Alan Greenspan, the former head of the Federal Reserve Board, testified yesterday before the House Committee of Government Overisght and Reform.
The testimony was extraordinary both in his admission to having misjudged basic premises of the US economy and, most importantly for this Blog, the acknowledgement that the pro-management bias evidenced in our system of corporate governance was completely inadequate to protect shareholders. In other words, he is saying that the approach used by Delaware courts, excessive deference to management as a means of ensuring the best intersts of the company and shareholders, is wrong. According to one source:
Greenspan told the House Oversight Committee that his belief that banks would be more prudent in their lending practices because of the need to protect their stockholders had been proven wrong by the current crisis. He called this a "mistake" in his views and said he had been shocked by that.
Greenspan said he had made a "mistake" in believing that banks in operating in their self-interest would be sufficient to protect their shareholders and the equity in their institutions. Greenspan called this "a flaw in the model that I perceived is the critical functioning structure that defines how the world works."The head of the nation's central bank for 18 1/2 years, Greenspan said in his testimony to the committee that he and others who believed lending institutions would do a good job of protecting their shareholders are in a "state of shocked disbelief."
It is, of course, not limited to banks. Management has an incentive to maximize short term gains to ensure maximum compensation even if the long term consequences are disasterous, as the shareholders of Bear Stearns and Lehman have discovered. Yet the Delaware courts have all but eliminated the duty of care and have reduced the duty of loyalty to procedural standards that ignore fairness. They have not imposed meaningful duties to monitor.
They routinely dismiss shareholder suits challenging board behavior because of independent boards that are in fact not independent. Greenspan's criticism goes to the heart of the Delaware corporate governance model and his rational explains why much of the authority should be lifted from one state with a financial motive to favor management.