Checking managers

BS OPINION

Even if corporate oversight by the company board is rigorous, it is well nigh impossible to deter managers from misusing their position before some damage is done.

In Britannia's case, the problem seems to have been nipped in the bud before serious damage occurred, but several other companies, ranging from Enron to Worldcom to our own Tata Finance, have not been so lucky.

As a matter of fact, ever since Berle and Means pointed out the divorce between ownership and management in a path-breaking study 71 years ago, the issue of how to discipline managers has been debated.

The most influential person in the modern corporation is no longer the owner or owners but the chief executive, who runs the day-to-day business of the company.

To be sure, there is a board of directors which, in theory, is supposed to represent the shareholders and provide oversight, but the board is critically dependent for its effectiveness on the papers and documents to which it has access.

And every CEO intent on feathering his own nest at the cost of the company is going to ensure that the papers in question do not reach the board. Under these circumstances, the board can do little till the irregularities are detected at the time of audit.

Many solutions have been proposed to what economists call the agency problem "" where the goals of the principal (the owners) and agents (the managers) conflict.

The most obvious one is to monitor managers more closely, and this is sought to be achieved by the current emphasis on corporate governance.

Given the shortcomings of this approach, a more sophisticated one calls for aligning the interests of the managers with those of the owners, and managerial compensation by way of stock options is one of the ways of doing this "" except that chief executives have been known to dilute the conditions of their option rights when performance does not measure up to the original yardsticks.

Yet another method is to let the market for corporate control do the monitoring "" bad managers will be punished, so goes this theory, by their companies being taken over.

Another solution is provided by large institutional shareholders, those who are 'too big to sell' and who increasingly want to monitor managers, the classic example being the US pension funds.

Unfortunately, not one of these methods of control succeeded in making managers stick to the straight and narrow in a slew of US companies.

What is to be done? One option would be to encourage whistle-blowers in a company; in the US, they are even being offered financial rewards. The other option is separation of powers.

While a CEO needs freedom to function, there exists one area where reports may be made directly to the board. That area is concurrent auditing. This is currently an unglamorous job, done usually by a manager nearing superannuation.

This needs to be changed, and concurrent auditors' pay and rank improved, so that competent persons are attracted to the job. The crucial factor, however, is that he must report to the board. Done properly, concurrent auditing is the single most important function that will enable irregularities to be detected early.