Is Europe Immune to Corporate Scandal?

The recent $1.4bn settlement between Wall Street's top investment houses and the US Securities and Exchange Commission (SEC) epitomizes the distorted incentives and regulatory failures that underlay the string of spectacular corporate failures seen in America in recent years. The admission that securities analysts deliberately skewed their research to attract investment-banking customers shows how easily the proper functioning of checks and balances in corporate governance can break down-even in the most advanced system-leaving minority shareholders at risk.

Managers, after all, are imperialists by nature, inclined to undertake massive investment projects, mergers, and acquisitions. So investment banks are only too willing to play along. Rising share prices facilitate managerial empire-building and imply a massive windfall for insiders with stock options. So managers are quick to embrace "aggressive" or "creative" accounting methods that flatters earnings projections, conceals risks, and portrays a smooth record of profit growth. Finally, managers, not distant shareholders, control access to well-paid appointments and lucrative consulting jobs. So internal and external auditors are often co-opted.

To be sure, the US corporate and securities scandals exposed regulatory gaps-insufficient enforcement of disclosure requirements, for example, or excessive reliance on peer review for auditors and on so-called "Chinese Walls" to keep brokerage and investment-banking activities separate. Moreover, US accounting standards have been unable to cope with bookkeeping's uncharted frontiers of off-balance sheet transactions, structured financing methods, and Byzantine contract valuations.

The deeper question is whether these problems are limited to the US, and whether they reflect America's characteristic diffuse structure of corporate ownership. Diffuse ownership, with a large number of relatively small shareholders entrusting day-to-day company operations to independent managers, prevails in the US and the UK. Concentrated ownership, with one or more controlling shareholders, prevails in continental Europe (and, indeed, in the rest of the world).