TY - JOUR

T1 - Corporate Governance and the 2008–09 Financial Crisis

AU - Conyon, Martin

AU - Judge, William Q.

AU - Useem, Mike

PY - 2011/9

Y1 - 2011/9

N2 - The financial crisis of the late 2000s resulted in enormous costs to the economies of many countries and the fortunes of millions of families, and it challenged a host of our conceptions and theories of corporate governance. The governing boards of many financial-services firms seemed unable to prevent the risky and ill-fated decisions that jeopardized their firms, devastated their investors, and helped precipitate a financial meltdown that morphed into global recession. Company boards were also directly responsible through their compensation committees and consultant advisors for a sharp rise in executive compensation during the 2000s that may have contributed to undue short-term risk-taking among the financial-service companies that helped spark the recession. The macroeconomic environment also changed. Historically low interest rates, and the development of new ways of financing mortgage products led to an irrationally exuberant mind-set of lending and borrowing in the housing market. The quality of some loans was questionable, but home asset prices continued to increase – until they collapsed in 2008. The boom and bust in the housing market was an important contributor – one of many including inadequate corporate governance – to the perfect financial storm of 2008–09. From a conference with 87 papers on the role of corporate governance in precipitating or exacerbating the financial crisis, and from five articles by governance researchers and three articles by prominent governance participant-observers included in this special issue, it is evident that governance played a contributing role. An article by Muller-Kahle and Lewellyn finds that directors of sub-prime lenders compared with other lenders served on a larger number of other company boards, presumably allowing then less time to monitor the sub-prime lender's risky practices, and they served for fewer years on the sub-prime lender's board, suggesting that they were less experienced in evaluating the financial risks of the sub-prime markets. A second article by Grove, Patelli, Victoravich, and Xu report that the higher the levels of debt held by banks, a policy presumably monitored and approved by directors, the lower bank financial and operating performance during the financial crisis. A third article by Yeh, Liu, and Chung finds that director independence on the auditing and risk management committees affected risk taking behaviors and subsequent performance. In the pursuit of productive avenues for reform, a fourth article Pirson and Turnbull argue for a network of boards representing multiple constituencies, convened through a “stakeholder congress,” that would bring more sources of information to the attention of more actors who could make more effective use of the information in guiding company risk management. A fifth article by Nicholson, Kiel, and Kiel-Chisholm argue for the re-establishment of professional restraints and creation of a new set of more responsible social norms within the financial sector to avoid the next financial meltdown. Three well-informed participant observers corroborate these findings and direct special attention to both company and country governance issues at they help foster the financial meltdown. Berglöf finds that the absence of both micro and macro protections against excessive and systemic risk may have opened the way for the perfect storm. Feinberg concludes that distortions from economically-rational pay practices – ultimately the responsibility of the board – may have contributed to the financial crisis as executives sought to optimize their pay in ways that were not optimal for the firm nor its investors, customers, or lenders. Johnson places some of the blame for the crisis indirectly on the governance door step – directors who hired and monitored the bankers at center of the crisis had helped foster a culture of short-term greed and narrow self-interest that became toxic when it became systemic and no longer limited to a few aberrant players. Taken together, the five articles and three commentaries in this issue point to the importance and interplay of both micro and macro governance factors in contributing to the financial crisis of 2008–09 – and to the importance of reforming those factors to help avert another financial crisis in the future.

AB - The financial crisis of the late 2000s resulted in enormous costs to the economies of many countries and the fortunes of millions of families, and it challenged a host of our conceptions and theories of corporate governance. The governing boards of many financial-services firms seemed unable to prevent the risky and ill-fated decisions that jeopardized their firms, devastated their investors, and helped precipitate a financial meltdown that morphed into global recession. Company boards were also directly responsible through their compensation committees and consultant advisors for a sharp rise in executive compensation during the 2000s that may have contributed to undue short-term risk-taking among the financial-service companies that helped spark the recession. The macroeconomic environment also changed. Historically low interest rates, and the development of new ways of financing mortgage products led to an irrationally exuberant mind-set of lending and borrowing in the housing market. The quality of some loans was questionable, but home asset prices continued to increase – until they collapsed in 2008. The boom and bust in the housing market was an important contributor – one of many including inadequate corporate governance – to the perfect financial storm of 2008–09. From a conference with 87 papers on the role of corporate governance in precipitating or exacerbating the financial crisis, and from five articles by governance researchers and three articles by prominent governance participant-observers included in this special issue, it is evident that governance played a contributing role. An article by Muller-Kahle and Lewellyn finds that directors of sub-prime lenders compared with other lenders served on a larger number of other company boards, presumably allowing then less time to monitor the sub-prime lender's risky practices, and they served for fewer years on the sub-prime lender's board, suggesting that they were less experienced in evaluating the financial risks of the sub-prime markets. A second article by Grove, Patelli, Victoravich, and Xu report that the higher the levels of debt held by banks, a policy presumably monitored and approved by directors, the lower bank financial and operating performance during the financial crisis. A third article by Yeh, Liu, and Chung finds that director independence on the auditing and risk management committees affected risk taking behaviors and subsequent performance. In the pursuit of productive avenues for reform, a fourth article Pirson and Turnbull argue for a network of boards representing multiple constituencies, convened through a “stakeholder congress,” that would bring more sources of information to the attention of more actors who could make more effective use of the information in guiding company risk management. A fifth article by Nicholson, Kiel, and Kiel-Chisholm argue for the re-establishment of professional restraints and creation of a new set of more responsible social norms within the financial sector to avoid the next financial meltdown. Three well-informed participant observers corroborate these findings and direct special attention to both company and country governance issues at they help foster the financial meltdown. Berglöf finds that the absence of both micro and macro protections against excessive and systemic risk may have opened the way for the perfect storm. Feinberg concludes that distortions from economically-rational pay practices – ultimately the responsibility of the board – may have contributed to the financial crisis as executives sought to optimize their pay in ways that were not optimal for the firm nor its investors, customers, or lenders. Johnson places some of the blame for the crisis indirectly on the governance door step – directors who hired and monitored the bankers at center of the crisis had helped foster a culture of short-term greed and narrow self-interest that became toxic when it became systemic and no longer limited to a few aberrant players. Taken together, the five articles and three commentaries in this issue point to the importance and interplay of both micro and macro governance factors in contributing to the financial crisis of 2008–09 – and to the importance of reforming those factors to help avert another financial crisis in the future.

U2 - 10.1111/j.1467-8683.2011.00879.x

DO - 10.1111/j.1467-8683.2011.00879.x

M3 - Journal article

VL - 19

SP - 399

EP - 404

JO - Corporate Governance: An International Review

JF - Corporate Governance: An International Review

SN - 0964-8410

IS - 5

ER -