Professional Documents
Culture Documents
F reinforcing contributing factors to the crisis. Other candidates include: greed, wishful
thinking and linear extrapolation; an addiction to efficient capital markets and
principal agent model thinking; belief in mathematical models replacing judgment; and, in
general, regulatory capacity and appetite lagging the developments of global financial
markets. Persistent shortcomings in corporate governance do however certainly belong on
the list.
Corporate governance for me is the system of rules regulations and practices by which we
hold managers and owners accountable and responsible for whatever performance society
expects. Remark that I did not say ‘‘by which we hold managers accountable for shareholder
value’’. That shareholder value and social responsibility are twin brothers in a sustainable
world should no longer need defending. That investors and owners should be an integral
part of the corporate governance system however is often underestimated.
Corporate governance thus involves many aspects. For example we should have paid more
attention to the rules and regulations that govern banks as lenders and as investors. We
should also have done a better job of clarifying rights and responsibilities of investors as
shareowners. Ultimately however the main instrument of corporate governance remains the
role and responsibility of the Corporate Board.
Not that Boards will ever be able to be up to the job of holding management accountable. For
that reason we need to add a process of active ownership, which requires investor
governance, we also need to have active disclosure and transparency in several areas, and
we need sound accounting and reporting. In fact we need al the help we can get to create a
system of accountability within which free enterprise can flourish. Even then we will also
need a measure of self-responsibility which requires managers to behave as professionals.
DOI 10.1108/14720701011069614 VOL. 10 NO. 4 2010, pp. 375-377, Q Emerald Group Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j PAGE 375
Based on my own interviews of directors of financial institutions, and examining recent
studies by the OECD and others, it is clear a failure of corporate governance is at the basis of
practically every financial institution’s downfall in this crisis, and is also separating those who
came out relatively unscathed from those that ran completely aground. Basically, in case
after case Boards were either unaware, ill informed, ill equipped or not proactive.
Yet all of this is barely eight years after the previous value meltdown resulted in Sarbanes
Oxley, and a whole wave of corporate governance rules and revised codes across the globe.
Did we then not remedy things after 2001? Actually I am afraid not. Based on the primacy of
shareholder value and belief in principal agent theory we added financial reporting,
strengthened audit committees, assured independence of directors, required financial
expertise of committee members, put mathematical risk models in place and moved to fair
value accounting, whilst creating an ever greater reliance on variable remuneration to align
executives both at the top and on the trading floor.
I would submit that whilst all the corporate governance effort and codes may have helped to
bring unsophisticated companies or countries to the basic level of governance structure, it
has blinded us for the fact that complex companies were literally out of control. Code
compliance gave a false sense of security. As a result we have destroyed the credibility of
business to mind its own shop for a while to come. The call for legislative and regulatory
action can no longer be pre-empted by promises of self-regulation.
One problem with corporate governance, and this is a challenge to academics and code
makers who want to understand causal relationships and develop structural prescriptions, is
that it ultimately it is an issue which is to be dealt with company by company, board by board,
as each individual board member steps up to the plate or doesn’t. Structural features of
governance are a very poor indicator of real quality of checks and balances in practice.
I would like to suggest that many if not most boards are still struggling to fulfil the roles which
are theirs, and also that the root cause of this failing are weaknesses in the Board’s process.
A first role of the Board is to set direction and approve strategy. From working with Boards I
would surmise that in this crisis they typically fell short in three key areas. On is goal setting.
What are reasonable stretching objectives? How to look at internal objectives, peer based
ambitions or market based expectations. Few Boards have a proper view, little theory is
available, yet a lot of the disasters start from inappropriate goal setting and lemming effects.
From this flows the next challenge: providing proper business focus. I would surmise that
much of the problem is due to inappropriate business scope and product offering extension
in search of satisfying these performance expectations. This brings us to the third strategic
issue: what is the proper risk appetite for the organization. This is something Boards failed to
set appropriately.
A second role of the Board is to provide proper performance and risk oversight. Here Boards
have fallen equally short. Partly because they did not see both sides of the coin together,
partly because they did not understand the risks, partly because they had incomplete
information – which in turn is because the underlying processes of risk management were
segmented, void of judgment and highly technical. Again, a lot of soul searching and
process design will be required to tackle these issues.
The third role of a Board is the selection, development and rewarding of leadership. Whereas
the first two are the biggest challenge, it is the latter which gets all the attention. Only 22 per
cent of the compensation of the main European Bank managers and 6 per cent of that of the
six largest American Bank managers was fixed. This says a lot for the underlying
assumptions about what we expect from these managers, and how we expect them to
behave. The top manager’s job is multidimensional, has to deal with multiple time horizons
and should be evaluated as such, using a combination of KPIs and judgment. Shareholder
value even over an interval is a poor proxy.
The fourth role is to set the tone at the top, to shape the values and to ensure they are brought
to the coalface. Here too it is clear that in many financial institutions the fish was rotting from
the head. Chuck Prince said: as long as the music plays you have to dance. Perhaps not.
j j
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Perhaps leadership means leaving the floor when the rhythm is too hectic. What is clear is
that in most banks the traders that brought in the dough were clearly put ahead of the risk
managers that raised questions or proposed limits.
j j
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