Are prosecutors going too far?

That's what the New Yorker's James Surowiecki is strongly suggesting in this week's Financial Page column. He's citing questionable criminal cases against Joe Nacchio, the former CEO of Qwest who is accused of insider trading, and Conrad Black, who is accused of defrauding Hollinger International shareholders. Surowiecki doesn't sound totally convinced that prosecutors have run amok, but when an arrogant piece of work like Black comes off looking like the victim, the government has at the least a perception problem.

At the heart of corporate law is something that economists call the “principal-agent problem.” Shareholders—the principals—pay corporate executives to serve as their agents in running a company, and executives are legally obliged to put the company’s interests above their own. But it’s impossible for shareholders, even with a good board of directors in place, to monitor everything executives do. That means executives have a lot of leeway to exercise their own business judgment. It means that they can make decisions more in their own interests than in those of the shareholders. And, if they are clever and corrupt enough, they can steal from the company. These are all usually called “agency costs,” and they’re an inevitable part of the way corporations work. Although fraud is an agency cost, most agency costs are not fraud. That’s sometimes hard for shareholders to remember, especially when executives do a bad job. So when things go wrong at a company it’s a temptation for investors to claim that the company failed because its executives were criminal, rather than simply fallible.

Which is precisely what the CEO apologists are maintaining. Part of being an effective chief executive, they say, is being able to take risks, and when the feds are scrutinizing your every move, the effects can be paralyzing. Sounds like mostly hogwash to me, but the position is gaining strength among academics and investors.

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Mark Lacter
Mark Lacter created the LA Biz Observed blog in 2006. He posted until the day before his death on Nov. 13, 2013.
Mark Lacter, business writer and editor was 59
The multi-talented Mark Lacter
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