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The Dangers of Too Much Governance

October 15, 2003 | Bengt Holmstrom , Steven N. Kaplan | Strategy

Most people accept that innovating involves risk. If a gene-therapy patient dies, regulators stiffen controls, but not so much that gene therapy becomes impossible. Similarly, the United States must apply balance in addressing business scandals, say the authors. Corporate-governance problems call for safeguards, but not to the point of hobbling economic growth. As dangerous as an Enron is, a system designed to make all future Enrons impossible would be worse.

The common wisdom that unbridled executive compensation has hurt the stock market irreparably and that investor confidence must be restored is not supported by facts, according to the authors. Research shows that the U.S. stock market outperforms other countries' over long horizons and, even after the scandals, was no worse than other stock markets.

Why has it done so well over the long term? Factors including incentive pay and improved governance have played a role. CEOs have more equity ownership than 20 years ago and care more about stock prices. Institutional investors are increasingly important and push for higher stock returns. Boards are more independent. The recent scandals do not necessarily indicate a poorly designed system, the authors argue. Redesigning the system to eliminate all excessive behavior would pose greater risk to innovation and growth than the behavior itself.

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