Regulation through Reputation

 
 

Attempts to regulate corporate misbehavior need to find a better instrument than intrusive regulations.

Print Friendly, PDF & Email

In the aftermath of the global financial meltdown, the public has turned its attention, and its anger, toward the corporate malfeasances that helped cause the crisis. Meanwhile, corporate leaders have been directing their attention increasingly to matters of corporate ethics, transparency, and disclosure. Debacles such as the $3.6 billion in bonuses awarded to executives by Merrill Lynch preceding its takeover by Bank of America have been met by global discussions about how to rein in executive compensation and the appointment of a domestic “pay czar.”

The recent G-20 summit convened in Pittsburgh represents a dramatic new escalation in the push for global governance of corporate financial affairs. The body’s efforts to promote international economic teamwork will not only attempt to curb excesses and set executive pay in accordance with the long-term plans of a firm, but also weigh in on issues as varied as sustainability, food policy, and corporate social responsibility.

At first glance, it all sounds like a promising idea: establish an international body that can provide robust oversight and regulation to foster greater stability in the financial world. But in fact the G-20’s Financial Stability Board (FSB) is sowing seeds that pose significant dangers for world economic freedom. Of particular concern is the danger that lies in ceding pseudo-legal authority to institutions such as the FSB to establish international norms for executive compensation and other corporate governance arrangements, which forcefully intrude into the internal functions of private firms while at the same time cranking up rules covering everything from accounting to climate change.

The problem with such a move is that it represents a stark departure from the general trend in global governance constituted by the emergence of “soft law,” or civil regulations. Within the past several decades, substantial changes in global governance and business regulations have been taking place in accordance with the process of globalization. The growing corpus of transnational civil regulations utilizes private, non-state and market-based regulatory regimes to govern multinational enterprises and global supply networks. For the most part, the regulations have been influencing the manner in which global companies and markets bear on human rights practices, labor conditions, environmental sustainability, and community development, particularly in less developed countries. The mounting influence of the stakeholder view of corporate governance together with the emergence of corporate social responsibility (CSR) reveals an intensifying influence of the so-called “global public domain” in molding public policy and regulation toward business enterprises. Scholarship indicates that the regulatory power of the state is accordingly undergoing extensive decentralization. Thus, a blend of state and market, public and private, traditional and self-regulatory institutional structures characterized by alliances built among nation-states, private nongovernmental actors (activists, NGOs) and business enterprises is replacing the traditional mode of hierarchical command-and-control regulation with regard to economic actors.

 

However, in the eyes of some, the march toward instituting global civil regulations for international business firms has been advancing on thin ice in the sense that it is unclear just how such emergent systems of economic governance—sometimes referred to as “governance without government”—are to be reconciled with the connected ideas of democracy, the rule of law, and legal accountability.

It can be difficult to discuss or understand “democracy” in the world arena. Corporate accountability to environmental, labor, and human rights standards—and now executive pay structures as well—is strongly decentralized and diffused. Elections, sometimes called “procedural representation,” are being replaced with functional representation by technical experts, and purported moral representation is being asserted by social groups and NGOs. Such developments increase the number of political players, creating a diffraction of political legitimacy.

As for the concept of the rule of law, corporate officers, public authorities, and the heads of non-profit enterprises are all subject to legal accountability for their behavior through established transnational mechanisms of administrative and criminal law. The World Trade Organization,  the Dispute Settlement System, the Hague International Criminal Tribunal for the Former Yugoslavia, the International Criminal Tribunal for Rwanda and the International Criminal Court represent institutions set up to enforce legal accountability in the global context. Of course, an agent’s failure to conform to standards of legal accountability will typically trigger reputational sanctions as well, and maintaining a solid record of compliance with legal accountability frequently provides for its own reputational rewards.

Yet many of the emerging forms of civil regulations for transnational business enterprises frequently operate more on the grounds of persuasion than by the force of coercion that is characteristic of domestic law and the traditional concept of the rule of law that undergirds it. International standard-setting bodies like the G-20 differ from recognized international economic institutions in that the former have numerous non-legal characteristics.  Such standard-setting institutions do not enjoy a distinct legal personality established by nation-states; they lack authority to conclude treaties, and are bereft of international legal immunities. Instead, they amount to nonformal groupings composed of state representatives and technical experts convened to speak to particular problems and to address sundry matters of special concern. Although these bodies lack competence at both national and international levels as far as hard law-creation goes, nevertheless the soft law norms that they are adopting have a perceptible effect on the conduct of states and influence the public policy debates about global financial governance.

