The first deficiency of contemporary corporations legislation is its focus on outlawing specific actions such as insider trading or issuing false documentation. A second shortcoming is to manage the risks of liability funders such as banks by imposing minimum capital requirements. The third deficiency is regulation’s global reach, either through formal rules such as those of the Basel Committee, or less formally via domestic legislation with global effect such as the Sarbanes-Oxley Act. My contention is that the first two features promote excessive risk in corporate finance, and the last feature makes resulting problems global.
What is the alternative? For me the answer is to introduce a new regulatory regime directed solely towards large corporations. Although these large firms constitute the majority of investor assets and – as the largest risks to the community and taxpayer - are `too big to fail’, they are few in number and so form a small group to control. In the United States, for instance, just 150 listed firms with assets above $50 billion comprise 80 percent of the assets of all firms. This small number of very large firms should face a uniquely tough regulatory regime with three planks.
First, large firms should be precluded from undertaking the most risky strategies. These include high leverage, use of OTC derivatives, and activities that cannot be observed such as off-balance sheet investment. The second reform recognizes that nobody outside a large firm can know anything but a portion of what is really going on inside the company. Large firms should prepare an annual Risk Report that includes sustainability measures from the Global Reporting Initiative.
The final proposed change to the way that large companies are regulated is to hold their executives to higher performance standards by introducing an offence of managing a company into bankruptcy. Strict liability would be imposed so that the offence is proven by acceptance of government bailout monies, filing for bankruptcy, or (in some jurisdictions) calling in a receiver. Those liable for the offence are company directors and officers at the date of the firm’s most recent accounts.
An obvious concern from these changes are the actual and opportunity costs. But confining changes to large firms means inherently high risk businesses such as mineral exploration or early stage R&D will not be affected. Superficially, too, these suggestions may appear radical. To the contrary, their principles are already in wide use because criminal offences typically relate to outcomes, not process breaches. None of the recommendations here is radical in concept, only in its likely effect.