Question

Many commentators stated that one of the causes of the last financial crisis(2007-2008) was lack of corporate governance. In the light of the above statement, discuss how corporate governance contributed to the financial crisis.(you may wish to refer to one of the companies involved int the financial crisis) (enron,AIG,world.com).

If the issue had been dealt with, what would have been the outcome?

Conclude on the basis of ethics/ law.

Answer 1

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. Remuneration of boards and senior management also remains a highly controversial issue in many countries. The development and refinement of corporate governance standards has often followed the occurrence of corporate governance failures that have highlighted areas of particular concern. The Enron/Worldcom failures pointed to issues with respect to auditor and audit committee independence and to deficiencies in accounting standards. The Parmalat and Ahold cases in Europe also provided important corporate governance lessons leading to actions by international regulatory institutions such as IOSCO and by national authorities. The recent turmoil in financial institutions starting in 2007 is often described as the most serious financial crisis since the Great Depression. It is therefore crucial for bodies such as the OECD Steering Group on Corporate Governance and others to examine the situation in the banking sector and assess the main lessons for corporate governance in general.

The available evidence also suggests below are some potential reasons for the failures/financial crisis.

Risk Management

Remuneration and incentive system

Board and executive remuneration

Incentive systems at lower levels have favoured risk taking and outsized bets

Poor Board oversight of risk policy

Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these failures led to the enactment of the Sarbanes–Oxley Act in 2002, a U.S. federal law intended to improve corporate governance in the United States. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms there, that similarly aimed to improve corporate governance. Similar corporate failures in other countries stimulated increased regulatory interest.

One of the most influential guidelines on corporate governance are the G20/OECD Principles of Corporate Governance. The Principles are often referenced by countries developing local codes or guidelines. Building on the work of the OECD, other international organizations, private sector associations and more than 20 national corporate governance codes formed the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) to produce their Guidance on Good Practices in Corporate Governance Disclosure. This internationally agreed benchmark consists of more than fifty distinct disclosure items across five broad categories:

• Auditing
• Board and management structure and process
• Corporate responsibility and compliance in organization
• Financial transparency and information disclosure
• Ownership structure and exercise of control rights

Companies listed on the New York Stock Exchange (NYSE) and other stock exchanges are required to meet certain governance standards. For example:

• Independent directors: "Listed companies must have a majority of independent directors ...
• Board meetings that exclude management
• Boards organize their members into committees with specific responsibilities per defined charters. "Listed companies must have a nominating/corporate governance committee composed entirely of independent directors."

Conclusion:

The importance of qualified board oversight, and robust risk management including reference to widely accepted standards is not limited to financial institutions. It is an essential, but often neglected, governance aspect in large, complex non-financial companies. Indeed, potential weaknesses in board composition and competence have been apparent for some time and widely debated. Furthermore, the remuneration of boards and executives remains a highly controversial issue in many countries.