International Finance Corporation A Member Of The World Bank Group The Cosmetic Corporate Governance – Will Companies Learn Lessons From the Global Financial Crisis!

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The Cosmetic Corporate Governance – Will Companies Learn Lessons From the Global Financial Crisis!

The impact of the crisis began to diminish. However, all key players, including top executives, regulators and investors, have much to learn from global financial failures. The Organization for Economic Co-operation and Development (OECD) Steering Group has issued a report entitled Corporate Governance Lessons from the Financial Crisis. The report concludes that among the main contributors to the financial crisis were failures and weaknesses in corporate governance arrangements. When they were tested, corporate governance routines fell short of their objective of protecting against excessive risk taking at financial services institutions.

Other major contributors to the global financial crisis include failures in transparency, failures in lending standards; failures in prudential standards; failure in risk management.

As for top executives’ remuneration, the real issue is not the amount they receive; that’s how the company pays them. A bad bonus culture encourages short-term thinking: close as many deals this year and get bigger bonuses! That approach encourages executives to focus their attention on achieving short-term goals at the expense of continuing growth goals.

Most financial institutions tie compensation to quarterly performance, encouraging short-term bets. When the bets win, the executives get the rewards, but when the bets go bad, as they did in the most recent financial crisis, the executives who took the plunge don’t have to give back their fat cat bonuses. Executives, in most cases, are no longer gambling with their own net worth. It is the shareholders who are affected. Thus executive greed acted as fuel which was thrown into the fire and contributed to the fiery global financial crisis. The right approach if we are to keep the financial system from being abused by the greed of top executives again is to maintain the partnership between top executives and their net worth tied to the well-being of the organization. As a result, they will be wary of taking big risks and discourage the malpractice of pursuing short-term gains. In addition, we need to replace bonuses with better long-term compensation such as deferred cash payments and limited stock.

The directors of troubled institutions seem to provide only superficial oversight to control the greed of top executives. Collapsed company boards bear full responsibility. Every month they look at the numbers. They are also responsible for complying with the regulations. And they set a remuneration package for top executives. Yet troubled companies only check the box for good corporate governance in their annual reports. In other words, there are organizations presenting real examples of cosmetics corporate governance to deceive different shareholders including investors, rating agencies and regulators!

The current global financial crisis has shed light on how poor risk management can lead to disaster. Risk management systems have failed in many cases due to corporate governance procedures rather than to the inadequacy of computer models alone.

With the emergence of new products such as advanced derivatives and certificates of deposit, they pose an unknown risk. Risk management may not be up to the task because many standard quantitative models and users of these models regularly misjudge the systematic nature of risk. To some extent this is due to the complexity of the product and the over-reliance on quantitative analysis. Unfortunately, many risk evaluations are wrong, including those given by rating agencies.

Directors of a collapsing financial institution need to better understand the implications of risk when making decisions about sophisticated products such as derivatives. The reality is that many board members have inadequate knowledge of state-of-the-art new products and are likely embarrassed to show that they do not! This is where director education and orientation falls short as best corporate governance best practice. Continuing education is important to ensure that directors understand all aspects of company affairs with a particular focus on risk. Each director should receive a customized orientation program in areas in which he or she does not have sufficient knowledge to effectively carry out the fiduciary supervisory role.

Finally, the concept that in difficult times companies will be more interested in supporting their profitability and therefore will not have time for corporate governance is irrational. Integrity cannot be compromised because corporate governance is not seasonal – it applies around the clock and should stick with senior corporate executives and directors. Companies must not put corporate governance on the shelf during bad times. It’s like a muscle, it must be trained or it will atrophy

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