Hany Abou-El-Fotouh* wonders whether companies have learnt any lessons at all from the global financial crisis The global crunch raises the need to understand what really happened in the big financial institutions which collapsed, and what we need to do to address defects in brittle, cosmetic arrangements of corporate governance and accountability. Obviously, the problems were not due to a lack of corporate governance, but rather how the corporate governance framework has been used to mislead different stakeholders, including regulators. If this episode is worth anything, it is worth the lessons it produced on how poor corporate governance helped create the quagmire we are in. All key players, including top executives, regulators and investors, have much to learn from the global financial failures. The Organisation for Economic Co-operation and Development (OECD) Steering group recently issued a report titled Corporate Governance Lessons from the Financial Crisis. This report concludes that among the major contributors to the financial crisis are the failures and weaknesses in corporate governance arrangements. When they were put to a test, corporate governance routines did not serve their purpose to safeguard against excessive risk-taking in a number of financial services institutions. Other key contributors to the global financial crisis included failures in transparency, lending standards, prudential standards and risk management. As for the remuneration of top executives, the real problem was not the amount they received; it was in how companies pay them. The bad bonus culture encourages short- term thinking, inciting executives to break as many deals as possible, in as short a time-span as possible. That approach came at the expense of sustainable growth objectives. Most financial institutions link compensation to quarterly performance, encouraging short- term gambles. When the bets win, executives get the rewards, but when the bets sour, as they have in the latest financial crunch, the executives who took the risks do not have to return their fat-cat bonuses. The executives were, in most cases, no longer gambling with their own net worth. It was the shareholders who took the hit. Thus, the executive greed acted as fuel thrown on the fires of and contributed to the blazing global financial crisis. The right approach if we are going to keep the financial system from being misused by top executives' greed again is to maintain a partnership between the top executives and have their net worth tied to organisations' well-being. In such an arrangement, they would be cautious about taking big risks and discourage the malpractice of running after short-term gains. Also, we need to replace bonuses with better, longer- term compensation, such as deferred cash pay and restricted stock. Directors of troubled institutions appear to have provided only thin supervision to control the greed of top executives. The boards of the collapsed firms carry the full responsibility. Each month they see the numbers. They are also responsible for compliance with regulations. And they set remunerations packages for the top executives. Nonetheless, they just ticked the boxes for good corporate governance in their annual reports. In other words, organisations presented and implemented merely cosmetic corporate governance, to fool different stockholders including investors, rating agencies and regulators. The current global financial crisis has shed light on how poor risk management can lead to catastrophic results. Risk management systems have failed in many cases due to corporate governance procedures rather than the inadequacy of computer models alone. With the advent of new products such as sophisticated derivatives and certificates of deposits, they posed unknown risks. Risk management may not have been up to the task since many of the standard quantitative models and users of these models regularly misjudged the systematic nature of risks. To some extent this was due to product complexity and an over- reliance on quantitative analysis. Sadly, many risk evaluations were wrong, including those provided by rating agencies. The directors of the collapsed financial institutions should have had better understanding of the implications of risk when it was time to take decisions on sophisticated products such as derivatives. The reality is many board members had an inadequate knowledge on the sophisticated new products, and likely were embarrassed to show that they lacked the adequate knowledge. Here is where directors' education and orientation failed. Ongoing education is important to ensure that the directors are familiar with all aspects of the company's affairs, with a particular focus on risks. Each director must receive customised orientation programmes in areas where he or she lacks adequate knowledge, in order to be able to effectively undertake a good supervisory role. Finally, the notion that in bad times companies should be excused for being more interested in supporting their profitability and accordingly for having less time for corporate governance, is irrational. Integrity cannot be compromised because corporate governance is not seasonal: it is for all times. Companies must not put corporate governance on the shelf in bad times. It is like a muscle, and must be exercised, or it will waste away. * The writer is director of policy and corporate affairs and board secretary at Commercial International Capital Holding (CICH), the investment banking arm of Commercial International Bank.
