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Whistleblowing and the Public Director: Countering Corporate Inner Circles

80 Pages Posted: 21 Nov 2003  

James A. Fanto

Brooklyn Law School and Co-Director of the Center for the Study of Business Law & Regulation

Date Written: November 20, 2003

Abstract

I argue that, in the corporate scandals, the contrast between the behavior of many executives, board members and corporate advisors who were reluctant to challenge corporate misbehavior and that of the small number of corporate whistleblowers who did points to a disturbing social psychological reality that has been overlooked in the discussion of, and reforms addressing, the scandals: a group dynamic that binds group members together so that it blinds them to their failings and abuses. I contend that this social psychological reality, long known to and studied by social psychologists, is a basic cause of the scandals.

I first review recent corporate scandals and highlight the evidence of the social psychological phenomenon of the inner group or circle in them. I next explain how social psychological theories, such as "groupthink" and the group production of evil, account for why corporate inner circles behaved improperly. I then look at reform proposals of advisory groups on corporate governance and self-regulatory organizations and argue that the reforms these groups either propose or implement will prove ineffective because they fail to recognize the role of the inner circles in the scandals.

I offer a response, inspired by social psychological theory, that would help prevent future scandals by keeping a board from falling under the domination of an inner circle. I propose that public companies have a significant minority of "public" directors who would be selected for shareholder election to boards from a group of individuals identified by a new government oversight board and whose goal would be to oppose and monitor the firm's inner circle. Since I assume that many existing board members, who now compose an elite coming from a few specific backgrounds, are particularly prone to joining inner circles, I argue that public board members should primarily be drawn from outside this elite. This ambitious reform is needed because investments in public companies have replaced bank investing for most ordinary Americans and because private ordering is not solving the inner circle problem. I then explain how provisions in Sarbanes-Oxley, and the implementing SEC regulations, that change board practices can be understood as an implicit, but imperfect, effort to create an oppositional attitude among board members and their advisors that would counter the rise of inner circles and their groupthink. I discuss the reforms' limitations due to their inadequate grounding in social psychology.

Keywords: corporate governance, directors, social psychology

JEL Classification: K22

Suggested Citation

Fanto, James A., Whistleblowing and the Public Director: Countering Corporate Inner Circles (November 20, 2003). GWU Law School, Public Law Research Paper No. 83; Brooklyn Law School, Public Law Research Paper No. 4. Available at SSRN: https://ssrn.com/abstract=471261 or http://dx.doi.org/10.2139/ssrn.471261

James A. Fanto (Contact Author)

Brooklyn Law School and Co-Director of the Center for the Study of Business Law & Regulation ( email )

250 Joralemon Street
Brooklyn, NY 11201
United States
718-780-7566 (Phone)
718-780-0375 (Fax)

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