Thursday, November 7, 2002

In keeping with 32 years of tradition, friends and colleagues gathered for the Annual Workshop on Commercial and Consumer Law from October 18-19, 2002. Convened again by Prof. Jacob Ziegel, the event provided two days of enlightening discussion capped by an after dinner address by internationally renowned professor and scholar John Coffee, Jr. of the Columbia University School of Law.

In his address, Prof. Coffee traced the historic causes of the current crises in corporate governance, dismissing catchphrases such as "infectious greed" and "failure of morality" that are commonly used in the popular media. Instead, he proposed a systemic explanation rooted in the long-term structural changes in American corporate law and finance, locating the crisis in the unhappy confluence of two interdependent trends. 

The first recognizes the diminished efficacy of remedial mechanisms designed to deter accounting irregularities. The second identifies what behavioral economists have termed the "status quo" bias, that is, the self-reinforcing optimism of investors that can distort market realities in times of rapid growth. He said this trend, in concert with lesser deterrence, has contributed to the appeal of creative accounting.

At the same time, consulting began to displace traditional accounting services as the most profitable operation for the Big Five. As a result, auditors were willing to acquiesce to aggressive accounting in order to maintain the relationships that brought in the lucrative consulting contracts. Likewise, institutions on which investors rely for sound advice - such as securities analysts, debt rating agencies, investment bankers and sometimes even lawyers - became immersed in the market bubble by the rapid growth in the late 1990s. 

There is evidence to show that a number of significant changes in the legal landscape have resulted in a dramatic reduction in the litigation exposure of accountants and auditors. And the expense associated with forensic investigation of sophisticated accounting techniques often prove beyond the resources of the SEC, effectively removing any serious threat of criminal conviction.

On the incentive side, the trends began long ago with reforms intended to make corporate managers more responsive to the market and to shareholders. In addition, the increased proportions of equity compensation for managers, coupled with the advent of the hostile takeover and the leveraged buyout in the late 1970s, caused managers to focus principally on engineering higher earnings and short-term gains in stock prices.

As the bubble expanded, cautionary voices became an unwelcome nuisance, and certainly bad for business as fund managers competed to offer higher returns. As Prof. Coffee aptly put it:  "It is dangerous to be rational when everyone around you is being irrational."

While the Sarbanes-Oxley Act promises to restore the independence of auditors, Prof. Coffee remains guarded, advocating more rigorous regulation to reverse the structural trends which allowed these nefarious practices and resulted in audit failures. 

Described by the National Law Journal as "one of the most influential lawyers in the United States," Professor Coffee joined Columbia Law School in 1980. Previously, he was a Professor at Georgetown University Law Centre, and a Visiting Professor at Stanford University Law School, the University of Virginia Law School, and the University of Michigan Law School.

- Nersi Makki