Heskett Column - Have We Carried the Concept of Alignment Too Far?

In the past several weeks we have been treated to vastly restated earnings, the conviction of an entire accounting firm, and the baiting by congressional committees of witnesses drawn from the ranks of corporate managers. We are faced with the prospect of new SEC regulations, a revamped Financial and Accounting Standards Board, new New York Stock Exchange rulings regarding board composition and other matters, and a Corporate and Auditing Accountability, Responsibility, and Transparency Act (CAARTA) by Congress. A misguided overreaction? Possibly. But even Goldman Sachs chairman Henry Paulson said last month, "I cannot think of a time when business overall has been held in less repute."

Regardless of the facts and the appropriateness of the responses, it now appears that actions based on perceptions will not be trivial. Investors, both U.S. and more significantly foreign, are voting with their feet. This hardly provides a stimulus for corporate investment. Executives are confronted with options so far underwater that they may not surface in the span of a management career. And employees are disillusioned by what they read repeatedly about the alleged self-dealing of a relatively small number of high profile leaders. Even my publisher informed me this week that at least one major retail book chain will not promote a book on management unless it is an exposé. Can a wholesale decline in interest in management as a career be far behind?

Is it possible that one culprit is a highly appealing concept universally taught in business schools in the 90s, the importance of aligning the interests of employees and management with shareholders? An important vehicle for achieving alignment was the stock option grant. The bigger the better. This made the potential payoff huge, especially to top executives. It created an incentive to push aggressive accounting to the limits. The practice benefited everyone in the ranks of the aligned—shareholders, employees, top executives, those associated with the capital markets, and anyone desiring a "healthy" economy. Those not joining in risked enormous erosion of value. Accountants could hardly be expected to be more than a weak reed in the hurricane fed by policies of alignment.

Among the proposals for legislation and oversight, one relatively simple one has been set forth by the SEC and supported by the administration to provide checks on what might be regarded by some as the excesses of alignment. It involves holding CEOs and chief financial officers personally responsible for the accuracy of financial reports. Others might include directors among those held responsible, with at least the confiscation of all incentive pay gained as a result of deliberate inaccuracies.

How did we get into this mess? Did an overemphasis on alignment have anything to do with it? What kinds of checks and balances are needed in the future? What do you think?