Article
Written by Nick Driver
Posted on 07/11/2014

Is corporate governance weakened by equity incentives?

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Appropriate corporate governance requires an individual or small team to oversee the effectiveness of governance within an organisation and there are suggestions that equity incentives harm the success of these ‘gatekeepers’.
 

Do incentives motivate or corrupt?

A recent post on the Harvard Law School Forum regarding corporate governance and financial regulation argued that although corporate gatekeepers do reduce governance failures, the reduction drops significantly when gatekeepers are given an equity incentive. 

These corporate gatekeepers are typically external agents such as auditors, analysts or credit rating agencies, and can therefore be considered impartial. This impartiality should mean they are best placed to oversee governance and act responsibly, but compensation also offers an incentive to act dishonestly and turn a blind eye to the actions of those they are overseeing. The result is an increase in the instances of unscrupulous behaviour from senior managers, which heightens compliance risk greatly.

How to incentivise and maintain strong governance

The authors of the Harvard forum post do offer suggestions for how firms can employ an effective gatekeeper and compensate them fairly at the same time. They suggest hiring a lawyer for the role, rather than an individual from another company. The reasoning is that lawyers “have their entire reputational capital built on their successful careers as effective lawyers, have the habit of being a lawyer, and are not yet skilled in value-creation.”

They continue to suggest that many lawyers coming into a business will not have previously been offered, “Equity incentives with payoffs tied to outcomes unrelated (or not closely related) to legal milestones.” It is therefore necessary to reward a gatekeeper for maintaining full compliance, rather than based on the financial success of the business.

Why corporate governance matters

Corporate governance is more than a formality to help your business avoid employee fraud and make sure senior managers are acting responsibly, as it also influences the wider business culture. C-suite executives need to lead by example to promote transparency of information and accountability for actions, as this good practice will then filter down to all levels. Externally, it is also beneficial to reputation management, and with good standing in the industry, you can attract a wider pool of talent when recruiting while also encouraging customers to choose you over a competitor.

 

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