Lapses in corporate governance like those that occurred recently at Enron and WorldCom are by no means a new phenomenon. Scandals litter U.S. business history. But before the Civil War, and especially before the 1820s, corporate scandals were rare, and not because early corporations were few or insignificant. Scholars do not yet know precisely how many publicly traded companies formed before the Civil War, but a good guess would be approximately 10,000. Early corporations were small by today's standards, but as fully-formed businesses, they faced the same pressures as today's largest companies, especially after adjusting for the primitive level of monitoring technology available to them.

A few of those early corporations, especially the infamous "wild cat" banks, were bad seeds. The vast majority, however, were well governed. This is all the more interesting given that they were but lightly regulated compared to today's corporations. Except for the first and second Bank of the United States, there was no federal oversight at all, and state oversight varied over time and type of business. Early corporations largely regulated themselves, directly and through self-regulated organizations like clearinghouses and securities exchanges.1

Several scholars have pointed to stockholder "democracy" or "activism" as the key ingredient of the governance success of early U.S. corporations.2 Active stockholder monitoring is certainly part of the explanation. Early stockholders voted their shares with alacrity, unafraid to oust directors or make independent inspections of the company's books and physical assets. They used the newspapers to publicly expose inefficient or corrupt practices, and they did not hesitate to sue wayward directors or to hunt down and imprison officers guilty of peculation.

Today, however, wide portfolio diversification means that retail investors have little incentive or ability to monitor the issuers of each of the securities that they own. Small investors can steer their savings to institutional investors, like TIAA-CREF, that use their scale economies to try to keep issuers in check, but stockholder activism remains costly and hence is unlikely to provide a systemic solution to governance problems.

The degree of stockholder activism is not the only difference between governance today and governance two centuries ago. In fact, the early history of U.S. corporate governance suggests four structural reforms: 1) Officers ought to receive deferred compensation bonuses and not stock options; 2) all directors should be "outside" directors with significant tenure of office; 3) top officers should be hired from within the organization; 4) business schools should mandate that students take a course dedicated to the principles of governance.

Public Policy Possibilities

The leaders of America's first corporations, men like Alexander Hamilton, Michael Hillegas, John Jay, Robert Morris, and Thomas Willing, were also politicians with experience in legislatures, judgeships, or executive or military offices. Many actually helped to write America's first constitutions. We would not want to replicate their revolutionary experiences each generation—Jefferson's beliefs about the efficacy of bloody rebellions aside—but we can try to approximate those experiences in the classroom. Future business leaders should have to think deeply about the reasons why American constitutions, and their corporate bylaws (one hopes), contain various "checks" and "balances." Furthermore, though it may not be possible to imbue morality where family and church have failed, at a bare minimum we can scare the shenanigans out of any future wrongdoers, especially if heads roll due to the most recent defalcations. Early U.S. business leaders knew that there were real world repercussions for wrongdoing. One of the most famous of them, Robert Morris, who by many accounts personally financed the American cause in the last, desperate years of the Revolution, spent the final part of his life imprisoned for the commercial debts that he piled up during the exuberant boom of the '90s—the 1790s that is.

Where the wrath of law fails to prevent theft, governance structures can help to thwart nefarious schemes. For the most part, early U.S. corporations drew their top officers from within the company. Today that practice sounds old-fashioned and maybe even a little silly. It served a very practical purpose, however. Companies that hired from within did a better job of screening their leadership. CEOs did not always start in the mailroom, but they rarely moved directly into the top slot. No matter how thorough their searches, companies that bring in a CEO from the outside are turning their executive branch over to an almost complete stranger. Promoting from within also gives employees an incentive to monitor their bosses.

Early U.S. corporate leaders would also shake their heads—back and forth—at the placement of officers on the board. The founding generation thought of officers as the executive branch of the company's government and charged them with the day-to-day execution of the company's business. The board was the legislature. It was directly elected by the stockholders, who charged it with setting policy initiatives and monitoring the executives. Early officers were invited into early boardrooms, but only to share information, not to vote or influence deliberations. Allowing officers to sit on the board is like having members of the executive branch sit in the U.S. Congress, a practice that the Constitution happily forbids in all cases but one—the Vice President officially presides over the Senate. But no VP since John Adams has taken that duty seriously, except to break tie votes once in a great while. To make an individual "Chairman and CEO" is the equivalent of electing an individual "Speaker of the House and President." In fact, it is worse because corporations do not have a second board, like the Senate, to check such a potent combination of executive and legislative power.

Unless we return to a period of renewed stockholder activism, it might be best to provide directors with a much longer and more secure term of office than they currently enjoy. Like governors of the Federal Reserve, directors should serve only a single, long term. That way, they do not feel the need to curry favor. Likewise, they should be expelled for chronic nonattendance or malfeasance but not for voting against the officers' wishes. Directorships should not be sinecures; directors should not make like bobblehead dolls and vote "yes" to every dog and pony show brought before them. Ideally, directors' remuneration should come from improved company performance and the higher dividends or stock prices that will follow. They are, after all, the direct representatives of the company's owners, not the representatives of its agents.