What Bank Regulation Tells Us About Corporate Governance

An excellent new draft paper by Robert Hockett and Saule T. Omarova has some important insights and context for corporate governance.  Like ontogeny recapitulating phylogeny or like the impressions left by the tiny veins of a leaf thousands of years ago, the vestigial evidence of the earliest stages of development provide important information about the history of the corporate structure and where, how, and why some of the original elements were outgrown or discarded.

Commercial banks are unlike most other American business firms: they are privately owned corporations in a market-capitalist economy, and yet they are explicitly backed, intrusively regulated, and, when they nevertheless fail, expeditiously liquidated by the federal government. In these important respects, banks are undeniably “special,” and widely recognized to be so. But banks also are “special” in a deeper, more far-reaching and constitutive sense, as the most salient living embodiment of a particular understanding of the business corporation. They amount to a vestige of what might be called the original American corporate settlement that established the boundary between private and public interests in the management of large-scale productive enterprise.

In describing how government oversight of non-bank corporations was reduced and the level of control of bank and non-bank enterprises diverged, the authors are frank about the incentives to remove state controls from private enterprise.

Combining with all of these good faith reasons for loosening corporate requirements, of course, would have been less noble ones. Corporate privilege in general, and unconditional limited liability in particular, constituted a grand invitation to externalize costs upon others, and those actuated by such temptations would have found
nobler-ringing rationalizations of their demands for corporate status ready at hand in the developments just described. It is difficult to quantify precisely how prevalent responsibility-ducking motives were among even those clamoring for “free incorporation” on plausible political and economic grounds, but the literature suggests that the “market for incorporation” had become rife, by the late 19th century, with “stock-watering,” creditor swindling, and other scams. [footnotes omitted]

There has been a lot of pressure to treat banks more like non-bank corporations and significant movement in that direction, as the authors note. But they suggest some small steps to the contrary, possibly beginning with (or, rather, returning to) the notion that enterprises justify the enormous benefits and subsidies they get from incorporation by “taking a clue from the bank chartering process and requiring each business entity seeking incorporation to provide to the chartering authorities (1) a more specific description of the business activities it plans to conduct (a statement of “business purpose”), and (2) a separate description of how exactly its business activities would benefit the national, regional, or local economy or community (a statement of “public purpose”).”

This is an important paper and we look forward to seeing the final version.

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