The Mess at Morgan: Risk, Incentives and Shareholder Empowerment

Abstract

The financial crisis of 2008 focused increasing attention on corporate America and, in particular, the risk-taking behavior of large financial institutions. A growing appreciation of the “public” nature of the corporation resulted in a substantial number of high profile enforcement actions. In addition, demands for greater accountability led policymakers to attempt to harness the corporation’s internal decision-making structure, in the name of improved corporate governance, to further the interest of non-shareholder stakeholders. Dodd-Frank’s advisory vote on executive compensation is an example.

This essay argues that the effort to employ shareholders as agents of public values and, thereby, to inculcate corporate decisions with an increased public responsibility is misguided. The incorporation of publicness into corporate governance mistakenly assumes that shareholders’ interests are aligned with those of non-shareholder stakeholders. Because this alignment is imperfect, corporate governance is a poor tool for addressing the role of the corporation as a public actor.

The case of JP Morgan and the London whale offers an example. Although JP Morgan suffered a massive loss due to the whale’s risky trading decisions, JP Morgan shareholders benefited from this risk-taking. Accordingly, shareholders were poorly positioned to address the incentives that drove risky operational decisions. So-called “improved corporate governance” in the form of shareholder empowerment, rather than functioning as a solution, may have exacerbated the problem. In the end, the mess at Morgan demonstrates limitations on the value of shareholder empowerment in addressing the public impact of the corporation and suggests that, at least in some cases, regulatory approaches such as the Volcker rule may be warranted.

Keywords: Corporation law, corporations, securities regulation, risk management, investment banking, Dodd Frank Wall Street Reform and Consumer Protection Act, Volcker Rule, JP Morgan Chase, publicness, executive compensation, accountability, regulation, credit derivatives trading, corporate wrongdoing

JEL Classification: G18, G23, G28, G32, G38, K22