a common root cause: a
shocking breakdown in corporate governance resulting from the
endorsement of perverse financial incentives by directors, coupled with
ineffective monitoring of firm-wide risk.

As Warren Buffett has said, “Executive compensation is the acid test
of corporate governance.” Financial incentives determine what
objectives an organization pursues, and they drive the way managers
conduct a business.

Enron’s board ratified a cocktail of financial incentives and
compensation contracts that promoted reckless gambling with shareholder
money. Its bonus system, in particular, gave new business developers
and commodity traders many incentives to inflate estimates of future
profitability in order to pocket annual bonuses before the actual
performance of multi-year transactions was known.

Lacking the recapture of bonus payments for unprofitable contracts,
executives had little accountability in deploying shareholder capital.
Finally, short-term quantitative criteria displaced qualitative
measures of executive performance. The result was overcompensation,
outsized risk-taking, and supreme overconfidence.

In the current subprime crisis, mortgage bankers and some commercial
bankers utilized similar incentives to achieve short-term gains.
Mortgage brokers, for example, were paid on commission with no economic
penalty for writing p...

entire article -http://www.truenorthleaders.com/blogs/?p=272

...provides an independent voice when recruiting new directors,
approving board meeting agendas, asking for information on firm-wide
risks, evaluating CEO performance, creating a process for CEO
succession. He also organizes the independent directors in the event of
a unexpected issue, such as a takeover bid, resignation of the CEO, or
fiscal crisis. Without clear separation of board governance and
corporate management, the entire corporation may be put at risk.

If directors fail to provide clear oversight of executive
compensation and risk-taking, they may abdicate their fiduciary
responsibilities to groups of dissident shareholders and, ultimately,
to the government. The Enron case resulted in the rushed passage of
Sarbanes-Oxley legislation, a process that took just 31 days and
considered only limited input from the business community. Unless
boards of directors act immediately to adhere to their fiduciary
responsibilities, this could happen again in 2009.

In our opinion, this would not be in the best interests of
free-market capitalism and the growth of the U.S. economy, but it may
happen unless boards take their responsibilities very seriously.