To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies



Lutgart Van den Berghe 6/09/2011

TO WHAT EXTENT IS THE FINANCIAL CRISIS A GOVERNANCE CRISIS? -From diagnosis to possible remedies-


‘The credit bubble was not just a simple market failure, but a failure of To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies business leadership, corporate governance and risk management, exacerbated by flawed incentive structures with banks” (John Plender, Financial Times, 22 August 2008).


Prof.dr.Lutgart Van den Berghe

GUBERNA

&

VLERICK LEUVEN GENT MANAGEMENT SCHOOL


Over time, the development To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and refinement of corporate governance standards and recommendations have often been the consequence of corporate governance failures. Even if the collapse of Enron and the like, may not have been caused by corporate governance To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies failures in a strict sense, there were serious deficiencies that facilitated or at least did not prevent such disastrous business practices. New legislation (like Sarbanes-Oxley and the European governance To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies directives) and an impressive set of governance recommendations (European recommendations and numerous national governance codes) were developed to cure the governance deficiencies identified. The new legislations and recommendations of the post To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies-Enron era implied important investments in new governance structures and procedures. This gave lean way to the expectation in the business world and society at large that the efficiency and effectiveness of governance would drastically To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies increase. It is therefore all the more disturbing that those remedies have not been able to prevent the financial turmoil.


Although the root causes of the financial crisis seem to lay To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies in macro instabilities -excessive liquidity and cheap money- and micro regulatory failures, numerous studies also point to governance failures, which -at least- aggravated the financial meltdown. According to the EU To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies-report of the de Larosière Group (2009)1, corporate governance is one of the most important failures behind the present financial crisis. Also the OECD (2009b) clearly pointed to corporate governance failures as an To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies important factor behind the financial collapse: ‘This Report concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements.” The prominent international shareholders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies’ association, ICGN (2009b), stated that it is now widely agreed that corporate governance failures were not the only cause of the financial crisis, but were highly significant. Other investors2 state that corporate governance did To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies not cause the financial crisis (macro-imbalances did), but certainly aggravated the crisis. In a report to the G20, Becht (2009;2) stated that the current financial crisis is a classic example To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies of board failure on strategy and oversight, misaligned or perverse incentives, empire building, conflicts of interest, weaknesses in internal controls, incompetence and fraud.

Whether we like it or not, the societal To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies backlash of these failures goes far beyond the financial sector. Society is loosing trust in business leaders in general and is heavily criticizing their societal behaviour, condemning their huge remuneration packages and the lack of To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies effective board oversight.


Therefore, everyone interested in effective governance has to further reflect on the lessons to be learned and on the possible remedies to restore (societal) trust in the business world To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies. Besides our ambition of contributing to such deeper reflection, it is our goal to go beyond the symptoms and investigate the more systemic governance failures. It is clear that those governance To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies failures are not the monopoly of the financial sector. On the contrary, the systemic governance failures could be relevant for all types of business activities and organisations. So the lessons to be To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies learned and the possible remedies do have a far larger scope than financial institutions alone.


Without having the intention neither to moralise on business practices nor to follow the societal To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies revolt or the classical hunt for the guilty, we can not deny that even in companies that formally complied with most of the governance recommendations, things went wrong. As in the previous cycle, we can To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies again try to analyse the underlying governance failures and investigate possible remedies. However, we have to notice that some of the previous remedies were insufficient and/or had (unforeseen To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies) side-effects that мейд things even worse. Consequently we would like to point out that governance mechanisms should be critically evaluated on a regular basis, their side-effects be investigated and -where necessary To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies- be drastically adapted. However, we should be aware that even strengthened governance cannot guarantee absence of corporate problems in the future.

^ 1. Corporate Governance may not/no longer rely on the assumption that To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the ‘market will take care of it’ Governance codes adhere to market discipline
The leading (Anglo-American) corporate governance literature and the corporate governance codes for listed companies depart from the assumption To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies that the market is the final disciplinary mechanism to guarantee that firms are governed in the best interest of their owners. In corporate finance and corporate governance this paradigm has long been defended, in To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the sense that listing at the stock exchange could only evolve towards a perfect market in as far as the shareholdership was completely open, dispersed and volatile. Such capital structure guaranteed that To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the requirements of market operation were optimally fulfilled, i.e. a large number of market parties that could not significantly influence the market price (dispersed shareholdership), shares that were To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies often traded (high liquidity, thanks to high velocity and free float) and companies without any inside shareholders (who could take advantage of their controlling position to detract private benefits), but with outsiders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies that monitored the listed company on the base of equal information (fair disclosure) and in complete transparency.


