Whatever I may have learned from these experiences, I approach the subject of Corporate Governance with a fair degree of trepidation. Everyone but me seems to know exactly what is meant by corporate governance. Revealingly, in much the world (though generally not in the US), it seems to be used interchangeably with ethics though it seems unlikely that such a concept would mean much to Aristotle, Kant, Bentham, Mill, or even John Rawls. Indeed, of the philosophers to whom my course pays some heed (and it is not a philosophy course) it is possible that only Machiavelli and perhaps John Locke would have had a word to say about it, but one can’t even be sure of that.

Yet wherever one goes, corporate governance is the passpartout – “the key that opens all doors.” In Asia, where I have done research in the last two years for The World Bank, corporate governance is believed to be the key to combating corruption. Business people, governmental officials, and journalists from Eastern Europe and countries in the Former Soviet Union for whom I have conducted State Department briefings have a similar view of the importance of corporate governance in resisting corrupt practices. In the US, effective corporate governance is regarded as a necessary condition for efficient capital markets. In the social democracies of Western Europe it is regarded as the institutional mechanism for stakeholder accountability.

And that is just a list of a few of the marvelous things good corporate governance is supposed to do for us. During the last year, in the US, bad governance has been blamed for making even the most mediocre CEOs wealthy beyond belief, condoning and perhaps even encouraging accounting scams, and endowing CEOs with the kind of dictatorial powers than even a tin pot banana republic dictator would envy. Such expectations – both good and bad – seem extravagant to say the least for a subject that seems to elude precise definition.

Yet we should not be surprised. Corporate governance is important because of the failure – or, at the very least – the lack of success of civil society in enforcing behavioral norms for business conduct. In global business practice, it is difficult to expect the world’s governments to pass laws that are clear enough in their demands and enforced with sufficient rigor and uniformity to constitute an effective deterrent to bad practice.

The US, to cite just one example, has a reasonably effective court system and prosecutors who have every incentive to pursue malfeasance and bring perpetrators to justice. And yet in the first 18 years of the Foreign Corrupt Practices Act (FCPA) (1977-1995) only 16 companies were prosecuted for violations of the Act. How much more difficult would it be to enforce such laws in a so-called “transitional economy?”

The reluctant conclusion is that, to the extent that the process exists at all (at least on a global scale), much of business conduct norm making has been privatized. The institutions that control and direct corporate purpose hold the key to fulfilling whatever moral expectations we may have for business practice – honest and transparent financial reporting, efficient financial markets, effective methods for countering bribery, and stakeholder accountability, to cite just a few examples.

In developing economies, we expect corporate governance to establish the rules of the game that will serve as markers for effective legislation and the rule of law. In developed markets, corporate governance is the key to avoiding the high costs of capital that can be the by-product of an over-regulated economy. Regardless of the political system or economy in which we live, we place a heavy burden on this thing that we call corporate governance. Is it equal to the many tasks that we have set for it?

Let us begin with the board’s oversight of honest and transparent financial reporting and its potential impact on capital markets. Here Enron is a case in point. The Enron Board of Directors waived the company’s code of conduct to enable Enron’s CFO Andrew Fastow to invest in, direct, and engage as Enron’s representative in transactions with the special purpose vehicles. These off-the-books partnerships became the black hole into which losses often disappeared.

Enron’s audit committee members, the first line of defense against such abuses, were all independent directors. They had no financial ties to the company unless you count the very substantial largesse that their respective educational and medical institutions received from the company. In this regard, it is unlikely that a US board would have tolerated such conflict of interests if these directors had been connected with profit-making organizations. As so-called “public members” they were exempt from such scrutiny but were they free of conflicts of interest?

And what can we say about the competence of such individuals to deal with the complex financial and accounting issues with which they were confronted? Except to offer the retrospective judgment that they failed miserably, we cannot know how qualified the Law School Dean, Medical Center President, and economics professor may have been for this task.

The Enron Audit Committee may not have been unusual. In fact, other than their purported “independence,” all too frequently the members have nothing to contribute to the audit committee’s work. Indeed, it is hardly surprising that independent directors are blissfully ignorant of the accounting arcana of a particular business. Many of them do not come from the private sector and may have little experience with accounting practices, and, as the Enron case demonstrates, they may have conflicts of interest that would not be tolerated if they were senior executives of other publicly traded companies.

And finally, at least some of these people are professional directors – being board members is how they make their living. They don’t want to be fired. Arguably, at least some of them are less independent than those directors who work for the company because the company employees who reach the director level can, perhaps, find high-paying jobs with other companies.

These caveats are not meant to demean the work of professional directors – many of whom are highly effective. Nor is it my purpose to impugn the conscientious efforts of people from the public, academic, and philanthropic sectors whose participation in board deliberations is meant to and often does help to focus the board’s attention on the larger context in which its decisions are made. I am only saying that all too often independent directors have conflicts or lack essential competence with respect to a particular board assignment.

The Enron case is an example of particularly ingenious methods used to conceal the outcome of stupid business plans that were incompetently executed. Yet although we can expect and are likely to get better financial data from most companies, earnings statements of publicly-traded firms that link top executive compensation to stock price performance are suspect because of what economists call moral hazard.

