Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure

I have written a paper on the role of the Securities and Exchange Commission in the corporate governance process.  The SEC has traditionally been consigned to disclosure, with substance left to the states.  In fact, the Commission has long been involved in the substance of governance.  We will be talking more about this topic in future posts.  Thepaper can be found on SSRN.  The abstract is below.   Comments are invited.

Abstract

This article explores the role of the Securities and Exchange Commission in the corporate governance process. Traditionally, most have viewed substance as a matter for the states and disclosure for the Commission. This “neat” dichotomy has been long accepted but little examined.

The Commission was always meant to play a role in the governance process. Congress assigned to the SEC the authority to regulate disclosure in part to prevent various abusive practices by management, including the payment of excessive compensation and self perpetuation. Disclosure largely eliminated secrecy but did end self interest. Instead, pressure built on states to loosen substantive standards. Disclosure, therefore, contributed to the continued decline in substantive standards under state law.

With the link between substantive standards and accurate disclosure increasingly apparent, the Commission began to intervene into the governance process more directly, employing disclosure as a mechanism designed to alter the behavior of officers and directors. The approach, however, didn't work particularly well. Disclosure couldn't entirely compensate for the declining substantive standards under state law.

These dynamics have changed significantly with the adoption of Sarbanes-Oxley. The Commission has now become more overtly involved in the governance process. The impact of these changes have yet to be fully realized but they contain the potential for a profound shift in the traditional approach to corporate governance.