By Nell Minnow
Founder, The Corporate Library

Sarbanes-Oxley, like most legislation (especially that enacted in a rush of publicity), has been both too much and too little. Its impact has been marginal, and unlikely to be much more. So far, its primary impact has been the all-butinstant appearance of literally dozens of firms, seminars, consultants, and publications, all designed to solve — for a healthy fee — all worries associated with S-Ox compliance. As the Wall Street Journal put it this August, "A corporate governance gold rush is on."

But even full compliance with S-Ox, with or without the help of outsiders, is likely to have more form than substance. One reason is that by history and policy, corporate governance in the United States is still the province of state law, with the federal government's role very limited and mostly concerned with disclosure and process rather than substance. In effect, that means that the legislature of Delaware, the second-smallest state, sets the rules for the majority of public corporations and their directors, officers, and shareholders. This has been a good situation for corporations, who trade filing fees and tax money for highly protective laws and judicial rulings. It has not been as good for shareholders, but since most of them do not live in Delaware, they have had no recourse.

While S-Ox does present the greatest incursion ever into the state control of corporate governance, it still just nibbles at it around the edges. For example, it does not add anything new to say that audit committees have the right to select the auditors and to retain consultants; it is merely a reminder of rights they already had under state law.

Then there are "locking the barn door" provisions — new requirements that would probably have become standard practice through market demand. These include the "attestation" provision, the requirement of auditor rotation, the reduction of organizational and incentive compensation conflicts of interest for security analysts, and the prohibition of auditor consulting services.

Some reforms are so overbroad that they almost qualify as shrill. The prohibition of loans to executives is so broadly drafted that there is some concern it may even preclude travel advances in some cases. The "noisy withdrawal" requirement that attorneys who resign due to concerns about violation of securities rules must make a public disclosure of the basis for their withdrawal may be counter-productive. Corporate officers could become more reluctant to consult counsel in sensitive situations if they believe that the traditional attorney-client privilege has been curtailed and they might be subjected to disclosure without their participation and permission. I am not sure that going from a two-year sentencing guideline in prison for low-level securities fraud a few years ago to 15 now is particularly beneficial.

Potentially, the most significant and far-reaching provision of S-Ox is the creation of the Public Accounting Oversight Board, the first independently funded authority with the ability not just to set but also to enforce standards on the accounting and auditing professions. However, it is just getting started (with some sense of irony, it has moved into the office space vacated by the now-closed Arthur Andersen). Its import and effect will not be known for years.

The key point to remember about S-Ox is that under it, the role for regulation by government or by the quasi-governmental self-regulatory organizations is really quite limited. The corporate abuses of Enron, Global Crossing, WorldCom, Tyco, and the others were primarily a market problem and the role of the government should be to remove impediments to the market like conflicts of interest and then let the market do what it does best — respond to information with precision and efficiency.

That is why the most significant change has been, appropriately, on the market side.

When the traditional rating agencies — S&P, Moody's, and Fitch — and specialty firms like Institutional Shareholder Services, Governance Metrics, and my own firm, The Corporate Library start looking at corporate governance because their customers want it, then you know the market is working. As analysts and investors begin to make this information a critical part of the risk assessment of any investment, the market will resolve these issues by increasing the cost of capital for any company that does not demonstrate a commitment to transparency and to effective and independent oversight.

Crucially, the director and officer liability insurers are now looking at governance risk as they evaluate their premium charges and consider coverage of boards. This will provide another powerful form of market feedback. Note that indicators of governance risk will not be mere adherence to structural "best practices" that have never been correlated to any measure of performance or creation of shareholder value. As this area is examined more closely and understood more thoroughly, structural solutions like populating key committees with directors who meet some standard of "independence" will be less important than evidence that the board members have the expertise, the energy, and the opportunity to represent the interests of the shareholders.

The S-Ox requirements will take more time to implement and understand, so it would be unfair to make any attempt to measure their effectiveness at this point. But it is possible to see how seriously Corporate America is taking the fallout from the year of the corporate meltdown (one which has continued this year with scandals at K-Mart, Sprint, and HealthSouth). One key indicator is CEO pay.

While performance is down by any measure, CEO compensation continues to rise. Even more disturbing, the relative insensitivity to performance of the pay packages at turnaround companies like Sprint and Tyco show that boards have not yet learned their lesson.

The more important question will be whether shareholders have learned their lesson. Outrageous pay plans could not exist without shareholder votes in favor of stock option grants. And while the number and level of support for shareholder proposals on key issues like expensing stock options and improving the board composition and structure is increasing, it could play a much more vital role. As money managers and mutual funds prepare for disclosure of their proxy votes, the consistency of this exercise of shareholder ownership rights will become a more constructive and effective force, and could even lead to exercise of more active rights like filing shareholder lawsuits or nomination of directors.

The law and the market will have a profound impact on addressing — and even preventing — the problems that led to the collapse of Enron, Global Crossing, WorldCom, and the others. But it is possible that the impact of changes in technology will be even more significant. All of corporate governance of the 20th century was poised on one simple fact: the inability of shareholders to find each other and communicate with each other, at least not without huge expense.

That is over now.

At United Companies Financial, a group of unhappy shareholders who "met" on an online message board realized that they owned 40 percent of the stock. When the company went into bankruptcy, the shareholders from the message board essentially became the equity committee. At Luby s, shareholders organized through a message board were instrumental in replacing the CEO.

As shareholders become more focused on governance risk and better able to recognize and assess it, this kind of technology will enable them to demonstrate that the market is the most effective way to solve these problems.

Nell Minow is the editor of The Corporate Library, an independent research firm specializing in corporate governance. With Robert Monks, she coauthored Corporate Governance, an MBA textbook. nminow@thecorporatelibrary.com.