Corporate Governance

Good corporate governance matters because it persuades, prompts, and encourages institutions to preserve the honesty and integrity of the promises made to investors (Macey 2008). The issue of governance is discussed in detail in Chapter 4, so the current discussion focuses on corporate governance as a way of regulating and providing guidance on controlling and directing businesses.

Grabowski (2013) claimed that corporate governance practices can build trust slowly, but it can be lost very quickly. In the literature, the subject of corporate governance is treated in a narrow or broad manner; the narrow definitions tend to focus on corporate accountability to shareholders, while the broadest definitions view companies as being accountable to the whole of society, future generations, and the natural world (Solomon 2013). Whether preference is shown for the narrow or broader approach, the role of corporate governance is to safeguard and advance the interests ofnumerous stakeholders through setting a company’s strategic direction and by appointing and monitoring capable management to achieve this goal (Walker 2009). Importantly, corporate governance exists to ensure proper accountability for governance failures, and despite the differences in the many definitions, the concept of accountability remains at the center of corporate governance (La Porta et al. 1998).

As already mentioned, corporate governance matters. This was demonstrated during the 2008—2009 financial crisis when a number of corporate governance aspects were found to be unsatisfactory (Goodhart 2009). The global financial catastrophe has made companies, regulators, and society more conscious of the possible failings in regulation, board function, and shareholder behavior. As shown by the International Corporate Governance Network report, poor corporate governance underpinned the 2008 financial crisis (Skypala 2008). Most debated are misaligned remuneration arrangements that encouraged management to agree to unreasonably risky investment pathways while failing to punish failure. For instance, in the years leading up to the crisis, directors’ management style was frequently reckless and almost resembled a casino gambling approach. Bankers frequently exhibited uncontrolled self-interest, lack of professionalism, and reckless decision making.

Banks must have strong corporate governance procedures that encourage management and owners to appreciate the risks they are pursuing “and to price risk efficiently in order to cover both the private costs that such risktaking poses to bank shareholders and the social costs for the broader economy if the bank fails” (Alexander 2009, 64). However, personal accountability in the investment banking industry remained weak, and this breakdown in accountability resulted in reckless business decisions in global credit markets, with disastrous consequences for the global economy. This widespread failure on the part of the boards of directors to understand and control the risks that were taken by their companies is a major concern (Macneil 2010). Their failure is particularly problematic because good corporate governance places a great deal of importance on boardroom behavior. Management is expected to consist of fit people in terms of ethics and competence who are capable of discharging their responsibilities properly. Nonetheless, numerous post-crisis reports, such as the Green Paper on Corporate Governance commissioned by the European Commission (2010), identified several deficiencies that contributed to the failure of boards to exercise effective control over senior management. Boards of directors were unable to ensure that the risk management framework of their financial institutions was suitable (see European Commission 2010). Boards were also found unable to recognize the systemic nature of certain risks and were consequently not in a good position to deliver sufficient information to their supervisory authorities. Linked to this, there was a lack of appreciation of the risks involved, as well as inadequate training for those employees in control of distributing risk products (European Commission 2010). These deficiencies raise serious questions about the specific individual quality of the board of directors and its composition, training, and qualifications. Additionally, according to the report by the International Corporate Governance Network, boards “failed to understand and manage risk and tolerated perverse incentives” (Mallin 2013, 8). Indeed, major weaknesses in bank corporate governance worldwide exposed a key weakness of the past few years; specifically, too many people simply failed to understand the risks involved (Tomasic 2009).