Corporate Governance Lessons from the Financial Crisis

Topics: Risk, Risk management, Corporate governance Pages: 48 (14584 words) Published: September 18, 2010
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...

References: Basel Committee on Banking Supervision (2006), Enhancing corporate governance for banking
organisations, Basel.
Basel Committee on Banking Supervision (1998), Framework for Internal Control Systems in Banking
Organisations
Blundell-Wignall, A. (2007), “Structured products: Implications for Financial Markets”, Financial
Market Trends no
Borio, C. (2008), “The financial turmoil of 2007: a preliminary assessment and some policy
considerations”, BIS Working Papers, 251, Basel.
Chen, C. et al. (2006), “Does stock option-based executive compensation induce risk taking? An
analysis of the banking industry”, Journal of Banking and Finance, 30.
Felton, A. and C. Reinhart (eds.) (2008), The First Global Financial Crisis of the 21st Century, CEPR,
London, VoxEU.org
Financial Services Authority (2008a), The FSA’s internal audit review of its supervision of Northern
Rock, and the FSA’s management response, London, April.
Financial Services Authority (2008b), Final notice to Credit Suisse First Boston, 13 August, London.
Financial Stability Forum (2008), Report of the Financial Stability Forum on Enhancing Market and
Institutional Resilience, Basel.
Fukao, M. (2001), Japan’s lost decade and weaknesses in its corporate governance structure, Keio
University
Guerrera, F. and P. Thal-Larsen (2008), “Gone by the Board: why the directors of big banks failed to
spot credit risks”, Financial Times, 26 June.
Gup, B. (ed.) (2007), Corporate Governance in Banking: A Global Perspective, Elgar.
Hau, H., J. Steinbrecher and M. Thum (2009), Board (in)competence and the subprime crisis,
www.voxeu.org/index.php?=node/2775.
Heller, D. (2008), “Three ways to reform bank bonuses”, Financial Times, 3 February.
Honohan, P. (2008), “Bank failures: the limitations of risk modelling”, Institute for International
Integration Studies Discussion Paper, 263.
House of Commons Treasury Committee (2008), The run on the Rock, Volume 1 and II, London.
Institute of International Finance (2008a), Interim Report of the IIF Committee on Market Best
Practices, Washington, D.C.
Institute of International Finance (2008b), Final Report of the IIF Committee on Market Best Practices:
Principles of Conduct and Best Practice Recommendations, Washington, D.C.
Institute of International Finance (2007), Principles of Liquidity Risk Management, Washington, D.C.
IOSCO (2008), Report on the sub-prime crisis.
Moody’s (2005), Don 'ts bank on strong governance: Observations on corporate governance in US
banks, Special comment, New York.
KPMG (2008), Audit committees put risk management at the top of their agendas,
www.kpmg.co.uk/news/detail.cfm?pr=3120, June.
Ladipo, D. et al. (2008), Board profile, structure and practice in large European banks, Nestor Advisors, London
Nestor Advisors (2009), Governance in crisis: A comparative case study of six US banks, available at
OECD (2008), “The recent financial market turmoil, contagion risks and policy responses”, Financial
Market Trends no
Ricol, R. (2008), Report to the President of the French Republic on the Financial Crisis, Paris.
Sachverständigenrat (2008), Das deutsche Finanzsystem: Effizienz steigern – Stabilität erhöhen,
Wiesbaden.
Securities and Exchange Commission (2008a), Summary Report of Issues Identified in the
Commission Staff’s Examinations of Select Credit Rating Agencies, Washington.
Securities and Exchange Commission (2008b), SEC’s Oversight of Bear Stearns and Related Entities,
Report No 446-A.
Senior Supervisors Group (2008), Observations on Risk Management Practices during the Recent
Market Turbulence.
Société Générale (2008a), Report of the Board of Directors to the General Shareholders Meeting,
company website.
Société Générale (2008b), Summary of PwC diagnostic review and analysis of the action plan,
Company website.
Der Spiegel (2008), Casino provincial, 28, 2008, pp. 80-86.
UBS (2008), Shareholder Report on UBS’s Write-Downs, company website.
Van Manen, J. and Jod de Groot (2009), “Business risk reporting”, to be published in: The Handbook of
International Corporate Governance, Kogan Page.
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • FINANIAL CRISIS 2008 AND CORPORATE GOVERNANCE Essay
  • Hilton hotels Corporate Governance Essay
  • Global Financial Crisis Essay
  • Corporate Governance and Financial Performance Essay
  • Corporate Governance in the Hershey Company Essay
  • Corporate Governance RBS Essay
  • Essay about Effective corporate governance
  • corporate governance Essay

Become a StudyMode Member

Sign Up - It's Free