Sir David Walker is a leading City grandee and was the chairman of Morgan Stanley, the investment bank. In 2007 Walker was commissioned to produce a report into the then hugely controversial private equity business. His findings on transparency were rated toothless and in the eyes of many paved the way for the excessive opacity of markets that in turn engendered the current crisis. Sir David identifies four fundamental flaws:
1. The boards of the bank failed to understand the scale and type of risk they were running
2. Non-executive directors were hopeless in holding powerful executives to account
3. Bonus schemes rewarded short term performance and therefore encouraged dangerous risk taking.
4. Institutional shareholders caught up in exuberance of skyrocketing returns failed to exercise proper stewardship.
These flaws are no different from the ones exposed in the dotcom debacle of 2000 and the raft of scandals such as ENRON, WorldCom, Tyco etc that followed. Indeed these transgressions are now enshrined as standard text in books such as "Corporate Governance" (McGraw-Hill Executive MBA Series, New York, 2003, p. 229):
1. Executive compensation grossly disproportionate to corporate results;
2. Stock promotion, such as initial public offerings (IPO), that has gone to an extreme in the creation of very questionable or unproven business concepts;
3. Misuse of corporate funds;
4. Trading on insider information, particularly by managers exercising stock options that have rewarded short-term thinking;
5. Misrepresentation of the true earnings and financial condition of too many companies; and
6. Obstruction of justice by concealing activities or destroying evidence.
Wednesday 5 August 2009
WHAT IS IT THAT IS DIFFERENT AND NEW AND WILL WORK NOW THAT HAS BEEN PROMISED BY SIR DAVID WALKER?
It is, therefore, not surprising that Sir David’s recommendations while welcomed by the government that appointed him have met with adverse reactions both from bankers and investors. In a show of untamed arrogance and audacity, reminiscent of heyday of Wall Street, Goldman Sachs has declared record profits in the second quarter of 2009 and announced hefty bonuses for its staff - equivalent to a US$ million for each staff. The public was furious at bankers’ irresponsibility in forgetting that they were in business because of tax payer had bailed them out with – a stunning sum of £904 billion in UK alone. Banks had cheated to raise their stock values in order to get bonuses which are in vast multiples of the remuneration of ordinary, but equally hard working and honest people. They criticised recommendations as "pretty similar to the countless others before it. We need radical thinking - but we got tinkering".
Sir David claims his proposals - taken with those put forward by the Financial Services Authority - would be the "toughest remuneration regime in the world". Sir David warns, "there is no reason why his proposals - with the exception of the suggestions on risk - could not be applied to "any other listed company board". But looked at from the most eye-catching of Walker’s proposals: that the compensation of all highly-paid bankers should be publicly disclosed, have no teeth. The highly paid would not actually be named; their compensation would just be disclosed in bands. Besides these proposals cannot be implemented until adopted in the Combined Code and subjected to the same Comply or Explain regime.
We are unlikely to find effective answers unless we self-introspect and ask ourselves why despite a rash of regulations, the world economy has again been thrown into turmoil? What is it that is new and different that we can do now that will be more effective to secure it? The irony is that everyone knows the problem. Greed is a given in human nature. It is beyond class, creed, clan, caste or calling. It is the key driver of business. Economists refer to it as self-interest. But businesses when questioned are often in a muddled state of self denial.
The holy cow of corporate governance is that It is board process that most impacts board performance. The key criteria constitute the number of outside directors, the separation of the role of chair and of chief executive officer, the size of the board, the composition of committees, the independence of directors and so on. Since directorship of boards was confined to a small elite the selection was invariably restricted to the same gene pool.
So let us examine board membership of Goldman Sachs, Lehman Brothers, Merrill Lynch and City Group Smith Barney. These boards consisted of some of the leading business leaders in the United States. Indeed, the approximate 61 members of the boards of these companies also were on the boards of approximately 183 leading U. S. corporations -- most of them on more than one. In other words, the boards of directors of these leading financial institutions were primarily made up of directors of major business corporations.
These boards were constituted according to best accepted board practice -- they averaged about 14 members, had one or two prominent women members, they drew some of their membership from institutions of higher learning -- the Ivy League schools seemed to be a fertile place to find directors -- and there was not an excessive amount of interlocking among directors. So why were these boards so totally ineffective in preventing malfeasance.
Having come from similar backgrounds – class, creed, education, schools, even the independent outside director had the same values, the same standards, the same attitudes about running an enterprise and board functioning emphasized uniformity, cohesiveness and consensus. Group dynamics -- not board structure-- was the determining factor in how the boards operated.
It does not need rocket science to prove that such a process would have very little impact on the financial performance of a company. Nonetheless regulators have continued constantly to advocate and provide protection for shareholders by concentrating on board structure.
Groupthink, a term coined by social psychologist Irving Janis (1972), occurs when a group makes faulty decisions because group pressures lead to a deterioration of "mental efficiency, reality testing, and moral judgment" . Groups affected by groupthink ignore alternatives and tend to take irrational actions that dehumanize other groups. A group is especially vulnerable to groupthink when its members have similar background, the group is insulated from outside opinions, and there are no clear rules or incentives for departure from norm.
