Corporate Governance Lessons from the Financial Crisis

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The Corporate Governance Lessons from the Financial Crisis

Grant Kirkpatrick *

This report analyses the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries. It concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies. Accounting standards and regulatory requirements have also proved insufficient in some areas. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests. The article also suggests that the importance of qualified board oversight and robust risk management is not limited to financial institutions. The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries. The current turmoil suggests a need for the OECD to re-examine the adequacy of its corporate governance principles in these key areas.

------------------------------------------------------------------------------------------------ * This report is published on the responsibility of the OECD Steering Group on Corporate Governance which agreed the report on 11 February 2009. The Secretariat’s draft report was prepared for the Steering Group by Grant Kirkpatrick under the supervision of Mats Isaksson. Main conclusions

The financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements

This article concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements. When they were put to a test, corporate governance routines did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies. A number of weaknesses have been apparent. The risk management systems have failed in many cases due to corporate governance procedures rather than the inadequacy of computer models alone: information about exposures in a number of cases did not reach the board and even senior levels of management, while risk management was often activity rather than enterprise-based. These are board responsibilities. In other cases, boards had approved strategy but then did not establish suitable metrics to monitor its implementation. Company disclosures about foreseeable risk factors and about the systems in place for monitoring and managing risk have also left a lot to be desired even though this is a key element of the Principles. Accounting standards and regulatory requirements have also proved insufficient in some areas leading the relevant standard setters to undertake a review. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests.

Qualified board oversight and robust risk management is important

The Article also suggests that the importance of qualified board oversight, and robust risk management including reference to widely accepted standards is not limited to financial institutions. It is also an essential, but often neglected, governance aspect in large, complex nonfinancial companies. Potential weaknesses in board composition and competence have been apparent for some time and widely debated. The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries.

The OECD Corporate Governance Principles in these key areas need to be reviewed

The current turmoil suggests a need for the OECD, through the Steering Group on Corporate Governance, to re-examine the adequacy of its corporate governance principles in these...
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