alan greenspan : corporate governance remarks by mr alan greenspan, chairman of the board of governors of the us federal reserve system, at the 2003 conference on bank structure and competition, chicago, illinois ( via satellite ), 8 may 2003. * * * corporate governance, the subject of our conference, has evolved over the past century to more effectively promote the allocation of the nation ’ s savings to its most productive uses. and, generally speaking, the resulting structure of business incentives, reporting, and accountability has served us well. we could not have achieved our current level of national productivity if corporate governance had been deeply flawed. yet, our most recent experiences with corporate malfeasance suggest that governance has strayed from the way we think it is supposed to work. by law, shareholders own our corporations, and corporate managers ideally should be working on behalf of shareholders to allocate business resources to their optimum use. but as our economy has grown and our business units have become ever larger, de facto shareholder control has diminished : ownership has become more dispersed, and few shareholders have sufficient stakes to individually influence the choice of boards of directors or chief executive officers. the vast majority of corporate share ownership is for investment, not for operating control of a company. thus, corporate officers, especially chief executive officers, have increasingly shouldered the responsibility for guiding businesses in what one hopes they perceive to be the best interests of shareholders. not all ceos have appropriately discharged their responsibilities and lived up to the trust placed in them, as the events that led to the passage of the sarbanes - oxley act demonstrated. in too many instances, some ceos, under pressure to meet elevated short - term expectations for earnings, employed accounting devices for the sole purpose of obscuring adverse results. a change in behavior, however, may already be in train. the sharp decline in stock and bond prices after the collapse of enron and worldcom has chastened many of those responsible for questionable business practices. corporate reputation is emerging out of the ashes of the debacle as a significant economic value. i hope that we will return to the earlier practices of firms competing for the reputation of having the most conservative and transparent set of books. * * * it is hard to overstate the importance of reputation in a market economy. to be sure, a market economy requires a structure of formal rules - - a law of contracts, bankruptcy statutes, a code of shareholder rights - - to name but a few. but

ratings exposes a counterparty to extraordinary demands for collateral if its rating is downgraded. collateral demands arising from rating downgrades may be especially costly to meet because a downgrade would reduce the availability of funding and increase its costs at the same time. incentives for effective risk management as this discussion of the risks associated with derivatives makes clear, effective risk management by market participants is the key to ensuring that the benefits of derivatives continue to exceed their costs. some may see government regulation of otc derivatives dealers as essential to ensuring efficacious risk management. this view presumes that government regulation can address the challenges these types of markets engender and that it can do so without lessening the effectiveness of market discipline supplied by counterparties. market participants usually have strong incentives to monitor and control the risks they assume in choosing to deal with particular counterparties. in essence, prudential regulation is supplied by the market through counterparty evaluation and monitoring rather than by authorities. such private prudential regulation can be impaired - - indeed, even displaced - - if some counterparties assume that government regulations obviate private prudence. we regulators are often perceived as constraining excessive risk - taking more effectively than is demonstrably possible in practice. except where market discipline is undermined by moral hazard, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk - taking than is government regulation. the very modest credit losses that have appeared in derivatives portfolios at u. s. banks are a testament to the effectiveness of market discipline in this area. indeed, credit losses on otc derivatives also have been quite modest at derivatives affiliates of u. s. broker - dealers, which are subject to very limited government regulation. this is further evidence of the powerful effects on behavior that result when market participants recognize that they bear the bottom - line consequences of their risk - taking decisions. a key support for market discipline is the information that market participants have for evaluating the creditworthiness of counterparties. over the past decade, enormous attention has been given to disclosures market participants make with regard to their risk exposures, particularly those associated with derivatives activities. both public authorities and private - sector working groups have recommended ways to enhance market discipline through improved public disclosures. the result of these efforts, however, has been mixed. clearly, we have made great strides in expanding the volume of publicly disclosed information related to risk exposures and derivatives