In the past quarter-century, a dramatic shift in the thinking about the goals of the corporation took place and measurement of its value. In their book "Stakeholder Corporation" published in 1997, Wheeler and Seelampa established that stakeholder focused corporations outperformed shareholder focused corporations. The principal purpose of publicly traded corporations was to maximise value of their shares on the stock market and not the bottom line results. Rewards to the directors and management began to be determined not by the quality of a company's products or services, but by the performance of company shares.
The acceptance of this concept has been catastrophic, particularly for institutions in the financial sector. With the ever-greater complexity of the financial needs of companies and their clients, investment banks started using "financial engineering" to manufacture an array of complex financial products that have no intrinsic economic value, but which when properly (or improperly) manipulated can generate fees and profits . This is deception and is precisely what made subprime mortgage lending calamity -- the genesis for the current man-made economic meltdown--possible. Changing the structure of boards won't make any difference . What will is a transformation in corporate culture that prevents Groupthink.values dissent in the boardroom and encourages free and frank dialogue.
Sir David claims his proposals - taken with those put forward by the Financial Services Authority - would be the "toughest remuneration regime in the world". Sir David warns, "there is no reason why his proposals - with the exception of the suggestions on risk - could not be applied to "any other listed company board". But looked at from the most eye-catching of Walker’s proposals: that the compensation of all highly-paid bankers should be publicly disclosed, have no teeth. The highly paid would not actually be named; their compensation would just be disclosed in bands. Besides these proposals cannot be implemented until adopted in the Combined Code and subjected to the same Comply or Explain regime.
We are unlikely to find effective answers unless we self-introspect and ask ourselves why despite a rash of regulations, the world economy has again been thrown into turmoil? What is it that is new and different that we can do now that will be more effective to secure it? The irony is that everyone knows the problem. Greed is a given in human nature. It is beyond class, creed, clan, caste or calling. It is the key driver of business. Economists refer to it as self-interest. But businesses when questioned are often in a muddled state of self denial.
The holy cow of corporate governance is that It is board process that most impacts board performance. The key criteria constitute the number of outside directors, the separation of the role of chair and of chief executive officer, the size of the board, the composition of committees, the independence of directors and so on. Since directorship of boards was confined to a small elite the selection was invariably restricted to the same gene pool.
So let us examine board membership of Goldman Sachs, Lehman Brothers, Merrill Lynch and City Group Smith Barney. These boards consisted of some of the leading business leaders in the United States. Indeed, the approximate 61 members of the boards of these companies also were on the boards of approximately 183 leading U. S. corporations -- most of them on more than one. In other words, the boards of directors of these leading financial institutions were primarily made up of directors of major business corporations.
These boards were constituted according to best accepted board practice -- they averaged about 14 members, had one or two prominent women members, they drew some of their membership from institutions of higher learning -- the Ivy League schools seemed to be a fertile place to find directors -- and there was not an excessive amount of interlocking among directors. So why were these boards so totally ineffective in preventing malfeasance.
Having come from similar backgrounds – class, creed, education, schools, even the independent outside director had the same values, the same standards, the same attitudes about running an enterprise and board functioning emphasized uniformity, cohesiveness and consensus. Group dynamics -- not board structure-- was the determining factor in how the boards operated.
It does not need rocket science to prove that such a process would have very little impact on the financial performance of a company. Nonetheless regulators have continued constantly to advocate and provide protection for shareholders by concentrating on board structure.
Groupthink, a term coined by social psychologist Irving Janis (1972), occurs when a group makes faulty decisions because group pressures lead to a deterioration of "mental efficiency, reality testing, and moral judgment" . Groups affected by groupthink ignore alternatives and tend to take irrational actions that dehumanize other groups. A group is especially vulnerable to groupthink when its members have similar background, the group is insulated from outside opinions, and there are no clear rules or incentives for departure from norm.
In the past quarter-century, a dramatic shift in the thinking about the goals of the corporation took place and measurement of its value. In their book "Stakeholder Corporation" published in 1997, Wheeler and Seelampa established that stakeholder focused corporations outperformed shareholder focused corporations. The principal purpose of publicly traded corporations was to maximise value of their shares on the stock market and not the bottom line results. Rewards to the directors and management began to be determined not by the quality of a company's products or services, but by the performance of company shares.
The acceptance of this concept has been catastrophic, particularly for institutions in the financial sector. With the ever-greater complexity of the financial needs of companies and their clients, investment banks started using "financial engineering" to manufacture an array of complex financial products that have no intrinsic economic value, but which when properly (or improperly) manipulated can generate fees and profits . This is deception and is precisely what made subprime mortgage lending calamity -- the genesis for the current man-made economic meltdown--possible. Changing the structure of boards won't make any difference . What will is a transformation in corporate culture that prevents Groupthink.values dissent in the boardroom and encourages free and frank dialogue.
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