Governance or regulation? Efficiency, stability and integrity in the financial sector
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Volume 7 Numbers 1/2
Papers Governance or regulation? Efficiency, stability and integrity in the financial sector Geoffrey Wood Cass Business School, City University, 106 Bunhill Row, London EC1Y 8TZ, UK tel: +44 207 040 8740; fax: +44 207 040 8881; e-mail: [email protected]
Geoffrey Wood is Professor of Economics at Cass Business School in London. He is a graduate of Aberdeen and of Essex Universities, and has worked in the Federal Reserve System, the Bank of England and at several universities in Britain and overseas. He has authored and coauthored, or edited over 20 books and has published over 100 academic papers. His fields of interest are monetary economics, monetary history and financial regulation.
Journal of Banking Regulation, Vol. 7, Nos. 1/2 2006, pp. 2–16 # Palgrave Macmillan Ltd, 1745–6452/06 $30.00
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ABSTRACT This paper considers two possible approaches by governments to ensuring that firms take account of what the government regards as the public interest. One is termed regulation and comprises telling firms what must be achieved, telling them what processes to follow, or both. The other is termed governance, and involves arranging incentive structures so that firms find it in their interest to achieve what the government wants. It argues first from three examples, drawn respectively from banking, investment management and accountancy, that governance will achieve objectives both more accurately and more durably. These three examples are then generalised by use of principal–agent theory, and it is maintained that the proposition is of general validity, well beyond the examples which prompted it.
INTRODUCTION There are two ways for governments to get organisations to do what they think is in the public interest. One is telling them what to do. This can mean prescribing the outcome, prescribing the process, or even both together. These are forms of regulation. The other is explicitly to recognise that organisations are run by people, not by automata waiting passively to be told what to do. That recognition suggests that rather than simply issuing instructions one should organise incentive structures such that these rational individuals, out of their own self-interest, do what the government wishes. The latter course can best be described as governance. The aim of this paper is to contrast regulation and governance. First, brief definitions of regulation and of governance are proposed. Then three examples, from different areas of life, are considered, and it is suggested on the basis of these that in general governance is better than regulation in two ways. First, it is more likely to achieve the desired result. Secondly, it is likely to be effective for longer. Having set out examples which suggest this conclusion, an analytical framework is sketched out which suggests that the claim, based on examples, is likely to hold in general. The discussion is then briefly related
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to the distinction between common law and civil law. After that the paper concludes with, as is appropriate for a conference
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