Sunday, November 12, 2006

 

Helping the State: The Role of the Press and Whistleblowers in Fighting White-Collar Crime

Yesterday’s Tages Anzeiger (November 11, 2006, print edition) revealed a new „corporate scandal“ in Switzerland. This time, however, the scandal is somewhat special. In fact, no law was broken, no regulation by-passed, and no company went bankrupt. What happened? According to the newspaper, 40 mangers of Cablecom, a non-listed telecom company, had acquired during the takeover of the company by American institutional investors in the fall of 2003 a 8% stake in their own company for CHF2.8m. two years later, when the company was sold to the US group Liberty, the same 8% stake was sold by these same mangers for CHF144m. This is of course not shocking in itself. However, what the popular Swiss newspaper Blick decries as being outrageous is the fact that the same year, i.e. in the fall of 2005, the management of Cablecom announced the layoff of 260 staff. Once more, the unlimited greed of the managing elite seems to contrast starkly with the hardship that the “normal” employees have to endure.

Be that as it may, what is interesting in this case is the way in which this issue was made public. In fact, Cablecom, as non-listed company, does not publish any annual report or accounts. Hence, no information about the value of the company and the shareholdings of its executives is available. In fact, the above-mentioned facts and financial figures where made public by an employee who got hold of a copy of the “confidential” annual report and informed the press.

Even though this particular case is, at most, a case of reprehensible moral behaviour (realising a benefit of 5000% on one’s investment and at the same time laying-off 260 staff in order to reduce costs), the mechanism that was at work is very important. Several academics in the field of finance have expressed the view that a functioning (financial) press – i.e. one that is precisely capable of revealing this kind of incidents – can serve as a functional equivalent for legal protection of investors and other stakeholders that do not control the companies decision-making process. In other words, in countries where minority shareholders and other minorities in the firm are not well protected in company law, the public denunciation of “crooks” in newspapers can have a deterring effect on other potential crooks and can permit to punish crimes that otherwise would go unpunished. This at least is the thesis defended by Alexander Dyck and Luigi Zingales in their study on private benefits of control.

This brings us back to a point, which I’ve made in several previous posts. In fact, I have pointed out the limits of public regulation for preventing “misbehaviour” by corporate insiders. The financial press is in fact a mechanism that can denounce criminal or unethical behaviour, push the corporate elite to justify their actions, and put certain issues on the political agenda by creating a public pressure. Even though such mechanisms can of course be (ab)used for populist goals, the financial press can exercise a certain control over corporations in ways that the state cannot.

This is especially the case, where there is no immediate clearly identifiable victim of the insiders’ actions. Most legal offences of corruption are such cases: none is immediately harmed and none is hence going to file a law suit against the delinquent. In such cases, the denunciation of crimes – or supposed crimes – to the press by another corporate insider can prove to be the only way to stop this kind of wrongdoings.

The legislators in different countries seem to have understood this and have adopted legislation that aims at protecting the so called “whistleblowers”, i.e. employees of a company that denounce the fraudulent and criminal behaviour of their collaborators or superiors. In the US, the Sarbanes-Oxley Act reinforces the protection of “whistleblowers”. In Switzerland, following the initiative of a social democratic and a radical democratic MP (Remo Gysin and Dick Marty), the Parliament has asked the Federal Government to elaborate a proposition in order to legally protect whistleblowers. Also, the Swiss branch of Transparency International has established in April 2005, in collaboration with the Federal Government, a hotline for whistleblowers (cf. NZZ Online, October 5, 2006). Once a week, people who detect criminal or unethical behaviour within their company can call this hotline in order to denounce their colleagues. What may appear at first glance as disloyal behaviour towards once company is in fact an important mechanism of corporate control.

All countries, however, do not seem to adhere to this view. Thus, in May 2005, the French commission on the protection of data privacy (Commission nationale de l’informatique et des libertés, CNIL) has prohibited two companies to establish such “ethical lines” for whistleblowers, fearing that such hotlines could lead to an “organised system of professional denunciation”. The risk of some whistleblowers being motivated by personal motives rather than a genuine will to knock criminal behaviour in their company on the head can of course not be completely excluded. However, such hotlines do constitute an instrument for fighting crime, in a place where the state has no chance to do so.


Comments:
What about the empowerment of a group of actors (say, representatives of employees for example) within or outside the company as an instrument for preventing harmful behavior from another group? The new power of the insiders or outsiders might have a deterrent effect on others. That's actually what is being implemented as regards hazard prevention in high-risk industries in France. The representatives of the employees (CHSCT) just gained several information rights on risk management as well as some sort of an institutionalised whistleblower mission as regards major risk prevention...
 
Julien, Thanks for the comment! Very relevant! My answer would be that recent years have seen an increased suspiciousness in many countries towards control by insiders. In fact, one of the main features of the so called “Americanisation” of corporate governance practices in Europe and other parts of the world implies precisely a weakening of internal controls, which are replaced by outside control mechanisms through market forces. Thus, board room representation of bankers, employees, large shareholders are rather considered to constitute a risk of expropriation for minority shareholders. The only efficient control is – in this view – control from outside through market signals, which is summarized in the famous “wall-street-rule”: “sell out if you dislike management”. In that sense, what is needed to achieve efficient control on managers (or insiders in general) is transparency and strict accounting rules so that insiders cannot extract private benefits of control.

I guess the advocates of this view just scored a point when we look at the “Hartz-Prozess” in Germany (cf. http://www.faz.net/s/RubFC06D389EE76479E9E76425072B196C3/Doc~EDC7C2DC2FC9340B7A711CE43B363DA4C~ATpl~Ecommon~Scontent.html. )In fact, the German corporate governance system is characterised by its far-reaching codetermination rights for employees; meaning that half of the seats on the supervisory board of large stock corporations are held by employees and/or union representatives. This is of course a potentially powerful means of internal control. However, what happened at Volkswagen during the era of Peter Hartz, is that large sums were spend in “gifts” to supervisory board members, and notably to the employees representatives, in order to buy their votes for difficult decisions. This extreme case does of course not put into question the codetermination system as such, it shows however poignantly the limits of the reliability of internal control mechanisms. The problem is – in my view – that when a very limited number of people interact over a long period of time and have collectively far-reaching control over resources, sooner or later someone will be tempted to abuse this power…
 
mmmh, the issue of enduring relationships between insiders is a good point... although I remember reading some guys who argued that external control might just as well be "captured". Actually, the argument was about regulatory control agencies and private businesses. There are cases when controllers actually developed an excessively cooperative relationship with those they controlled, so that they internalised the latter's interests and therefore failed to retaliate in case of non-compliance. So that actually, you might conclude (like those same guys) that the issue is less at first about having control groups inside or outside, but rather that you actually have more than one. In other words, you have your regular oversight group plus an empowered third party who may actually get involved in case the former would not perform well in its mission. actually it's some kind of a market mechanism, since the control itself is subject to some form of competition... Of course, there's always the possibility that the company would actually have enough resources to capture the third party as well... mmmh... dunno.
 
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