 

In this regard, it should be noted that although the G-20 is for the time being only equipped to deploy moral suasion against nation-states deemed noncompliant with their edicts, there has nevertheless been chatter in some circles suggesting the possibility of impending sanction authorization. Yet to the extent that organizations embarked on crafting international financial standards perpetuate a misrepresentation of the character and status of those standards as, on the one hand, either completely noncompulsory suggestions that need not be taken seriously or, on the other hand, as binding coercive norms carrying the full force and effect of law, the substance of their guidelines will harbor the potential to hamper economic progress and financial growth.

The possibility of such a negative influence can be seen in the failure of international regulatory standards issuing from the array of financial norm-setting bodies (i.e, the “Gs” ranging from the G-7 and G-10 up to the G-20) to protect adequately the global financial system from the financial crisis. It was in part the incapability of such associations to foresee the potent risks generated in the financial system during the past decade that has sparked such widespread condemnation of both the organizations and their committees (such as the G-10’s Basel Committee on Banking Supervision) for a lack of transparency and accountability in their decision-making structures, as well as for their negligent oversight of the international standard-setting methodology.

It will therefore be important going forward for global civil society to specify carefully not only the nature of the authority, but also the degree of professional competence and credibility that emerging sources of global financial soft law must carry concerning institutional structures of decision-making set up in the name of attaining financial stability and economic growth.

 

More often than not, the motivations for business enterprises to comply with soft law stem more from the need to protect intangible reputational assets of the firm than from the avoidance of any physical pain or loss of liberty of the sort produced by conventional legal sanctions wielded against human persons. We might term this sort of compliance dynamic the “rule of reputation.” Indeed, it is arguable that the regime of global civil regulations and their accompanying “rules of reputation” are no less significant or effective than systems of domestic or international law; such corporate governance systems are backed by the force of reputational sanctions the nature and extent of which are not always fully comprehended by legal experts and economists alike.

As we contemplate new efforts to create worldwide standards for corporate governance, the concept of reputational capital needs to be squarely incorporated into our thinking. In the interest of preserving personal freedom and economic sovereignty, the overall process should be one inspired by corporate self-regulation grounded in moral virtue, not by excessive governmental intervention of politicians and international technical experts. It goes without saying that efforts at imposing more laws and restrictions cannot possibly be effective so long as the prevailing mindset of business managers is to find loopholes for any regulations that stand in their way or prove to be unbeneficial.  By establishing more bureaucracy, barriers, and complexity in the business world it becomes more difficult for wealth-creating entrepreneurs to pave their way and pick themselves up during and after the crisis.

Failing moral standards in business and across society are a major invisible force behind the financial crisis. Moral principles should be integrated into systemic governing bodies and corporate actions to ensure the common good. Market participants must realize that they are responsible not only for their own contribution but for how their contribution impacts the entire financial system. There must be mutual respect and a spirit of pursing the overall good of the firm and the human community, not just a narrow focus on correcting details of individual performance. Yet bodies such as the G-20, populated by officials and their delegated bureaucrats, many of whom remain clueless about the specifics of how successful business firms operate in competitive environments, the way trustworthy companies are able to generate real wealth, the fine art of creating lasting jobs, benefits, salaries, and building equity in products and services that make up the value that business delivers, tend to direct their attention towards fixing technicalities and minimizing risk. In order to establish enlightened leadership for business it is more important to look at broader root causes and to propose solutions likely to foster the forthrightness in commercial activity that is required to restore the moral deportment of many well established business enterprises around the world.  Rather than staking our hopes on increased regulatory intervention, what we need to realize is the simple truth that in the world of business, both today and since antiquity, reputation rules.

Kevin T. Jackson is Professor of Law and Ethics at Fordham University’s Schools of Business in New York City, and a Senior Fellow of the Witherspoon Institute. He is the author of Building Reputational Capital and sits on the Editorial Board of Public Discourse.

Print Friendly, PDF & Email

 

 

Related Reading


 

Web Briefings


PD logo

Want more great articles?

Sign up for daily or weekly emails!

subscribe button