Economic Quarterly

The accounting scandals of 2002 highlight the fundamental problem of corporate governance: how can a large public corporation align the incentives of a small group of professional managers with the interest of its widely dispersed shareholders? The economic literature on corporate governance builds on the basic fact of asymmetric information between a company's insiders and outsiders. This essay, from the Bank's 2002 Annual Report, reviews insights from this literature and discusses the legislation passed in response to the events of last year. While dramatic scandals lead to political and regulatory responses, the most powerful source of discipline on corporate managers remains their interest in establishing and maintaining credibility with the financial markets in which they raise funds.