The most powerful shareholders are the large institutional investors, such as pension funds, insurance firms, and mutual funds, and they too have belatedly begun to exert pressure on companies with their enormous voting power. The Chief Investment Officer of Calpers, one of the world’s largest pension funds with more than US$130 billion of assets under management, noted that the scandals have had the beneficial effect of unleashing "a new age of corporate governance." In a startling display of shareholder activism that would have been unheard of a few years ago, he wrote a letter to 500 other large institutional investors who have substantial holdings in General Electric stock to encourage each of them to vote in favor of measures that will pressure management to align the executive stock option plan more closely with the company’s performance. Nothing will do more to restore confidence in the integrity of financial markets than actions like this that demonstrate a higher level of vigilance and activism through the exercise of voting rights. It is the shareholders themselves, as the Calpers initiative demonstrates, that are the single most important safeguard against corporate abuse.

Reasons for Optimism

One litmus test of leadership, whether embodied in a government, a company or an individual, is the capacity to respond effectively to crisis. By this measure there is cause for optimism that the corporate scandals are serving as a catalyst for constructive change around the world. Unquestionably, there is a higher level of public awareness about the importance of transparency, effective governance and integrity by those who participate in financial markets, and the severe consequences that result from lapses in vigilance and oversight. One World Bank governance specialist observed, for example, "I no longer need to explain what I mean by the term corporate governance. Wherever I go, it’s become a household word." Ultimately, better-informed, more vigilant stakeholders will do as much to raise the level of integrity in the marketplace as any new law or regulation.

This extraordinary newfound level of public awareness, coupled with an equally potent sense of outrage, explains why governments have responded with alacrity to the scandals with something more than rhetoric. After a similar torrent of scandals was exposed following the 1929 stock market crash, more than three years passed before Congress enacted a set of reforms that dramatically changed the landscape of financial market regulation in the United States, setting a standard that many other countries followed. In contrast, the Sarbanes-Oxley Act became law less than eight months after Enron declared bankruptcy, creating a new benchmark that is being subjected to careful global scrutiny. Regardless of the country or culture, new laws are being passed to tighten oversight and enforcement of firms that raise capital in public securities markets. Although some may continue to argue that the self-correcting mechanisms of the market will suffice to punish corporate wrongdoers and restore the public’s confidence in the integrity of corporate affairs, that refrain has begun to ring hollow even for capitalism’s strongest supporters.

Finally, the scandals have served as a sober reminder that a well functioning market economy must continuously strive to calibrate the balance between public and private governance responsibilities. Well-designed and enforced public policies can help strengthen the incentives, both positive and negative, that encourage appropriate behavior by those responsible for ensuring that the marketplace operates fairly and efficiently. But personal integrity and sound judgment cannot be legislated, particularly in an open, competitive market economy where the legal and ethical boundaries will never be completely clear. These qualities must be embedded in the individuals who go to work every day in the marketplace; they are the ones who must earn the public’s confidence for the system to work effectively. These practitioners presumably rise to the pinnacle of their respective professions not only because of their technical competence and ability to manage others effectively, but also because of their integrity. Rather than tough new legislation, perhaps the ultimate good that will result from the scandals is a newfound recognition by corporate executives and their legions of financial and legal advisors that they have as profound a public responsibility as any civil servant. If this lesson is first learned and then practiced, the public’s confidence and trust in the model so many sought to emulate will be restored.