For a long time, corporate governance overwhelmingly focused on such types of open listed firms. Notwithstanding that the To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies majority of listed companies all-over the world is still relying on inside shareholders (blockholders), there was a push towards more open, dispersed and anonymous shareholders. Governance best practices referred to To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies open dispersed shareholdership as the bench mark. Governance ratings promoted open dispersed shareholders and disliked controlling shareholders and stable blockholding, penalising such companies with a lower governance rating.

^ Curing the hurdles on To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the route to perfect markets
But of course hurdles could exist on the route towards open market transactions. Therefore legislation had to guarantee that such barriers be eliminated and governance To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies remedies had to be tailored to reach the goal of open financial markets.


Specific governance recommendations had to cure potential hurdles. Outside shareholders can only play their role as final gatekeeper of sound To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies governance practices, if they possess a sufficient insight into the company, they invest in. Transparency rules are a first governance remedy allowing market parties to play their role. However companies with To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies a dispersed shareholding structure have to cope with the collective action problem of passive, uninterested small shareholders3. Therefore, institutional investors are urged to play a more active role in disciplining the good To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies governance of listed companies (see e.g. the ERISA-legislation in the US, obliging public pension funds to use their voting rights). In practice, even the largest institutional investors hold relatively small To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies stakes, so that it becomes hard to justify investing large amounts of money in monitoring their portfolio companies. Another remedy is the famous ‘pay for performance’ solution has been promoted to make sure that managers To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies focused more on the interest of the dispersed shareholders. Besides board oversight (to promote shareholder’ interests) the last and ultimate discipline on management should be the market for corporate control: a manager To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies that is only pursuing its self-interest while neglecting the shareholders’ interests can loose his job when the shareholders decide to sell the firm. Therefore no barriers should exist To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies towards free trade in companies!


Each of these remedies shows downsides, weaknesses and/or unintended negative side-effects, proving over and over again that the assumption of perfect markets is unsustainable!

^ The financial To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies crisis showed much deeper flaws in the perfection of (financial) markets
Recently the perfect market paradigm has come under severe attack. In his most recent publication, George Soros (2008) pleads for a complete revision of To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies this market fundamentalism. Markets do not operate perfectly, not only because information is incomplete but foremost because the market parties can play a disturbing role (reflexivity) on the market outcome. Their To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies beliefs and previsions may substantially deviate from reality (intentionally influencing, if not even misleading other market parties) and this will affect the final outcome adversely and is at the origin To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies of boom- and bust cycles.


The financial sector is all the more vulnerable in this respect, because expectations do play a very important role in the market operations. If financial markets are To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies completely free this often leads to cycles of euphoria and desperation. Speculation, day trading and short selling can be seen as market corrective, but are often also disturbing a stable market output To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and market prices that no longer reflect the underlying value of the company or the asset.


Looking at the actual financial crisis, cheap money (a Keynesian recipe to cure the crisis after the Internet bubble To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies) seems to be at the origin4 of an unprecedented credit expansion, amplified and accelerated by complex and opaque financial innovation (from securitisation to artificial financial products). Consequently we witnessed important To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies asset inflation, leading to a boom-bust bubble in all types of real and financial markets. The crisis erupted when monetary policy tightened, making capital more expensive

^ IFRS: from a solution for To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies better market transparency …
In academic research as well as in business calculations, value is defined from a market perspective (what is the market capitalisation, the company’s value to a potential shareholder, a potential To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies buyer, etc.) or from an accounting perspective. The market value can considerably differ depending on the market sentiment (cfr. boom and bust cycles). Former accounting principles where more historically oriented (with valuations based To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies on historic cost and economic depreciation principles) and offered more opportunities for stabilising provisions, hereby allowing to neutralise volatile business cycle effects. However, such smoothing principles were considered opaque, not allowing outsiders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies to have a fair view on the underlying market value of the company. Modern IFRS-accounting is much more market oriented too (here again we feel the pressure of valuation for To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies open market transactions) with consequently more volatility.


