By: John C Coffee Jr
Publisher: Oxford University Press
Price: $72.99
Reviewer: Sandy Maier
If the linkage between corporate failures and the quality of boards seems clear and simple, hold on to your hats. John Coffee, professor of law and head of the Center of Corporate Governance at Columbia University, has some alternative theories that pin much of the blame on auditors, corporate attorneys, securities analysts and rating agencies.
Coffee comes out swinging, saying that “all boards of directors are prisoners of their gatekeepers”. His key theory is that “no board of directors – no matter how able and well-intentioned its members – can outperform its professional advisors”. He makes the reliance, in fact the dependence, of the board on its professional advisors clear: “Only if the board’s agents properly advise and warn it, can the board function efficiently.”
The definition of gatekeeper is quite specific for Coffee: one who “vouches” for the quality of the disclosures and assurances of the corporation. The ability to affirm the integrity of the corporation comes about because the gatekeeper has served many clients over many years. The obvious examples include auditors who certify financial statements, investment bankers who give fairness opinions, and credit agencies which assign ratings.
Much of the book involves scholarly review of the historical development and present role of each of these types of advisors. Coffee reminds us that in many cases the current functions of these groups have evolved rapidly and changed dramatically in recent history. Auditors, for example, were originally appointed by investors, emerging relatively lately as more than mere bookkeepers by claiming independence and duties to third parties.
The ancient profession of law long resisted the idea that duties might be owed to investors; indeed, lawyers still resist broader responsibilities. Security analysts were originally compensated by investors (through brokerage commissions) as were rating agencies (through subscription fees for access to ratings).
Two trends are highlighted over and over. First, fees paid to auditors, attorneys, investment bankers, rating agencies (and indirectly, analysts) are now universally paid by the corporation, not the investor whose interest we trust them to represent. The question is reduced to simple test: can an investor trust watchdog hired and paid for by the party to be watched?
Second, the volume and importance of peripheral business coming to advisors through management has grown dramatically. Both these factors create fertile breeding grounds for conflicts of interest.
While some of the structural problems have been addressed by Sarbanes-Oxley, Coffee uses lengthy examples (including Enron and WorldCom) to assert that the situation is far from being adequately rectified.
In complementary argument, he finds that boards of directors have been extensively reformed – with independent majorities, tighter definitions of independence, smaller membership, fewer insiders, more time being spent by directors, and greater use of the “lead director” concept. Boards are more independent, harder working, and more proactive. If boards and their performance have improved over recent years, some other factor must logically explain poor outcomes, and Coffee makes spirited case to pin the tail on professional advisors.
As Coffee reviews each profession he marshals good deal of factual material and some concise commentary. In discussing the role of corporate attorneys, for example, he sets out revealing quote from current US Senator and former chief executive of Goldman, Sachs & Co – “In fact, in our corporate world today… executives and accountants work day to day with lawyers. They give them advice on almost each and every transaction. This means when executives and accountants have been engaged in wrongdoing, there have been some other folks at the scene of the crime – and generally they are lawyers.”
The book concludes with series of suggested steps to improve the situation. Most are variations on the theme of restoring principal-agent relationship between investors and professional advisors. Succinctly, Coffee advocates schemes that restore, as much as possible, the responsibility (and often the hiring and payment functionality) of investors to select and manage professionals. The proposals are anything but simple, and will intrigue and interest, if not convince.
Finally, in what seems to me to be both hopeful view of boards, and stripped-down summary of the “bottom line” of corporate governance, Coffee hits the nail on the head when he reminds us that directors can often be relied upon to act when professionals fail, because directors’ “principal liability is for passivity in the face of known risk”.
All in all, the book is worthwhile waltz through the world of corporate governance from the somewhat unusual perspective of the role of professional advisors. It’s not based on an intuitive or simple argument and it’s not calculated to appeal to lawyers, investment bankers or other professional advisors – but it is likely to provoke thought and debate.
