I think it’s useful to discuss a bit more in detail Julien’s comment on my post on whistle-blowing. In fact, his very relevant point concerning the “capturing” of external control by the controlled makes me think of Arthur Andersen or the external auditing in general. In fact, audit companies are precisely supposed to perform an external control on their clients, making sure that the accounts are right. The problem however is precisely, that “outside” does not mean “independent”, “neutral”, or “without personal interest”. Any durable social relation implies some degree of mutual dependence. This is notably true for an auditing firm and its clients: the firm is dependent on revenues that are paid by the client and the client-firm is dependent on the auditor’s favourable report. This mutual dependence can eventually lead to a situation where the interest of both conflate or at least overlap in large parts, especially when confronted with interests of actors which are not involved in this relationship. When an auditing firm like Arthur Andersen makes large parts of its profits thanks to a mandate in one particular firm, it seems very likely that they do not want to upset this valuable client and may turn a blind eye on some practices that they would otherwise consider to be problematic.
The problem lies hence in the confusion of the term “outside” and “independent” and especially in the difficulty to establish social relations between the controller and the controlled that guarantee that this relationship will allow a genuinely independent control.
I guess that’s precisely what Alain Minc meant when stating that “the independence of directors is an alibi” (thanks Julien for sending me this link). In this interview Minc – chairman of the supervisory board of the French newspaper Le Monde and business consultant – states that the idea of “independent directors” is largely an illusion. In fact, ‘independent directors’ is often synonym with ‘incompetent directors’ since they don’t know the company which they are supposed to control. The trade-off he suggests is that the more a director is “independent”, the less well she knows the company and hence the less competences she has to play her role as controller and vice versa: better knowledge of the company implies necessarily closer personal or professional relations and hence less independence.
According to Minc, the claim for independent, non-executive directors serves mainly the managers to increase their power. I made a similar point in an earlier posting when talking about “structural holes” that may appear between the board and management when too many non-executive directors sit on the board, allowing the CEO to exploit his informational advantage. Minc is right when stressing that people that sit on a board do necessarily have some kind of personal or professional ties, since they are part of the same rather small social group, the business elite. These ties are not per se a problem. Or rather, since they are inevitable, we have to deal with them. The challenge is hence to create organisational structures that allow an efficient control despite these social ties. Minc states that the solution is transparency, i.e. each director has to openly declare her ties. I don’t think that this is enough. Minc who holds seats in different companies with sometimes conflicting interests states that he does not intervene in decisions that could imply a conflict of interests. This, however, cannot be legally enforced or controlled, but depends entirely on the integrity and the business ethics of the director in question. In such a situation, transparency without enforcement mechanisms does not allow for efficient control.
Efficient control might in fact be function of different dimensions that have to be efficiently combined: internal control, external control (by state agencies for instance), and market control. One could ad the dimensions peer-control, sectoral control by associations etc. (see Arndt Sorge’s recent book “The Global and The Local” pp.190f for a listing of different dimensions). The empowered third-party control, which Julien mentions in his comment, can indeed be seen as one possible combination of these instruments. But as he mentions as well, it looks like there will always be a part of the control structure which is contingent upon the actors’ integrity, and the risk of fraudulent behaviour cannot be entirely eliminated by organisational design. The efficiency of control mechanisms can be enhanced by the existence of a self-imposed “ethical code” among the business elite, and a social control among these elite guaranteeing the observation of this code. Without social norms within the elite condemning fraudulent behaviour and hence pushing managers to refrain from abusing their power, any control structure can ultimately be bypassed in one way or another…Unfortunately such social norms seem to have gone out of fashion in a more and more cynical society where hedonism and personal profits rank among the highest values…