As has already been explained earlier, transparency is the corner stone for efficient capital markets. Conditional upon such a market mechanism is to have a To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies level playing field for all shareholders with sufficient and transparent information on the value of the corporation. Shareholders -as outsiders- have to rely on such market information to decide on their selling To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and buying of stocks. IFRS accounting rules have become instrumental in this respect. Such rules proclaim that at any moment in time, outsiders should be aware of the true market value of all To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies components of the corporation, while any form of internal reservation had to be abolished because this led to incomplete information for outside shareholders.

^ …, to potentially adverse affects
However, it To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies is questioned whether important components of the IFRS-approach, like the fair value concept is fair at all. Such market-oriented valuation system has its downside, in that it is subject to To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies increased volatility (pro-cyclicality) and negative spill-over effects, certainly in times of boom and bust. These adverse effects hold for the upside as well as for the downside trends5. Potential capital gains To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies (market value above original cost or historic value) have to be accounted for, leading to an upswing in virtual profitability and reserves with potentially higher variable remuneration and dividend pay-outs, if To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies not share buy-backs. The more such increase in asset prices are the effect of speculation and asset bubbles the more dangerous this capital distribution process becomes.


The opposite (vicious) circular effects To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies are noticed when market values substantially decrease. Accounting rules helped trigger a negative feed-back loop that amplified the downside effect of financial markets (de Larosière, 2009), leading to capital losses, need for impairments To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies, depreciations and lower virtual profitability, eventually necessitating extra capital buffers, ‘fire sales’ while also limiting the growth and financing capacities. Moreover the more a company is judged on its To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies short-term (quarterly) market value, the faster the downward spiral goes, when things go wrong. This vicious circle can become a systemic risk when it comes to financial institutions which heavily rely on To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies mark-to-market operations for investments and financing. The question is therefore often raised to what extent the volatility syndrome of IFRS has been the fire that worsened the world-wide financial To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies crisis (Wymeersch, 2008; Heremans in Killemaes and Mouton, 2008).

^ From loopholes in the regulatory approach and insufficient insights into financial innovations …
In the post-communist era the free market fundamentalism won world-wide support To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies far outside the sphere of the capital market. Economic policy at national and international level focused on optimal market operations and on the elimination of all relevant barriers to free competition To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies (cfr EU liberalisation policy; cfr. abolishment of the Glass-Steagall act in the US). In such an era self-regulation was the route to complement a retreating supervision and regulation. The underlying paradigm To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies of this free market movement is that markets can better regulate themselves because the invisible хэнд (the self-interest) of the rational market parties will lead to the optimal market outcome To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies.


The supremacy of market thinking has convinced regulators to draw back and rely more on self-regulation within the financial sector. The end of the Glass Steagal Act in the US has To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies allowed investment banks to become active within the financial arena, while also allowing regular banks to become involved in much more types of investment banking. Moreover regulatory paradises continued to prosper for To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies firms like hedge funds and the like, not being subjected to any regulation, regular depository banks have been faced with. But also depository banks have found a way around stricter regulation, by focusing more and To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies more attention on ‘modern’ banking, preferably outside the perimeter of tough (solvency) rules. Numerous inventive and artificial investment vehicles were created, which allowed off-balance transactions, engagements and leverage To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies to grow exponentially, while at the same time being so complex that even standard risk models were no longer a valid tool for supervision. The standard model for calculating solvency requirements, foreseen in the Basle To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies I rules, has been largely replaced by the Basle II facility to use internal risk models. Such flexibility again led to a larger degree of freedom causing at the same To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies time a far more complicated supervision. According to the de Larosière report to the EU (2009), the definition of capital requirements placed too much reliance on both the risk management capabilities of financial institutions To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and on the adequacy of ratings while not sufficiently incorporating the macro-systemic risk of contagion. After the facts, one can observe that risks proved to be much higher To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies than the internal models had expected!

^ …to a general plea for more and tougher regulations, also outside the financial sector
Due to the loopholes in the regulation of financial market players and the serious monitoring To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies mismatch, the cry for more and tougher regulation is loud and clear. Illustrative in this respect is the view of Sarkozy (2008): ‘L’autorégulation pour règler les probl To what extent is the financial crisis a governance crisis? -from diagnosis to possible remediesèmes, c’est fini. Le laissez-faire, c’est fini. Le marché a toujours raison, c’est fini.


