Archive for February 12th, 2009|Daily archive page
An unprecedented economic crisis now dominates the world economy. Comparisons with previous recessions or the great depression of the 1930s miss the point. The world economy has never been in a situation like this before. Global companies are larger, more complex and interdependent than ever before, financial markets are vast and interrelated in a way previously unknown, and questions of corporate governance – the way power is exercised over all types of corporate entity – are being asked as never before. Consider a few:
- Where were the directors of the failed financial institutions?
- Why did their independent outside directors not provide the check on over-enthusiastic executive directors, that they are supposed to?
- Did the directors really understand the strategic business models and sophisticated securitised instruments involved?
- Did they appreciate the risk inherent in their companies’ strategic profile?
- Where were the auditors?
- In approving the accounts of client financial institutions did they fully appreciate and ensure the reporting of exposures to risk? Expect some major legal actions as client companies fail. Hopefully, we shall not see another Arthur Andersen – there are only four global accounting firms left!
- Did the credit agencies contribute to the problem by awarding high credit ratings to companies exposed to significant risk? Expect some major changes here.
- Government bailouts of failing banks have produced near nationalised conditions in some cases. That turns governments into major institutional investors. (The Chinese government is the world’s largest institutional investor: maybe there are some insight there – see chapter 8)
- Government bailouts also raise the ethical issue of so-called moral hazard; by protecting bankers from their past reckless decisions, would others be encouraged to take excessive risks in the future?
- Will the experts who designed the sophisticated loan securitisation vehicles and other financial engineering systems be held to account? Are their ideas and enthusiasms now under control? This key issue has not yet been addressed.
- Where were the banking regulators? Although the extent of the crisis is unprecedented, the regulators seem to have been beguiled into complacency. There is some evidence that they might have been taken-over by the industry they were there to regulate. New rules are inevitable. But remember, the US Sarbanes and Oxley Act, drafted hurriedly in response to the Enron collapse and the loss of confidence in the market, has proved far more expensive than expected and has not been entirely successful, as we are now seeing.
- Were any of the financial institutions’ activities illegal? Compare the situation with Enron, where some top executives continued to believe that nothing they had done was wrong, even as they approached jail. No doubt there are investigators pursuing this question right now.
- Finally, did excessive bonuses and share options encourage short-term and unrealistic risk-taking with shareholders funds? Predictably, this has been a major focus of the tabloids. In the future, some control is likely on performance related remuneration. The news that some bankers had lost their fortunes as share prices collapsed was cold comfort to mortgagees who lost their homes, shareholders who lost their savings and employees who lost their livelihoods.
It is fascinating to see that the subject of corporate governance, though not always mentioned as such, has become central to political, social and economic thought.