The impact of the crises began to diminish. Still, all key players, including top executives, regulators and investors, have a lot to learn from global financial failures. The steering group of the Organization for Economic Co-operation and Development (OECD) has released a report entitled Corporate Governance Lessons from the Financial Crisis. This Report concludes that among the main contributors to the financial crisis are the failures and weaknesses in corporate governance arrangements. When put to the test, corporate governance routines did not serve their purpose of safeguarding against excessive risk-taking at a number of financial services institutions.
Other key contributors to global financial crises include failures in transparency, failures in lending standards; failures in prudential standards; failures in risk management.
As for the compensation of top executives, the real problem was not the amount they receive; it’s how companies pay them. Poor bonus culture encourages short-term thinking: make as many offers as you can this year and get a bigger bonus! That focus pushed executives to focus their attention on achieving short-term goals at the expense of sustainable growth goals.
Most financial institutions tie compensation to quarterly performance, encouraging short-term bets. When the bets win, the executives get the rewards, but when the bets fail, as happened in the last financial crisis, the executives who took the risks don’t have to pay back their fat bonuses. Executives, in most cases, were no longer gambling with their own net worth. It was the shareholders who took the hit. Thus executive greed acted as fuel thrown on the fire and contributed to the fiery global financial crisis. The right approach if we are to prevent the financial system from being battered again by the greed of top executives is to maintain a partnership among top executives and link their net worth to the well-being of organizations. As a result, they would be wary of taking big risks and would discourage the malpractice of running after short-term gains. In addition, we need to replace bonuses with better, longer-term compensation, like deferred cash pay and restricted stock.
The heads of troubled institutions seem to have provided only superficial supervision to check the greed of top executives. The boards of collapsed companies bear full responsibility. Every month they see the numbers. They are also responsible for compliance with the rules. And they set compensation packages for top executives. However, companies in trouble simply checked the good corporate governance boxes in their annual reports. In other words, these organizations presented an obvious example of cosmetic corporate governance to fool different stakeholders, including investors, rating agencies, and regulators.
The current global financial crisis has shed light on how poor risk management could lead to catastrophic results. Risk management systems have failed in many cases due to corporate governance procedures rather than inadequate computer models alone.
With the advent of new products, such as sophisticated derivatives and certificates of deposit, they posed unknown risks. Risk management may have fallen short, as many of the standard quantitative models and the users of these models used to misjudge the systematic nature of risks. To some extent, this was due to the complexity of the product and an overreliance on quantitative analysis. Unfortunately, many risk assessments were wrong, including those provided by rating agencies.
Directors of failed financial institutions should have a better understanding of the risk implication when making decisions related to sophisticated products such as derivatives. The reality is that many board members had inadequate knowledge about fancy new products and were probably embarrassed to show that they lacked adequate knowledge! Here where the education and orientation of the directors fails as a best practice of corporate governance. Continuing education is important to ensure that directors are familiar with all aspects of the company’s affairs, with a particular focus on risks. Each director should receive tailored mentoring programs in areas in which he or she lacks the appropriate knowledge to be able to effectively perform the fiduciary oversight role.
Finally, the concept that in bad times companies would be more interested in supporting their profitability and therefore will not have time for corporate governance is irrational. Integrity cannot be compromised because corporate governance is not seasonal, it is for all time, and it must be embedded in senior executives and corporate directors. Companies should not let go of corporate governance in bad times. It’s like a muscle, you have to exercise it or it atrophies
