If shareholder theory has taught me anything, it’s that greed is good –in it’s purest form. Greed incentives innovation, it spurs economic development, and has been the catalyst to dramatic increases in our quality of living. However, greed is often corrupted by the incentive to cheat and deceive others. As we’ve seen in countless examples such as Enron, WorldCom, and the 2008 financial collapse, greed has acted as the driving force behind systematic failure. When left unregulated greed has the ability to destroy established institutions, and in this case the global financial system. As detailed in the Inside Job, financial institutions such as Morgan Stanley originated as small, closely owned partnerships that mitigated risk in the investment of their assets. As the potential to generate profits increased, so did the scale of operations for these small financial firms. To this date, Morgan Stanley has grown into a behemoth employing more than 50,000 people. As the firm grew, the investment strategy employed by its founders transformed into one defined through increased margins and profitability. In addition, the sale of equity to the public engrained the ideology of shareholder theory into these companies. Public ownership of these companies has aided the transition from risk averse, closely owned partnerships to profit driven monsters that have been given other people’s money to play with.
It has become evident that there exists an agency problem between corporate leaders and the public they claim to be serving. Although there have been attempts to regulate these industries, often times, the regulators have been unable to detect fraud before a meltdown. It’s for this reason that I’m frustrated with the economic system that we will soon inherit.
Both Brooksley Born and Arthur Levitt attempted to regulate corporate power through restrictions to the laissez-faire derivatives market or the break-up of conflicts of interest between public auditors and their clients. In Born’s attempt to impose regulation on the derivatives market she was immediately met with fierce opposition from the very financial institutions that were exploiting the market for significant gain. Similar to @benoberfeld I’m frustrated by the influence Wall Street has on public policy. This influence was evident by Wall Street’s ability to stymie Born’s investigation and further, pass legislation outlawing the future regulation of derivatives trading. It’s difficult to comprehend how meaningful policy changes will ever be implemented in a system where corruption has such a large influence in government. Similar to Born’s investigation into derivatives trading, Arthur Levitt was also restricted in his investigation into the conflict of interest between public audit firms and their clients prior to the Enron collapse. Unsurprisingly, it was companies such as Enron and the accounting firms that fought Levitt’s proposed legislation. After learning of these two incidents of failed regulation, how often are regulators able to catch fraud before it happens?
I believe the current state of corporate governance is underdeveloped in its ability to catch fraud prior to meltdowns. While external regulators are important in the detection of fraud, history has proven that it is unlikely that they will be unsuccessful in preventing a failure. On the other hand, often times the corporation is much more familiar with their own business processes and therefore have a better ability to detect fraudulent activity. The question is, how often are corporations aware of their own fraudulent activity but choose to ignore it?