Speech by SEC Chairman:
Remarks to the American Council on Germany
"Corporate Governance in a Global Arena"
by Chairman Arthur Levitt
U.S. Securities & Exchange Commission
"Corporate Governance in a Global Arena"
American Council on Germany
New York, N.Y.
October 7, 1999
Thank you Paul for your generous introduction and to the American Council on Germany for having me here this evening. I want to congratulate Sandy Warner and Ulrich Hartmann, for their remarkable accomplishments, and for their leadership during this exciting era for business and markets worldwide.
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These are exhilarating times indeed times of profound change with momentous ramifications for our future. Today, the forces of technology and globalization are recasting the worldís markets with both silent influence and bold strokes. Through greater innovation, enhanced communications, and new computer networks, the notion of distance as a barrier has been all but archived. Like no other time in the history of global markets, we stand at the doorstep of limitless opportunity.
A broad public dialogue has already begun on many of the issues and developments unfolding as U.S. markets respond to the forces of technology and competition. Electronic communications networks are challenging trading floors. The national exchanges are pushing forward in their plans to demutualize. Options are now listing on multiple exchanges. Markets, at their most basic level, are being recast.
All of these developments pose tremendous challenges that stand to broadly redefine U.S. markets for decades to come. But, we can talk about the structure of capital markets, we can talk about order flow, we can talk about execution costs, and we can talk about liquidity all we want. Itís nothing more than an academic exercise if investors donít trust the quality of the underlying financial information.
Tonight, I would like to talk about what will guarantee high-quality and meaningful information for investors, regardless of what face or form our markets may take: strong corporate governance. Up until very recently, the mere mention of the phrase "corporate governance" induced heavy eyelids and wide yawns. Today, thatís not the case. At least, I hope itís not. Corporate governance is no longer an academic discussion. It is not an arcane topic for high-minded legal debate. Nor is it a dusty, little-used flowchart in a vacant boardroom.
On the eve of a new century, new global imperatives demand a revitalized and modern perspective on the fundamental responsibilities between companies and their investors. In record pace and staggering volumes, capital investments are crossing borders, transcending oceans, and traversing continents almost instantaneously. An explosion of information sources, real-time news feeds, and on-line resources has reinvented how we gather and disseminate information.
Information is the lifeblood of markets. But unless investors trust this information, investor confidence dies. Liquidity disappears. Capital dries up. Fair and orderly markets cease to exist. As the volume of information increases exponentially, the quality of information for investors and the markets they comprise must be our signal concern. The promise of a global marketplace, like never before, depends on it.
As more countries move to an equity culture, high-quality financial information becomes the currency that drives the marketplace. And nothing honors that currency more than a strong and effective corporate governance mandate. A mandate that is both a dynamic system and a code of standards. A mandate that is measured by the quality of relationships: the relationship between companies and directors; between directors and auditors; between auditors and financial management; and ultimately, between information and investors.
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Today, the effects of a companyís behavior not only resonate nationally, but more likely, globally. If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere. If a country opts for lax accounting and reporting standards, capital will flow elsewhere. All companies in that country regardless of how steadfast a particular companyís practices may be suffer the consequences.
But if strong corporate governance is to permeate every facet of our marketplace, its practice must extend beyond merely prescribed mandates, responsibilities, and obligations.
It is absolutely imperative that a corporate governance ethic emerge and envelop all market participants: issuers, auditors, rating agencies, directors, underwriters, and exchanges. Its foundation must be an unwavering commitment to integrity. Its cornerstone an undying commitment to serving the investor. This ethic should be safeguarded by those entrusted with the publicís interest. And this begins with an active and independent board of directors.
Boards need to understand the companyís operations top to bottom. They must demonstrate both a keen interest in hunting down problems, and a genuine eagerness in finding solutions. They must see both the snapshot picture and the panoramic view as they strive to reconcile long term objectives with short term goals. Above all else, directors must ask tough questions the kinds that make management think harder and auditors dig deeper. Their public responsibilities must always reign over professional relationships.
The trend towards greater accountability can be seen both in the U.S. and Germany. A long line of cases in this country interpreting the duties of directors under state corporation law demonstrate this trend. In Germany, the German Stock Corporation Law was recently amended to increase the monitoring responsibilities of the Supervisory Board over the Managing Board.
If state corporate law and recent initiatives in German regulation stand for a single proposition, it is that an active, involved, and educated board can rest more easily at night than a board comprised of directors who merely go through the motions and watch the clock.
This past year I also have been worried about unhealthy aspects that have developed in the relationship between Wall Street analysts and the companies they evaluate. Analystsí reports and earning expectations cannot be allowed to unduly influence responsible corporate practices or long-term decision making. The hypersensitivity of stock prices in todayís markets to a companyís ability to meet or exceed an analystís earnings model defies common sense. We must not permit this gamesmanship to tarnish the quality of financial disclosure.
My belief in strong corporate governance begins and ends with the investor. Every investor no matter what country he is from, or which market he chooses to invest in should be our paramount concern. But there is also a compelling economic rationale: Effective corporate governance helps facilitate a broad, more efficient allocation of capital.
Today the flow of capital is fueling economies like never before. Why? Because investors are empowered. Empowered with information. Empowered with the financial tools to evaluate this information. Empowered with the confidence and the willingness to commit capital globally.
Consider Frankfurtís Neuer Markt, reaping the benefits of an energized investor base. It has experienced soaring levels of activity and infusions of capital. Greater transparency, in no small part, served as the driving force.
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Todayís global marketplace has now become a hotbed for greater global opportunity. I canít help think back to when Daimler-Benz and Chrysler first began negotiations for their proposed merger. The union of these companies was a bold and visionary embracement of a new global reality. The day the first "ordinary" share of DaimlerChrysler traded on the NYSE becoming the first German company ever to do so was the beginning of a whole new era of opportunity, cooperation, and partnership for our two countries.
