Regulating Risk by 'Strengthening Corporate Governance'

Abstract

This paper, presented at the “Regulating Risk” symposium at the University of Connecticut School of Law, April 16, 2010, briefly reviews the connection between risk and corporate governance, then examines the “strengthening corporate governance” provisions of Subtitle G of the Restoring American Financial Stability Act of 2010 (also known as the “Dodd Bill”). The corporate governance provisions, covering majority voting for director elections, proxy access, and the separation of the roles of CEO and chairman of the board, seem likely to have one of two possible effects. On the one hand, the provisions may be pernicious, in that they further enhance shareholder power without a clear justification for increased shareholder power, and more particularly without a justification for shareholder power as a risk management device. Indeed, the Dodd Bill’s corporate governance provisions may work at cross-purposes to the risk management intent of the remainder of the Dodd Bill: the corporate governance provisions operate under the assumption that enhanced shareholder power will result in better monitoring of managerial behavior, which presumably will help to prevent future crisis, but both theory and evidence suggests that diversified shareholders generally prefer companies to take risks that other constituencies (including taxpayers) would not prefer. On the other hand, the Dodd Bill may have very little effect on investor behavior or risk management. Increases in shareholder power over the past years (fundamentally the result of increased federal regulation) have made management more responsive to - and in some cases probably overly responsive to - shareholder concerns over agency costs. Indeed, some of the proposed reforms already have been or were likely to have been put in place at most public companies. If private ordering is already working, what is the point of imposing strict governance constructs across the market as a whole, especially when most of the affected firms are victims of, rather than contributors to, the Financial Crisis‘