CEO / Board Member Friendships May Impact Corporate Governance

I just stumbled on a paper by a UCLA professor named Avanidhar Subrahmanyam. He and his team recently studied the impact of social networking on the quality of oversight and other monitoring activities. In short, close social ties decreases the quality of oversight while increasing the quality of evaluating the raw talent of a CEO.

Prof. Subrahmanym's own words:

We analyse frameworks that link corporate governance and firm values to governing boards' social networks and innovations in technology. Because agents create social networks with individuals with whom they share commonalities along the dimensions of social status and income, among other attributes, CEOs may participate in board members' social networks, which interferes with the quality of governance. At the same time, social connections with members of a board can allow for better evaluation of the members' abilities. Thus, in choosing whether to have board members with social ties to management, one must trade off the benefit of members successfully identifying high ability CEOs against the cost of inadequate monitoring due to social connections. Further, technologies like the Internet and electronic mail that reduce the extent of face-to-face networking cause agents to seek satisfaction of their social needs at the workplace, which exacerbates the impact of social networks on governance. The predictions of our model are consistent with recent episodes that appear to signify inadequate monitoring of corporate disclosures as well as with high levels of executive compensation. Additionally, empirical tests support the model's key implication that there is better governance and lower executive compensation in firms where networks are less likely to form

SEC Says that Cutting Compliance Spend is NOT a Good Idea

In a recent open letter to the CEOs of SEC-Registered firms, director Lori A. Richards urged companies to continue investment in compliance functions.

Your firm's compliance function is critical to assure that your operations comply with the law and rules for industry participation and to ensure that the interests of your customers, clients and shareholders are protected. Moreover, compliance is a vital control function that helps to protect the firm from conduct that could negatively impact the firm's business and its reputation.

While many firms are considering reductions and cost-cutting measures, we remind you of your firm's legal obligation to maintain an adequate compliance program reasonably designed to achieve compliance with the law.

She noted Chairman Cox's recent comments at the SEC headquarters as part of the 2008 CCOutreach National Seminar.

[E]xperience has taught us again and again that giving short shrift to regulatory compliance subjects a company's investors, employees, management, directors, and every other stakeholder to unacceptable risks….[C]ompliance programs have made huge strides in recent years in becoming more formalized and more robust…. Now more than ever, companies need to take a long-term view on compliance and realize that their fiduciary responsibility requires a constant commitment to investors. That means sustaining their support for compliance during this market turmoil, and beyond it as well.

Chairman Cox also noted:

You can't have a strong company without strong compliance, at every level — from strong CEO and executive support for the compliance team, to rigorous standards and processes, to broad financial and organizational resources for you to fully perform your duties.

That latter point bears emphasis. In a profit and loss driven world, there is always a risk that companies facing an uncertain economic future may choose to cut compliance expenses as a shortsighted way to save money. But experience has taught us again and again that giving short shrift to regulatory compliance subjects a company's investors, employees, management, directors, and every other stakeholder to unacceptable risks.

Today, when the future is uncertain, when markets are unstable, when investor confidence is shaken, this is the time — more than ever — when we need a powerful voice for compliance.

When a company cuts compliance, violations will occur. And if violations occur, punitive actions should and will be taken. In the current environment, that is true now more than ever. There will be no favor granted because a company made a cost-cutting decision to minimize their compliance budget. That's because now and always, the interests of investors are inextricably linked to strong compliance.

These comments were primarily intended for investment companies covered by the Division of Investment Management and the Office of Compliance Inspections and Examinations. That said, these comments clearly indicate the SEC's point of view about compliance generally. A point of view that should be carefully considered.