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Policing Corporate Boards

behavior analysis suggests enforcement mechanism needed

 

As a Faculty Fellow at the Edmond J. Safra Foundation Center for Ethics at Harvard University, I will spend this year at work on an article that integrates insights from social psychology into corporate law analysis. This work is part of an effort to create a better understanding of how enforcement policies and practices might help instill higher moral and ethical standards among American business leaders.

In the wake of recent widespread corporate scandals, courts, legislators, and scholars have begun to take a hard look at the US corporate governance system. A puzzling aspect of our corporate law regime is the absence of an effective enforcement mechanism for the duties of loyalty and care that form the foundation of traditional corporate law. A combination of substantive doctrines and procedural requirements embodied in state corporate law has made it nearly impossible for shareholders to prevail when challenging the decisions and practices of corporate management. One wonders how a set of virtually unenforceable rules can be expected to influence the actions of corporate officers and directors. More broadly, our corporate governance structure raises the question of whether a system of legal rules unbuttressed by a credible threat of sanction can actually deter the conduct it seeks to control.

A prominent defense of the existing corporate governance system rests on the assertion that social norms effectively constrain the conduct of officers and directors. Social norms are informal rules and standards enforced through peer-administered sanctions, such as disapproval, ostracism, or reputational injury. Advocates of a norms approach to corporate governance argue that internalized values, coupled with the threat of social sanctions, appropriately constrain the conduct of corporate managers. These scholars further argue that because social norm enforcement is immediate, direct, and cost-free, a normsbased governance system is preferable to an approach that relies on expensive and error-prone judicial intervention.

My paper scrutinizes this argument and concludes that relying on a norms governance system to police corporate misconduct is bound to fail. My review of social psychological literature suggests that selfregulation through norm enforcement is hardly the panacea that norm theorists describe. Rather, a number of social phenomena likely contribute to a sense of complacency and indifference among corporate directors charged with monitoring management to prevent the kinds of fraud exposed by the Enron and WorldCom scandals.

These social phenomena promise to undermine any self-contained system of norms-governance. They include basic human tendencies toward conformity, consistency, and self-justification. Such tendencies contribute to a social milieu in which unethical conduct may go unabated and could actually thrive without periodic intervention from external authorities.

Studies of boards portray directors as a surprisingly homogeneous group. Directors share common racial, social, economic, and religious backgrounds and have similar professional experiences. The common characteristics create a board culture which emphasizes collegiality, shared goals, and values, and discourages expression of dissent. More colloquially, most directors display a profound willingness to “go along to get along.” The prototypical director conduct is attributable to the social phenomenon of conformity: a willingness to comply with the wishes and opinions of others to avoid embarrassment or discomfort. This tendency toward conformity perpetuates many undesirable director traits which stand impervious to outside influence without external feedback and intervention.

Another strong human motivator is the drive for consistency. The drive leads to psychological discomfort that psychologists label cognitive dissonance. Cognitive dissonance occurs when a person simultaneously holds two inconsistent cognitions or beliefs. Psychologists argue that dissonance is most pronounced when the selfconcept is threatened. That is, one’s knowledge that he has committed an immoral act is dissonant with his self-concept as a moral decent person. The drive to reduce this type of dissonance can lead to the erosion of ethical standards.

When one’s self-concept is threatened, a common method for reducing dissonance is self-serving rationalization of the immoral behavior. Such self-justification leads people to soften their moral standards as they reconcile their own behavior with their self-image as a moral person. As a society, we want those who commit acts that conflict with their moral values to reduce dissonance by reforming their conduct, rather than through rationalization or denial. A norms approach, which eschews independent review of directors’ actions, leads in the opposite direction. The dearth of critical feedback on directorial conduct and an absence of personal liability for misdeeds facilitate self-justification and thereby contribute to norm erosion among corporate leaders.

An enforceable corporate liability regime is an important mechanism for diminishing the ease by which corporate leaders rationalize their misconduct. Shareholder litigation and the publicity that surrounds it can expose the hypocrisy of those who engage in or who fail to prevent similar misconduct. Studies show that confronting people with evidence of their own hypocrisy can create the sort of dissonance that leads to lasting behavioral change. The observation suggests that critical feedback from credible experts such as judges and specialized enforcement agencies can provide a crucial external check that should help keep social norms of corporate executives better aligned with the values of broader society.

—Renee Jones

Professor Renee Jones has been appointed the Eugene P. Beard Faculty Fellow in Ethics at Harvard University’s Edmond J. Safra Foundation Center forEthics for the 2005-2006 academic year. The center’s faculty fellowships support outstanding teachers and scholars who study ethical problems in business, law, medicine, government, and public policy. Jones is one of five faculty fellows selected from a pool of applicants from universities throughout the United States and other countries. She is spending the year at Harvard’s Kennedy School where she is participating in a weekly seminar for fellows that discusses problems in teaching and research in ethics. She is also devoting a significant part of her time to work on the project described in the accompanying article.

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