Review: Corporate Governance and the Global Financial Crisis

Corporate Governance and the Global Financial Crisis: International Perspectives by William Sun, Jim Stewart, and David Pollard addresses the worldwide crisis that cost Americans an estimated average of $188,000 per household. We will be paying back that debt for decades… or perhaps more accurately, our children will be paying back that debt. Yes, we’ve passed the usual spate of laws after a financial crisis and regulations are still being written, but almost nobody I talk to, except perhaps those on Wall Street, thinks we have solved the issues. This book discusses some of the weaknesses, such as executive pay, risk management, board practices, regulation capture, the failure of shareowners to obtain and/or exercise rights, etc. Perhaps more importantly, many of the contributing scholars offer possible solutions.

Part one of the book focuses on the limitations of a market-oriented approach to corporate governance. Most of us remember “greed is good” from the fictional movie character, Gordon Gekko. According to Wayne Visser, incentive systems led to CEO and executive greed, leveraging risk and transferring it to banking greed. Deregulation and speculation led to greed by financial markets, self-regulation and short-termism led to capital greed, and shareholder capitalism led to capitalist greed. The problems in corporate governance are not just technical or problems of implementation, they are systemic and fundamental.

As the editors point out in their introduction and as I have experienced as an activist, “it is contradictory to see shareholders as ‘owners’ and members, yet ‘outsiders,’ of the corporation.” Our voices are restricted while those of the derivatives market, with ten times the market of stock markets and which Warren Buffet called “financial weapons or mass destruction,” are heard loud and clear.

Thomas Clarke goes through some of the causes and subsequent reforms but ends on a pessimistic note. “Will the deference of regulators return when financial markets recover…surviving US financial institutions were preparing to pay end of year executive bonuses approximately equivalent to the billions of dollars of aid they had just received from Congress.” Greed is still alive and well on Wall Street. Roman Tomasic reviews the failure of British banks and limits of the law, concluding “the simple pursuit of sel-regulatory or soft-law mechanisms is not adequate.”

Blanaid Clarke examines efficient market theory and the market for corporate control and finds the markets far from efficient, especially given how control rights are allocated and exercised. “Weaknesses in the market for corporate control theory have been exposed and the banking crisis may act as a clarion call towards greater regulation (self or otherwise) in all sectors.”

Steven Schwarcz argues that complexity and information asymmetry contributed to the failures. He calls for sellers of complex securities to retain at least a portion of their lowest-ranked tranches and for reform of rating agencies.

Roland Perez sounds a warning against ‘over-financialized governance’ or ‘instrumented management.’ A major trend has been to increase the average rate of return by concentrating on the most profitable activities, leveraging capital, outsourcing and focusing on the short-term. This kind of management works well in ‘normal’ environments but is not so viable when markets become difficult, as they did during the period studied. Perez has more recommendations than I can list in a brief review but they aim at providing corporate governance a broader social foundation, for example, using a two-tier structure with management and supervisory boards.

Part two of the book takes a closer look at how internal governance systems have mostly failed. An essay by Robert Monks reviews various shareowners by type, reviewing the various conflicts of interest each face, and concludes that only about 20% might be thought of as real proprietors. So, how do we solve shareowner complacency when activism isn’t an attractive option for most funds? Monks offers several solutions, one being that shareowners above a specified size would have the exclusive right and obligation to nominate several directors. Another possibility is providing long-term shareowners more votes per share. Requiring and/or rewarding activism of large fiduciaries seems key.

Roger Barker also looks at why so few shareowners engage. Barker acknowledges conflicts of interest, as well as the fact that diffuse holdings lead to a free-rider mentality. He examines attempts to create an obligation to care through the UK’s Stewardship Code but finds it is unlikely to help much because UK companies are now mostly owned by non-domestic shareowners. He examines loyalty dividends, enhanced voting rights, stamp duty and other possibilities but increased government intervention and its ‘box-ticking’ approach, seems most likely. Better would be more concentrated ownership in less liquid markets.

Jay Lorsch highlights board challenges in an article that seems timeless, given the never ending complexities of board interactions and the need to balance the board-management relationship. Chunyan Liu, Jianlei Liu ad Konari Uchida find a positive correlation between independent directors and the frequency of management turnover in Japan. Such firms are also less likely to cut dividends, so appear better able to protect shareowner wealth. Christoph Van der Elst examines the harmonization of risk management focusing on Europe and points to several gaps.

A third theme is explored in the last selections, with more of a direct focus on new directions, although there was no lack of recommendations in several earlier chapters. Peer Zumbansen looks at transnational nature of corporations and to rough consensus models, such as those that have evolved around Internet governance, for guidance in developing deterritorialized corporate governance regimes.

Florian Moslein delves into the complexities of supply chains and networks of contracts, looking at herd behavior, concluding more research is needed. James Shinn updates the groundbreaking work he did with Peter Gourevitch in Political Power and Corporate Control. Using systematic data analysis, Shinn finds the “net effects of the Great Recession are attenuating some of the mechanisms of the Investor model and amplifying some of the mechanisms of the Pension Preferences model.”  Financial crises almost always lead to regulatory enhancements but did we get them right? It seems to me like the shotgun approach largely failed but neither did it support strongly the ability of minority investors to demand improved governance measures internally.

Nasser Saidi turns our attention to the Islamic finance industry. “Strengthening corporate governance in the financial sector will also extend beter corporate governance to the firms the banks lend to.” Saidi has several recommendations for improvement, most of which will be familiar to reformers around the world, such as ensuring independence and proper skill-sets. Suzanne Yound and Vijaya Thyil round out the book by synthesizing some of what has gone before into the beginnings of a holistic approach, taking Australia as the example so examined through something of a 360 degree approach of interviewing and analysis. If these two authors can do it well when applying the approach to an entire country, why aren’t more doing so at individual companies?

As we deal with the aftermath of the global financial crisis, those who turn for understanding and answers to this reader will find them placed in easily understood and useful contexts.  The editors are to be commended for gathering essays of such transformative power and in contributing their own substantive advice.

 

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