Although there are many arguments in favour of such extra regulation, the danger is that this To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies will not be limited to the financial sector. To the extent that the origin of the crisis is more systemic to the financial sector, it should be questioned whether enlargement of the To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies regulatory impact outside the financial institutions is justified. Self-regulation has the great advantage of flexibility, offering the possibility to tailor to the diverging and changing needs of the business world. Moreover, soft To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies law may finally have more teeth than originally assumed, e.g. when jurisprudence is developed with reference to these self-regulatory principles. On top of that, boards of directors and shareholders that To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies formally adhere to the governance principles will considerably increase the strength of self-regulation (Wymeersch, 2008).


In first instance, we should therefore try to encompass all relevant additional points of attention (e.g To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies. remuneration, risk management) into the self-regulatory approach of governance codes. However, one can not be blind that some governance failures will necessitate complementing that self-regulation with additional regulation (e To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies.g. on transparency). The EU sees the need for further regulation in two respects. The credit rating agencies, which greatly underestimated the risk exposures of banks, should be subjected to a registration within To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the EU as well as to external oversight. Another point for further regulation is remuneration. Since only 1 out of 3 member states seem to follow the EU recommendation on director remuneration, there is To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies a need for some urgent measures, certainly in the financial sector. The EU will investigate clearer policy guidance in this respect, including shareholder voting on some remuneration issues.


^ Growing To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies interdependence due to globalisation and repackaging of securities
If there is one sector where globalisation has been realised to a large extent, it is the financial sector. Complex webs of companies, joint To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies ventures and the like have been built around the world. However with the interrelationship between all players and with the interwoven products came also an important increase of vulnerability and systemic risk. Moreover To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies with regulatory oversight still being mainly national, controlling such interlocking relationships and complex interdependencies, became very complex, if not impossible.


The distance between the real economy and the financial economy has become that large To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies that any feeling for proportion and economic sense seems to have been drifting away with every expansion of the financial system.

^ In search for mechanisms to фокус more on long term value To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies creation and corporate responsibility
Value creation is a crucial term in defining corporate success and in judging the quality and performance of a corporation, its management and its board. However To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies, defining what value creation means, is not straight forward at all. What kind of value should be the reference base and how should we measure such important indicator? This discussion touches To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies upon the ‘raison d’être’ of corporations and will be differently answered whether you are a day trader, a hedge fund, a family owner, an employee or a customer, to name only a To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies few quite different views..


Even hard defenders of open market transactions were not blind for the potential downsides of a too hard фокус on self-interest and short term profit. Illustrative in this respect To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies is the ground work of Adam Smith. In his ‘Theory of moral sentiment’ (1759) he clearly pointed to the fact that the driver of market operations and economic development, being profit, should To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies be complemented with non-profit values. A market can only operate effectively if there is mutual trust between market parties and such trust is built on values such as fairness, human attitude, generosity To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies, eye for the public good, etc. According to Adam Smith, the government had to play the role of watchdog and where private markets would fail, government needs to complement the supply To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies of products and services (i.e. providing public goods).


According to Eddy Wymeersch (2008;1) the corporate governance debate remains constrained to the private interests of the parties involved and does not To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies include the public good that may be affected by company decisions6. Notwithstanding some (rather marginal) socially responsible investment funds (SRI’s), capital markets traditionally attach most importance to the value created for the (public) shareholders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies. In the actual discussion of the financial crisis one of the main critiques on the market parties is that they -by far- focused too much on short-term value creation To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies, at the detriment of huge risk exposures, while also ignoring the long-term and societal effect.


There seems to grow a general consensus that shareholders should become more supportive of the long To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies-term effects of business decisions and choices. Companies with stable shareholders (like controlling shareholders) will probably have a far easier task in convincing their shareholders than those with mostly short-term traders as To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies capital providers. But society is putting the heat on and is even going one step further in the direction of corporate social responsibility. The pressure is on companies to educate their shareholders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies so that they become more receptive, if not supportive of long-term value creation, including considerations on shareholder as well as stakeholder value.


