Icarus in the Boardroom

America loves risk-taking CEOs, but when such behavior crosses over to boardrooms it could have massive consequences because of the growing scale of businesses and society’s greater dependence on equity markets. Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From (Law and Current Events Masters), by David Skeel draws on Greek mythology to present a candid warning aimed at corporate directors and anyone concerned with our economic future.

Trapped in a labyrinth of his on construction, Dedalus made wings for himself and his son Icarus. He warned Icarus not to fly to close to the sun but Icarus got carried away, failed to heed the warning, and plunged to his death after the sun melted the wax that held his wings together. Similarly, the corporation is a powerful human innovation, but is dangerous if not used properly.

But this book isn’t about businesses being “socially responsible,” in the normal sense of health, peace, or global warming. Instead, Skeel is concerned with the impact that corporate failures can have on the economy as a whole. From that standpoint, Icarus in the Boardroom offers excellent advice on creating a sustainable business climate, getting to the source of problems instead of the symptoms.

He attributes several recessions and the Great Depressions to an ”Icarus Effect,” brought on by three factors:

• Excessive and sometimes fraudulent risks
• Competition (or, rather, tendencies toward monopoly)
• Increasing size and complexity  

The bulk of the book is devoted to a short history of the corporation followed by an excellent treatment of these three thematic factors and corporate failures though US history. He explains how government has responded to Icarus effects and how corporations have worked to first adapt, then often to circumvent or unravel government’s attempt to save us from corporate excesses.

In general, “the lobbying might of corporate managers, and the power of their political contributions, is too great for even relatively minor reform to succeed,” he notes. However, the wake of financial scandals provides an opportunity to “change the political calculus.” We witnessed such changes after the 1929 crash when reforms like creating the Securities and Exchange Commission stopped short of federalizing corporate law.

More recently we enacted Sarbanes-Oxley to address the scandals of Enron, WorldCom and Tyco. Where did we stop short this time? Skeel advises that we partially addressed fraudulent risk but left the other Icarun factors largely untouched. Among Skeel’s many recommendations:

• Conflicts of interest. Having auditors selected by a committee made up of “independent” board members does little; they’ll still be reluctant to choose an auditor who will rock the boat. Stock exchanges should assign and police auditors.
• Securities analysts. “If exchanges were required to assign a securities analyst to every listed company – and pay the analysts from companies’ listing fees – investors would know that there was at least one (unbiased) analyst covering every listed company.”
• SEC’s proxy access proposal, which wasn’t dead when Skeel wrote the book. Skeel favors it but warns that shareholder activism “often won’t curb problematic behavior if the behavior in question is profitable to the corporation.” As an example, he cites the fact that Tyco shareholders overwhelmingly rejected a proposal to move its domicile back to the US from Bermuda. Shareholders wanted to keep saving on taxes regardless of the negative impact on the larger society.
• Special purpose entities (SPEs). Instead of treating them under “enterprise liability,” as advocated by Adolph Berle in the post-New Deal era, Skeel takes a middle approach. Auditors and regulators should “focus on whether the spirit of the SPE status is being violated. SPEs that are not truly separate from the overall company should be denied separate treatment for accounting purposed.”

“Ordinary Americans no longer see corporations as ‘other,’” because more than half now own stock (directly or indirectly). As defined benefit plans dwindle and 401(k) participation increases, Americans have come to see their own stakes, however small, as tied to those of corporations. Skeel cites an important study by Dallas Federal Reserve Economists John Duca and Jason Saving that found “a direct correlation between stock ownership and the Republican vote in recent Congressional elections. As stock ownership goes up, so does the Republicans’ share of the Congressional vote.” It’s no wonder President Bush keeps pushing privatization of Social Security.

“The increasing identification between ordinary Americans and corporate America is perfectly understandable, but beneath it lurks a terrible irony: at the same time as our passion for real reform has declined, the risks have radically increased,” writes Skeel. In the past, investing in stocks was an activity largely limited to the rich who could afford to speculate. Now stocks have become the investment of choice for “life” savings and retirement. 

With so many of us now dependent on corporate performance, let’s hope it doesn’t take another Great Depression before American’s wake up to the need for reforms of the type outlined by David Skeel.

However, most of Skeel’s recommendations will require national reforms. With the US Chamber of Commerce spending more than $53 million a year lobbying against such changes, what is an enlightened board member to do (other than terminating membership in the Chamber)? Try the following:

• Independent auditors and treatment of SPEs. From a shareholder’s prospective, Mark Latham’s proposal for auditor independence based on shareholder vote could provide an answer to both these problems. Currently, shareholders vote on the auditor but they are given no choice. The vote is a meaningless rubber stamp of the audit committee’s selection. Allowing alternatives to be listed on the proxy and then having them voted on by shareholders would provide a serious incentive for audit firms to build reputations around reports which reveal inefficiencies as well as certifying to Generally Accepted Audit Standards geared toward disclosures to stock purchasers, rather than owners. Unfortunately, the SEC has continuously issued no action letters ruling Latham’s proposal deals with “ordinary business,” even though that contention appears absurd given Arthur Anderson’s role in Enron’s demise. However, nothing prevents an enlightened board from implementing this method of audit selection, which clearly is superior to current methods from the standpoint of reducing conflicts of interest.
• Securities analysts. Again, I would turn to one of Mark Latham’s proposals to allow shareholders to select a proxy advisor to be paid for by the corporation. Instead of advising shareholders when to buy and sell, the advisor would be recommending ways to fix the corporation to make it more efficient in generating wealth, as well as analyzing issues on the next proxy.
• SEC’s proxy access proposal. While the SEC proposal is dead until the US elects a new President, the options for enlightened directors are not closed. For example, Pfizer and then Disney recently voted to require that directors be voted by a majority of votes cast. Ashland agreed to solicit director candidates from major shareholders and to nominate a qualified candidate for election to the board. Shareholders of Microtune can nominate one director beginning in 2005 at the annual meeting and a second director at the annual meeting in 2006. See also Apria Healthcare’s innovative policy allowing shareholder to place nominees on the proxy under limited circumstances.