If leadership is about setting an example that others seek to emulate, who could argue with the proven track record of sustained economic success in the United States? During the boom years of the 1990s, it was hard to find fault with the country’s economic performance. With the stock markets breaking records on a daily basis and the economy reveling in the longest period of uninterrupted growth in the post-war era, the United States could rightfully claim the mantle of undisputed global leader in creating and practicing a brand of capitalism that was the envy of much of the world. Although far from perfect, at the core of the US economic model was an elaborate network of institutions and individuals who presumably practiced the virtues of fairness and transparency while maintaining a so-called level playing field—precisely the qualities that serve as the foundation for competitive markets and sustainable economic growth. Largely because of these characteristics, corporate access to investment capital—the fuel that drives private sector performance in any economy—was broader and deeper by far in the United States than any other country.

Regardless of the country or culture, a prerequisite for market efficiency is public trust—trust in a system where investor decisions are based on reasonably accurate and complete corporate disclosure, where all participants have equal access to information, and where the laws and regulations governing market behavior are effective and enforced. These are the underpinnings that allow investors and regulators to make comparative assessments about risk, price, and performance of those seeking to raise capital in the marketplace. In a market economy, trust is embodied most prominently in an interconnected network of public and private institutions that conveniently fall into three categories: the main government agencies that set the rules of the game for corporate and financial market behavior and monitor their performance, such as the regulators of securities markets and banks; the private sector self-regulating bodies that set standards for acceptable conduct within specific professions, such as accounting, law and banking; and perhaps most importantly, the companies themselves, along with their independent directors, outside legal counsel and financial advisors. The model works at its best when the investing public, the suppliers of capital, has confidence in the competence and integrity of these institutions, as well as in the individuals in key leadership positions who set the standards defining how these institutions operate on a day-to-day basis. The overpowering strength of the US economy, especially during the 1990s, seemed to provide the ultimate validation that the model worked like a finely tuned machine and enjoyed a high level of public confidence.

The credibility of this premise, however, has been seriously damaged by the flood of revelations describing corporate misconduct that began when Enron declared bankruptcy in December 2001. Although the alarm was first sounded in the United States, where the scandals rapidly seemed to take on epidemic proportions, similar headlines exposing corporate chicanery soon began to appear regularly in country after country. The cumulative evidence began to suggest convincingly that this was not simply a story of one or two rogue corporations and their advisors circumventing the rules of the game, or a one-off breakdown by public institutions responsible for oversight and supervision of financial markets. Instead, there appeared to be a systemic erosion of governance standards and practices on all three levels of institutional responsibility: government agencies demonstrably failed to effectively monitor corporate and financial market behavior, the self-regulators were far more intent on protecting than monitoring the performance of their professional members, and corporate executives were enriching themselves at the expense of their shareholders, apparently with the acquiescence of their boards and outside financial and legal advisors. The eruption of scandal raised serious and challenging questions about the effectiveness of the public and corporate governance practices that are at the heart of the model that drives market economies everywhere. These are the rules, standards, and enforcement mechanisms that define how corporate and financial managers disclose material information to investors and regulators, and how they are held accountable. Each revelation of the past two years has provided a graphic reminder that effective governance is critical to the functioning of a market economy. Absent disclosure and accountability, as the scandals demonstrated, public confidence evaporates and the self-correcting magic of the marketplace is unable to function.

What Went Wrong?

Each corporate scandal demonstrated first and foremost a violation of an essential requirement for the functioning of a market economy: public disclosure. In each incident, material information about the companies and the actions of their senior executives was purposefully withheld from shareholders, regulators, independent rating agencies, and others who are entitled to the information. As the evidence mounted in company after company, a severe crisis of public confidence erupted. This is the simple context that unleashed a torrent of criminal indictments, government investigations, and journalistic muckraking that has challenged a broad range of corporate financing practices that were once taken for granted—and considered legal. Although the intense public scrutiny understandably began in the United States, where wrongdoing by Enron, WorldCom, Tyco, and a growing number of other large companies was exposed, within a matter of months a similar pattern of corporate deception began to unfold in countries around the world. It was more than coincidental, for example, that the gigantic Dutch supermarket retailer, Royal Ahold, announced last spring that earnings had been overstated by more than US$500 million during the previous two years, notwithstanding a clean audit by one of the four large accounting firms, Deloitte & Touche. Or that the CEO of one of South Korea’s largest chaebols, the huge private holding companies that dominate the country’s economy, was indicted earlier in 2003 after revelations that profits had been fraudulently inflated to the tune of billions of dollars over a number of years. Clearly, the revelations in the United States triggered a global wake-up call as country after country began to uncover its own scandals.

Regardless of the specifics of each case, the belief that the problems are systemic has been reinforced by a growing recognition that virtually all stakeholders in the capital raising process appear to be complicit or directly involved: senior corporate executives involved in kickbacks, insider trading and other self-enrichment schemes at shareholder expense; accountants so closely entangled with their corporate clients that they appear to have lost sight of their public responsibilities to ensure full disclosure and validate the accuracy of financial reporting; outside corporate directors, allegedly independent, failing to diligently fulfill their fiduciary responsibility to shareholders by holding management accountable; investment bankers playing multiple roles, including creditor, underwriter, investment advisor, and sometimes investor in the deals they structure; stock analysts, purportedly conducting objective research, making recommendations on stocks that are underwritten and traded by the same investment bankers who decide their level of compensation; attorneys compensated by corporations to provide legal opinions on the legitimacy of financial transactions and then retained again by the same company to investigate whether the original opinions were appropriate; and politicians writing regulations to govern the same companies, accounting firms, and investment banks that finance their campaigns. All self-righteously claim to be independent and objective. But the professional judgment of every one of these stakeholders could be clouded by their large financial interest in the outcome of the capital raising process, victimizing the one stakeholder left outside the loop: the public investor.