The trial of Kenneth Kay, Enron's Chairman and CEO, has again brought to the fore the fundamental fallacies in the codes of corporate governance that regulators tout as panacea for the ills of the corporate sector , the most glaring of them being the assumption that the CEO can supervise and correct every activity a corporation undertakes, irrespective of the size of the corporation.
Nothing could be farther from the reality on the ground. When regulators seek to impose good governance, they sometimes end up doing more harm than they prevent.
William Allen, now a law professor at New York University but formerly a judge on the Delaware Chancery Court, where big corporate lawsuits are now being heard, had once opined that regulatory changes have gone too far. Many of the new regulations require taking measures that most Boards ought to have taken of their own volition.
By converting these voluntary measures into law, regulators convey the impression that they are focusing more closely on their supervisory role though, in reality, this is the quiet route to mechanizing, rather than energizing their supervisory role.
It is also an admission of the fact that corporate managers are no longer as responsible and trustworthy as before. Yet, no barriers are being erected to prevent corporations from expanding into unmanageable empires.
According to Enron's CEO Kenneth Kay, the company expanded to its pre-collapse size in 15 years, stretched its operations into 30 countries, and its work-force overshot the 30,000 figure.
This empire was supervised by over 500 vice presidents, 30 country chief executives, a 25-member executive committee and a 12-member board of directors of which he was the Chairman besides being the company's CEO.
Without any hesitation, he admitted his responsibility in the failure of the Enron but asked the question: "Is it fair to expect me to know with certainty that every Enron employee was reporting everything honestly?"
The misconception about CEO's enormous role also has a lot to do with unwarranted optimism about the ability of modern-day information technology to collect, collate and summarize the impact of every activity taking place in a corporation.
To make their lives easy, regulators conveniently overlook the fact that in spite of the amazing advances in information technology, it is no substitute for employee integrity; the infamous GIGO principle (garbage in, garbage out) continues to apply to computer generated information, its transmission and its eventual reporting to decision-makers. At each stage there is room for fiddling with the reported facts.
Without any doubt, regulators' expectation that Kenneth Kay should have known the truth about everything that went on in Enron is, misconceived. It seems no more than a deceptive attempt at passing the buck for absence of regulatory supervision entirely on to the CEO forgetting in the process the regulators' own role as well as that of the board of directors and the many Board-appointed supervisory committees.
The tragic part is that the tendency to pass the buck on to the CEO is spreading like a disease among the regulators. Yet, unwitting politicians nowhere seem to notice this tendency.
No politician has found it necessary to contain the drive for expanding companies beyond the size that can be supervised effectively by a CEO. None has found anything wrong with mergers and acquisitions that turn corporations into untamable monsters.
It is only when one of them collapses that a witch-hunt starts for scapegoats to shield regulators from getting the blame there-for. Yet, companies everywhere go on expanding increasing the chances of their collapse due to inadequate, or no supervision at all.
In spite of the devastating corporate collapses during the past three years, no government has found it fit to investigate whether the unwieldy size of the corporations was one (or, perhaps, the main) reason for their collapse because, in almost every such case, supervision became progressively lax as they expanded in size, although the fundamental truth about mismanagement and organizational chaos is that it grows in direct proportion to the size of the organization.
Almost everywhere, codes of corporate governance overemphasize the roles of non-executive Directors and supervisory committees composed of these Directors. In Pakistan, regulations limit executive directors to 25 per cent of the Board strength.
The balance 75 per cent must be non-executive directors. In reality, finding non-executive directors, who can effectively supervise company operations and the CEO, is tough because of the increase in supervisory responsibilities and the risk inherent in failing to fulfil them.
Defying these ground realities, regulations continue to require that supervisory committees of the Board must consist of non-executive directors. In this context, the state of Audit Committees - key tool of external financial oversight - is particularly alarming.
According to Peter Crist of Korn-Ferry, finding non-executive Directors familiar with financial accounting and having expertise in financial management to qualify for sitting on Audit Committees, is a "damn tough" job. Had Peter Crist examined the scenario in Pakistan, his experience would have been ten times more disappointing.
Supervisory committees of the Board exhibit little expertise for scrutiny even in the developed countries. Martin Taylor, a British businessman who sits on five Boards in five different countries, recalls the Audit Committee in an American corporation used to meet after the figures that it was supposed to scrutinize had already been released.
In Pakistan, Audit Committees meet more as a ritual than for carrying out the sacred task of examining and qualifying operating results. Colin Mayer, professor of management at the Oxford University, argues that non-executive directors have not been good at disciplining company managers.
In 420 of the 2,000 large American public corporations covered by a survey conducted by the New York Times, the Board's compensation committee, which determines the CEO's pay, included people with ties either to the CEO or to the company. This raises the question whether non-executive directors truly serve as the shareholders' watchdogs?
In April 1999, speaking at the Centre for Business Ethics at the University of St. Thomas in Houston none other than Kenneth Lay had said: "What a CEO expects from a Board is good advice and counsel, both of which will make the company stronger and more successful; support for those investment and decisions that serve the interests of the company and its stakeholders; and warnings in those cases in which investments and decisions are not beneficial to the company and its stakeholders."
These are fair expectations from a Board consisting of able and discerning directors. Apparently, the Enron had none of the kind on its Board. Kenneth Kay may have made serious mistakes, or committed some deliberately to benefit personally, but what were the Directors doing at the time? Were all of them as corrupt as Kenneth Kay or most of them were simply incompetent? The later is the more likely of the two possibilities.
In that case, contrary to the charges framed against him, Kenneth Kay alone shouldn't be blamed for the Enron disaster. The experiment of placing excessive confidence in the abilities of non-executive directors is failing.
The recent corporate failures call for urgent re-thinking by regulators about relying too heavily on the competence and integrity of non-executive directors. Instead of acting as shareholders' watchdogs, they can sometimes hurt the shareholders very badly.
Unless regulators come up with tough guidelines on the minimum professional capabilities of individuals being elected or co-opted as non-executive directors, they will have to share a large part of the blame for corporate failures.