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Corporate governance for government

In 1999, at the height of the Internet bubble, Goldman Sachs gave the directors of eBay pre-IPO shares in other companies Goldman was taking public.  This wasn?t charity; eBay paid Goldman Sachs $8 million to take it public the year before and Goldman was simply thanking eBay.  The problem is that eBay shareholders paid Goldman?s fee, but Goldman?s thank you gift was sent to eBay?s directors.  eBay shareholders sued their directors and won.  The law says a corporation?s directors cannot take favors that rightfully belong to the shareholders they represent.

In 2003, at just before the housing bubble, Countrywide Financial gave several US senators special ?VIP loans? that featured lower interest rates than were available to these senators? constituents. Like the eBay case, this wasn?t charity; Countrywide was trying to curry favor with important regulators, including Senate banking committee chair, Christopher Dodd. Unlike the eBay case, however, Dodd and the other government officials who received below market loans were not disciplined.

It is popular these days to vilify corporate actors for their carelessness and graft.  And they deserve it.  But we rarely apply the same treatment to politicians and government workers who waste tax payer dollars or sell policy favors.

The disparate treatment can be appalling.  Just this month, the GAO reported on accounting problems that cost the IRS $8 billion and a Pentagon inspector reported that $9 billion in Iraq war spending was of ?missing?. Yet it is unlikely any officials will be held responsible for these mistakes. Contrast this with the case of Jamie Olis, a tax planner at Dynegy, who helped his company to shift $300 million in costs from one period to another.  The fraud was nowhere near the $17 billion in government waste discovered this week, but Mr. Olis was sentenced to 24 years in jail for his role. (His sentence was later reduced.)

What if government officials were held to the same standards as corporate managers? After all, the two jobs are quite similar. Both politicians and corporate managers are periodically elected to serve the interests of voters and shareholders, respectively.  Both are subjected to less than perfect oversight by their constituents, who do not have the time to monitor the day-to-day activities of their representatives.

When corporate managers abuse their power, however, shareholders may sue.  They can allege that corporate officials were ill-informed or sloppy in their decision making (and this violated their ?duty of care?) or made decisions that are biased by a conflict of interest (violating their ?duty of loyalty?). Such suits are uncommon, but they exert a powerful deterrent effect.  Perhaps a politician?s political constituents should have a similar right to sue when their politicians act in ways that would get corporate managers into legal trouble.

Politicians may face ethics investigations by their peers, but these rarely amount to much.  As we?ve learned in cases from Tom DeLay to Charles Rangel, politicians are loath to discipline their own, and when it does come, it is often no more than a slap on the wrist.  There is also the possibility of criminal charges for bribery, but these are rarer still, even more so after the government struck down a key prosecutorial weapon in the recent honest-services fraud cases.

It might be argued that holding elected officials to the same standards as corporate managers will breed voluminous and vexatious litigation. But there are lessons that may be learned from shareholder litigation. Potential plaintiffs might be required to demand action from the Senate or House ethics committee first, and, only if they refuse to act or act in a way that is clearly biased by conflicted interest would a citizen right to sue arise. Remedies could also be limited in ways that make the prospect of frivolous litigation less likely. A fee-shifting rule in which the loser paid all the lawyer costs would be a way of doing this. Finally, we can imagine special courts?like the Delaware Chancery Court for corporate cases?designed to address citizen litigation. Such courts would be better able to weed out the purely political suits designed to embarrass or harass from those alleging true breach of duties owed to citizens. Although shareholders have broad rights to sue, there is not much frivolous litigation in Delaware.

Political elections have proved insufficient and ineffective at policing our politicians and bureaucrats. It is time to hold them accountable to the same standards to which they hold corporate managers.

Filed under: truth on the market

Full post as published by Truth on the Market on September 09, 2010 (boomark / email).