Corporate Governance Reform in a Time of Crisis

I. INTRODUCTION II. CORPORATE GOVERNANCE DIMENSIONS OF THE CRISIS A. Moral Hazard, Risk, and the Financial Crisis B. The Role of Equity-Based Compensation C. Curbing Risk-Taking in Financial Institutions III. SHAREHOLDERS AND CORPORATE GOVERNANCE A. Shareholder Power in the United States and the United Kingdom B. Culture, Politics, and Corporate Governance IV. THE POLITICAL ROOTS OF SHAREHOLDER-CENTRIC REFORM EFFORTS A. Shareholders as Stewards B. Shareholders as Spectators V. CONCLUSIONS I. INTRODUCTION The financial and economic crisis that emerged in 2007 wrought havoc on banking systems around the world, and leading global financial centers in the United States and the united Kingdom were hardly spared. To the contrary, New York and London found themselves at the very heart of the crisis, their banks similarly crippled by extraordinary levels of debt and losses on complex mortgage-backed securities. In the wake of the crisis, both countries have engaged in wide-ranging regulatory efforts to contain the damage and prevent such a catastrophe from occurring again, and these efforts have included corporate governance reform proposals intended to curb risk-taking. on both sides of the Atlantic these proposals have sought to empower shareholders--not only in financial firms, but in all public companies--evidently in the belief that this would permit the shareholders to constrain reckless managers of banks and other types of entities in the future. In light of the historical, cultural, and financial ties between the United States and the United Kingdom, it is perhaps unsurprising that the two countries would pursue broadly similar strategies in response to the crisis. What is certainly surprising, however, is that policymakers in both countries would seek to empower the very stakeholder group whose incentives are most skewed toward the kind of excessive risk-taking that led to the crisis in the first place. All the more baffling is the tendency to conflate financial and non-financial firms in these reform efforts, when risk incentives and associated regulatory problems differ substantially between the two domains. This Article explains why U.S. and U.K. policymakers have reacted to the crisis as they have. The matter is far less straightforward than it might appear at first blush, because although broadly similar by global terms, the U.S. and U.K. corporate governance systems in fact differ considerably on some fundamental matters--the U.K. system proving to be far more shareholder-centric than the U.S. system. This means that shareholder-oriented reforms are more in keeping with the status quo in the United Kingdom than in the United States, where managers have traditionally possessed greater autonomy. This in turn suggests that the political dynamics motivating shareholder-oriented reforms in each country must differ in fundamental respects. The Article proceeds as follows. Part II describes the risk incentives of shareholders and managers in financial firms, examines how excessive leverage and risk-taking in each country's financial system led to the crisis, and summarizes corporate governance reforms proposed to remedy these problems. Part III outlines core distinctions between the U.S. and U.K. corporate governance systems. It examines the far greater power and centrality that U.K. shareholders have historically possessed relative to their U.S. counterparts, and highlights three factors explaining this distinction: the earlier rise to power of U.K. institutional investors, the relative proximity and homogeneity of U.K. market actors, and broader differences in how each country's corporate governance system relates to external regulatory structures conditioning relationships among stakeholders in the firm. Critically, the more robust U.K. welfare state has tended to deflect political pressure to accommodate non-shareholders' interests within the corporate governance system, whereas weaker social welfare policies in the United States have brought about the opposite result, diminishing the emphasis on shareholders. …