Today, new international partnerships, joint business ventures, and strategic mergers are part of a normal business day. According to one recent study, Europe is the most "globalized" region in the world in terms of non-national directors. Increasingly, companies and countries are looking to their neighbors for diversity and a more externally directed perspective.
But in adapting to the imperatives of a global arena, we should not indiscriminately jettison the traditions and customs that make us different. In fact, our differences collectively have crafted a better marketplace. They have fostered heightened competition, spurred greater innovation, and driven us to the boundaries of our potential. A global playing field is, in most respects, good for companies, good for investors, and good for markets; but a homogenous one, where the impetus to innovate and compete is stifled, loses its dynamism. For the sake of our markets, I would be apprehensive if we didnít have our differences.
The fact is, many approaches to a corporate framework from management structure, to oversight boards, to even a companyís "culture" have existed, and prospered, for decades. And if the past is prologue, they will continue to do so for decades to come. But the fundamental hallmark for success the most basic underlying principle shared by all countries who enjoy resilient and robust capital markets is a commitment to quality.
Germany, as a business leader, demonstrates the same tenacity and authority in the global marketplace as it does in promoting quality at home. I applaud the German business community and its regulators for their recent strides in establishing a new accounting board the German Accounting Standards Committee to promote unanimity in their approach to accounting. As more German companies embrace a true equity culture, their time-honored attributes careful assertiveness and a relentless commitment to quality will serve as their mainstay.
If my time at the SEC allows me to offer any insight to the German standard setters, I would say: the real work is just beginning. There will be battles to preserve the integrity and independence of your standards. Some will criticize you simply because they are unhappy with your pronouncements and initiatives. They will attack you for the sake of parochial interests.
Our own Financial Accounting Standards Board has weathered many of the same storms. Not so long ago, the issue of derivatives incited a fierce challenge to FASB standards and by extension to FASB itself. And the mounting debate over the treatment for business combinations may prove to elicit no less passion on all sides of the issue.
But objectivity in standard setting is a value that must not be sacrificed. The process must be insulated from political agendas and special interests. Impartial and evenhanded standards will germinate in no other environment.
To all market participants, I say: be forthcoming with constructive criticism and frank dialogue. Work within the system. Open communication ensures that the process of standard setting never becomes inflexible or unresponsive.
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While globalization has graced both companies and investors with greater opportunity, it has also brought to light those areas that demand consensus not merely for convenience, but to support the imperatives of an international marketplace. International accounting standards, in particular, top that list.
Financial reporting is a language, just like German or English. It is the language that companies use to talk to investors. It is the language that investors use to ascertain value. It is what people use everyday to decide where to invest their hard earned dollars for financial security and future opportunity. These decisions can be hard enough. But try it in a language you donít understand, and it becomes all but impossible. Even worse, misleading.
We donít try to make computers communicate on incompatible networks. We donít hold international forums without interpreters. Why then, would we ask our investors to make critical financial decisions based on information that is inconsistent and incomparable?
If anyone doubts the disparate effects that different accounting practices can have, consider again the case of Daimler-Benz. Under German accounting standards, Daimler reported a profit of 168 million Deutschmarks in 1993. Under U.S. GAAP standards, the company reported a loss of almost a billion Deutschmarks for the exact same period. You can just imagine an investorís confusion and concern.
As more investors seek access to foreign markets, and more companies seek capital worldwide, the need for a common business language has become compelling. Broader horizons for new business opportunities demand financial reporting standards that supersede national borders and cultural customs. These standards are not merely an ideal for a better global marketplace they are fundamental to its very existence.
Progress is already well underway. In December 1998, the International Accounting Standards Committee completed the last major project in its core standards work program. Earlier this year, the International Organization of Securities Commissions and the SEC began their assessment of the completed standards.
Whatever standards take form, at the most basic level, investors must be assured that financial statements are comparable. High-quality international accounting standards will provide all investors with a basis to make the most informed business and financial decisions. Access to financial disclosure that is accurate and discernible should not be a luxury or even an expectation it is an investorís right.
But as the pace of todayís business brings even greater urgency to the need for these standards, we must not sacrifice certain basic principles. The standards must be unambiguous and comprehensible. They must avoid or minimize alternative accounting procedures to alleviate inconsistencies. And they must be capable of strict interpretation. International accounting standards need not be U.S. GAAP, but in terms of quality, comparability and verifiability they must be no less.
And finally, any global financial reporting system must include an infrastructure that ensures these standards are interpreted and applied rigorously. This means high-quality auditing standards, strong international audit firms with effective quality controls, profession-wide quality assurance, and active, meaningful regulatory oversight.
For some countries, this will mean a major commitment of capital and resources to secure this infrastructure. For others, it will require revamping current oversight procedures to accommodate new international demands. I wouldnít by any means suggest that this task is simple or the investment inexpensive. In the U.S., we have been through several different models over the past sixty five years and Iím still not persuaded that we canít do better. In either case, the short term toil in implementing these changes will be eclipsed by long term rewards.
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Our markets, our opportunities, our obligations, and our futures have become interlocked. And the stakes are too high for us to ignore this reality. Our neighborsí concerns are now our own. Our victories and our failures are shared by all of us.
In the last half century, the U.S.- Germany relationship has been anchored in a strategic alliance that fought to safeguard freedom and liberty. But, as the Berlin Wall fell, our history forged through common politics and shared interests has unleashed an even greater sense of economic opportunity. The free market driven by competition and innovation is changing the world. Together, let us seize this grand opportunity and let us make our tomorrow abound with even more promise.
Thank you very much.