Moral hazard occurs when “the individual’s perception of either the cost or the benefit of the activity differs from the true cost or benefit.” Pay incentives keyed to stock performance formulas result in moral hazard situations because the social costs, in this case, the capital market inefficiencies resulting from distorted earnings, are not on the radar screen of most compensation committee members. The only real deterrent is the fear of being caught doing something dishonest.

Conflicts of interest, limited director competence, and the moral hazard opportunities inherent in board approval of financial statements and senior executive compensation have led to efforts to address these problems through legal reform, regulatory enforcement, and voluntary compliance initiatives. As for voluntary compliance, with regard to senior executive compensation, The Conference Board’s Commission on Public Trust and Private Enterprise recommended that companies treat options as an expense and some have done so.

Time will tell whether in expensing options, directors will gain a better appreciation of their true costs and benefits, but the ultimate question is how well equipped the current system of US corporate governance is to deal with the moral hazard possibilities of linking senior executive pay to stock performance.

Thus, with regard to one of the three expectations stated at the outset, corporate governance has failed to protect and promote the efficiency – at least in the US – of capital markets. With respect to the task set for corporate governance in developing and transitional economies, it has been somewhat more useful. Corporate governance is a tool for devising effective methods to resist corrupt practices. Still, we must not make too much of this accomplishment. It is compliance programs, not governance, that do the lion’s share of the work in countering bribery.

Boards make a limited contribution to the four elements of an effective compliance system: [1] codes; [2] top management support; [3] implementation and training; and [4] whistleblowing, record-keeping and information sharing systems. Of these compliance system components, boards have until recently only been actively engaged in the approval of code language and the review of compliance program performance.

There are signs that boards are seeking a more active role. Research for a study that The Conference Board will release later this year suggests that directors are now requesting reports on sensitive issues that may have an impact on the company’s business practice [e.g., human rights in China], seeking more frequent meetings with auditors, and obtaining briefings on internal investigations.

In areas other than avoiding bribes, corporate governance has also been instrumental in setting higher business conduct standards. In East Asia, joint venture participation has given companies with well-developed compliance programs a wedge to exert pressure for adoption of their own business conduct standards. The lack of financial control has made such an exercise problematical. Still, even where these efforts don’t entirely succeed, improvement often results.

It is the third expectation – stakeholder accountability – where corporate governance has achieved its greatest success. The obvious examples of stakeholder engagement are found in Western European co-determination practices but there is also a potentially useful debate as to whether the continental co-determination [some would say co-optation] model or the Anglo-American arms length adversarial approach is best suited to achieving stakeholder accountability. The answer may depend on the culture in which the effort is made.

We should not conclude from the corporate governance structure that boards and directors are yet accountable in a legal sense. Despite the US Caremark decision, only one director has been criminally prosecuted. At least in the US, all corporate governance had done is to provide procedural mechanisms for dialogue and potential standing to sue.

Having worked through this exercise from worst to best, I am tempted to conclude, as Mark Twain did, when he first heard Wagner’s music that “it isn’t as bad as it sounds.” And it isn’t. Corporate governance is important. It will, however, achieve better results if we can bring our expectations into line with what it can realistically achieve. In that spirit, here are a few modest proposals:

[1] Don’t focus on structural or procedural issues. Pay more attention to the cultural context [national, industry, company] in which the board operates. Separation of the CEO and Chair’s responsibilities and director independence (whatever that means) are less important than an understanding of the cultural dynamics that drive board deliberations. Enron ticked off all the boxes. The company separated the Chair and the CEO, recruited a distinguished roster of independent directors, and had an Audit Committee consisting exclusively of non-executives. The Enron case proves that the Board and company culture will always trump formal structure and process requirements. Until you get inside the boardroom and see how the members relate to one another, the questions they ask, and the determination with which they pursue the answers, you cannot know if you have effective governance.

[2] Do insist on director competence, allocation of resources to the board, and regular meetings of non-employee directors to discuss issues of common concern. The first requirement for directors – all to often ignored – is that they know what they are doing. Directors may also need staff, and companies must provide independent consultants to help them to work through troubling issues. And non-executive directors should meet periodically and not conspiratorially to think through the problems that the company confronts.

[3] Given the moral hazard inherent in the process, board certification of financial statements may be an exercise that is beyond the board’s competence. I share the reservations that many have in delegating this task to an official governmental or regulatory body. One proposal I have heard that I think is worth considering is to require companies to insure their financial statements. Accountants would review the financial statements on behalf of the insurers rather than the company. The premium charged the company would be published. This number would serve as a market signal of the company’s financial viability. Had such a system been in effect in early 2001, Enron would probably not even have been able to obtain insurance. At that point, Arthur Andersen had identified the company as the riskiest client in its portfolio.

[4] Greater board involvement in company ethics and compliance programs should be encouraged. The directors are the custodians of the company’s long term interests. They are in the best position to request the reports, investigations, and discussions of the short-term crises and long-term trends that affect those interests. Everyone agrees that it is the board’s duty to protect the company’s assets, business opportunities and reputation but we need to recognize it can best fulfill that mandate by on-going review, discussion and debate regarding the broad social, ethical, economic, and political environments in which global business is practiced.