Taking into consideration the devastating externalities (societal To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and economic spill-over effects) of the financial sector, there is a plea to consider the ‘general interest’ when developing governance structures and processes within financial institutions7. However some do make a To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies clear distinction between the spill-over effects of financial institutions on financial and economic stability in general and the far broader concept of corporate social responsibility and ethical business behaviour. In this respect To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies Eddy Wymeersch (2008;4) states that the concept of ‘ethics’ is usually too elusive to be considered a usable yardstick, at least in legal terms. Moreover the contribution to financial stability is quite different from CSR To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies where no clear political authority is exercised, and where the use of corporate governance instruments is based on a largely voluntary approach.


However, several frameworks for socially responsible business and reporting have To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies been developed all-over the world. The OECD recently stated (2009a) that the global landscape of international initiatives to promote responsible business practice has become increasingly -and perhaps confusingly- crowed over the To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies last decade. Such CSR-reporting focuses on the value creation from an economic (profit), social (people) and societal (planet) perspective. Contrary to this growing attention for corporate social responsibility reporting, most of To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the world-wide discussions on corporate governance ignore the ethical and stakeholder perspective. There have rarely been bridges between the traditional financial and governance frameworks at the one хэнд To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and the socially responsible reporting frameworks at the other хэнд8. In the future, governance codes will have to attach more attention to this ‘enlightened shareholder value’ approach.


The omission of an ethical To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies and stakeholder perspective allows organisations to фокус on short-term shareholder value, stock price and quarterly results. Although more nuanced approaches exist everywhere, most of the players in the financial world are (were?) adepts of To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies the classical free market thinking. As already highlighted before, market fundamentalism leads to a nearly blind belief in the law of the market, also when it comes to the governance of market To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies operations and market parties. As already stated by the founder of the open market transactions, Adam Smith, when ethics and integrity lack, the market can no longer operate as a good To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies governance mechanism and capitalism dares to become casino-capitalism. Neglecting the long-term effect of corporate decision-making and totally ignoring the ethical dimension of profit maximisation are (partly) explanations for the mortgage To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies-crisis in the US. The mere fact that they operated with so-called ‘teaser rates’ (very low initial interest rates) clearly proves that such practices were far from oriented towards long-term To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies customer interests.


But the short-term disease is more widespread than in this mortgage-crisis. Financial firms, capital markets, financial analysts and large shareholder organisations have put the accent far too To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies much on creating short-term shareholder value, as if it was the ultimate goal of the firm. In the absence of long-term shareholders, most listed companies are driven, if not biased To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies by the share price and sometimes worse, making important choices and decisions on the base of the potential effect on the next quarter results. Interesting in this respect is the To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies view of the de Larosière Group (2009): ‘It is clear that the financial system at large did not carry out its tasks with enough consideration for the long-term interest of its stakeholders. Shareholders To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies' pressure on management to deliver higher share prices and dividends for investors meant that exceeding expected quarterly earnings became the benchmark for many companies' performance. The accounting system (IFRS) is To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies facilitating and even supporting such short term valuation approach, while remuneration systems were further accentuating this фокус.’


Even the international shareholders’ association, ICGN (2009a & 2009b) recognizes that the financial crisis was exacerbated by a failure To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies of governance, both within bank boards and, in some cases, by lack of engagement of shareholders, responsible for governance oversight. They propose an elaborated set of shareholder responsibilities, such as To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies explicit recognition of their responsibility to generate long term value, putting sufficient resources into governance that delivers long term value, taking governance factors as well as risk factors into consideration.


The financial crisis showed To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies that controlling shareholders or blockholders9 are -after all- not that bad when it comes to be a stabilising factor in times of turmoil, while giving preference to the long-term value To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies creation over the short-term optimisation. Long-term shareholders are considered to have a more disciplinary impact on risk appetite (Heremans in Killemaes and Mouton, 2008), generating a more natural self-control (Colmant, 2008b To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies), because of their more concentrated risk and their more important exposure to the well-being of the company. This does not imply at all that such type of controlled listed To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies companies can not and do not suffer from specific governance challenges, such as the potential of making abuse of a controlling position, or depriving the company of growth perspectives because of the To what extent is the financial crisis a governance crisis? -from diagnosis to possible remedies mantra of the controlling position of blockholders.



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