The topic of corporate governance is a vast subject that enjoys a long and rich history. It’s a topic that incorporates managerial accountability, board structure and shareholder rights. The issue of governance began with the beginning of corporations, dating back to the East India Company, the Hudson’s Bay Company, the Levant Company and other major chartered companies during the 16th and 17th centuries.
While the concept of corporate governance has existed for centuries, the name didn’t come into vogue until the 1970s. It was a term that was only used in the United States. The balance of power and decision-making between board directors, executives and shareholders has been evolving for centuries. The issue has been a hot topic among academic experts, regulators, executives and investors.
Corporate Growth Places Emphasis on Developing Corporate Governance
After World War II, the United States experienced strong economic growth, which had a strong impact on the history of corporate governance. Corporations were thriving and growing rapidly. Managers primarily called the shots and board directors and shareholders were expected to follow. In most cases, they did. This was an interesting dichotomy, since managers highly influenced the selection of board directors. Unless it came to matters of dividends and stock prices, investors tended to steer clear from governance matters.
In the 1970s, things began to change as the Securities and Exchange Commission (SEC) brought the issue of corporate governance to the forefront when they brought a stance on official corporate governance reforms. In 1976, the term “corporate governance” first appeared in the Federal Register, the official journal of the federal government.
In the 1960s, the Penn Central Railway had diversified by starting pipelines, hotels, industrial parks and commercial real estate. Penn Central filed for bankruptcy in 1970 and the board came under public fire. In 1974, the SEC brought proceedings against three outside directors for misrepresenting the company’s financial condition and a wide range of misconduct by Penn Central executives.
Around the same time, the SEC caught on to widespread payments by corporations to foreign officials over falsifying corporate records. During this era, corporations started to form audit committees and appoint more outside directors. In 1976, the SEC prompted the New York Stock Exchange (NYSE) to require each listed corporation to have an audit committee composed of all independent board directors, and they complied. Advocates pushed to get governance right by requiring audit committees, nomination committees, compensation committees and only one managerial appointee.
The 1980s Brought a Corporate Governance Reform Counter-Reaction
The 1980s brought an end to the 1970s movement for corporate governance reform due to a political shift to the right and a more conservative Congress. This era brought much opposition to deregulation, which was another major change in the history of corporate governance. Lawmakers put forth The Protection of Shareholders’ Rights Act of 1980, but it was stalled in Congress.
Debates on corporate governance focused on a new project called the Principles of Corporate Governance by the American Law Institute (ALI) in 1981. The NYSE had previously supported this project, but changed their stance after they reviewed the first draft. The Business Roundtable also opposed ALI’s attempts at reform. Advocates for corporations felt they were strong enough to oppose regulatory reform outright, without the restrictive ALI-led reforms. Businesses had concerns about some of the issues in Tentative Draft No. 1 of the Principles of Corporative Governance. The draft recommended that boards appoint a majority of independent directors and establish audit and nominating committees. Corporate advocates were concerned that if companies implemented these measures, it would increase liability risks for board directors.
Law and economic scholars also heavily criticized the initial ALI proposals. They expressed concerns that the proposals didn’t account for the pressures of the market forces and didn’t consider empirical evidence. In addition, they didn’t believe that fomenting litigation would serve a purpose in improving board director decision-making.
In the end, the final version of ALI’s Principles of Corporate Governance was so watered down that it had little impact by the time it was approved and published in 1994. Scholars maintained that market mechanisms would keep managers and shareholders aligned.
The “Deal Decade” Leads to Shareholder Activism
The 1980s was also referred to as the “Deal Decade.” Institutional shareholders grabbed more shares, which gave them more control. They stopped selling out when times got tough. Executives went on the defensive and struck deals to prevent hostile takeovers.
State legislators countered takeovers with anti-takeover statutes at the state level. That, combined with an increased debt market and an economic downturn, discouraged merger activity. The Institutional Shareholder Services (ISS) was formed to help with voting rights. Shareholders struck back with legal defenses, but judges often favored corporate decisions when outside directors supported board decisions. Investors started to advocate for more independent directors and to base executive pay on performance, rather than corporate size.
Financial Crisis of 2008
By 2007, banks had been taking excessive risks and there was growing concern about a possible collapse of the world financial system. Governments sought to prevent fallout by offering massive bailouts and other financial measures. The collapse of the Lehman Brothers bank developed into a major international banking crisis, which became the worst financial crisis since the Great Depression in the 1930s. Congress passed the Dodd-Frank Wall Street Reform and Consumer Act in 2010 to promote financial stability in the United States.
The fallout from the financial crisis has placed a heavier focus on best practices for corporate governance principles. Boards of directors feel more pressure than ever before to be transparent and accountable. Strong governance principles encourage corporations to have a majority of independent directors and to encourage well-composed, diverse boards.
Advancements in technology have improved efficiency in governance and they’ve created new risks as well. Data breaches are a new and real concern for corporations. The first targets were banks and financial institutions. As these institutions have bolstered their security measures, hackers have turned their efforts to smaller corporations within a variety of industries, including governments.
Today’s boards of corporations and organizations of all sizes are finding that the best way for them to protect themselves, their shareholders and stakeholders is to use technology to their advantage by taking a total enterprise governance management approach. Diligent, a leader in board management software, provides for their needs with Governance Cloud, a suite of fully integrated and highly secure governance tools. Diligent’s software solutions help boards put their best foot forth in assuring transparency, accountability, compliance and efficiency.
The history of corporate governance continues to be rewritten. How we define corporate governance will continue to be in a state of evolution in the coming years. Diligent will be following the trends and regulations to help boards perform their best regardless of what the future brings.