Banks in crisis: failures of corporate governance?

Corporate governance has been gaining more predominance around the world over the last decade.  However the last year or so which has brought the financial crisis and the ‘credit crunch’ has seen an unprecedented interest in some of the areas that are central to corporate governance: executive remuneration; boards of directors, independent non-executive directors; internal controls and risk management; the role of shareholders.

However the focus on these areas has brought into sharp relief some of the failings of the present system whether these have been brought about by greed, naivity, or a lack of real appreciation of the risk exposures of banks.

Bankers’ bonuses
Whilst many would agree that bankers have received huge payouts, often for a seeming failing company, bonuses appear likely to be cut, possibly by around 40% or more.  Peter Thal Larsen and Adrian Cox (FT, Page 13, 07/08 Feb 09) in their article ‘Barclays bankers braced for bonus cut’ highlight that even much reduced bonuses are likely to be controversial given that feelings are running high amongst the public and politicians alike.

The generous remuneration packages of executive directors of some of the UK’s largest banks have caught the headlines day after day in recent weeks.  In their article Former executives face bonus grilling’ (FT Page 2, 9th Feb 09), George Parker and Daniel Thomas mention an interesting historical fact ‘in the early 18th century, after the bursting of the South Sea bubble, a parliamentary resolution proposed that bankers be tied up in sacks filled with snakes and thrown into the River Thames’!  No doubt there are those who wish the same might happen today although a grilling before the Commons Treasury Committee may prove to be almost as unpleasant an experience!

Adrian Cox’s article ‘Barclays executives must wait longer for bonuses’ (FT, page 2, 11th Feb 09) highlights that Barclays is trying to design a pay structure that retains staff whilst rewarding long-term performance at a time when banks have been urged to show ‘moral responsibility’ in their remuneration structures.  The pay restructuring will affect not just directors but also senior employees, and other banks including UBS, Credit Suisse, RBS and Lloyds are in a similar position.

Risk Management

‘Former HBOS chiefs accused over risk controls as bankers apologise’ was the striking head of the article by Jane Croft, Peter Thal Larsen and George Parker (FT, page 1, 11th Feb 09).  Under questioning from the Commons Treasury Committee, Lord Stevenson, Andy Hornby, Sir Tom McKillop and Sir Fred Goodwin all apologised for what had happened at RBS.  Part of the questioning brought to light that a former employee had warned the board of potential risks associated with the bank’s rapid expansion.

Risk management is an area that is bound to gain a higher profile given the extent of the impact of the use of toxic assets which many feel were not well understood.

Where were the institutional shareholders?

Lord Myners, the City minister, has urged shareholders to challenge banks ‘Myners calls on shareholders to challenge reward cultures’ by Adrian Cox and Kate Burgess (FT page 3, 10th Feb 09). Lord Myners, they state, said that’ institutional investors should look at the content of remuneration reports and ask questions if the data are complex or opaque’.

My view is that it is an ongoing debate as to what extent institutional shareholders should intervene in the affairs of the companies in which they invest (investee companies).  It is widely recognised that engagement and dialogue are useful and necessary for an institutional investor to monitor the activities of investee companies.  However there is a line to be drawn between what it is feasible – and desirable – for the institutional shareholders to do, and what might be seen as undesirable and restrictive.

Sophia Grene article  ‘Funds say they did all they could to warn banks’ (FT, page 9, 8th Feb 09) highlights the view of the UK’s Investment Management Association that ‘fund managers did all they could to prevent banks hurtling to their doom, but under the current system, shareholders cannot shout loud enough to be heard’  The IMA also indicated a possible way forward for the future ‘investors can only do so much…..maybe we need to take a closer look at how investors and non-executive directors interact.  They’re privy to much more information than the investors’.

Walker Review of the Corporate Governance of the Banking Industry

Sir David Walker has been appointed to lead a review of the corporate governance of the banking industry which will look into remuneration and bonuses, risk management and board composition. The terms of reference can be found at:

http://www.hm-treasury.gov.uk/press_10_09.htm

Bankers abroad

In the US, President Obama has brought in reforms to limit the remuneration of executives to $500,000 at banks which have had a bail out.  Shares could also be given under incentive plans but would only vest once government support had been repaid, ‘Obama gets tough on pay for executives’, Alan Beattie and Edward Luce (FT page 1, 5th Feb 09).
Chris Mallin

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