ROLE OF CORPORATE GOVERNANCE IN THE FINANCIAL CRISIS

It is likely that regulation can be established that will be at least moderately effective in preventing the financial industry from engaging in the practices that led to the most recent financial crisis. Regulations can be established that will reduce leverage, increase reporting, increase capital ratios and prevent the use of off-balance sheet entities. However, it is unlikely that regulation can address what is arguably the primary cause of the current financial crisis which was the failure of corporate governance. Executive management and the boards of directors either were unqualified to manage the business that they were responsible for or knowingly approved practices which had the possibility of destroying their businesses. Alan Greenspan, during congressional testimony in 2008, stated that he was against increased regulation as he relied on banking management to exercise their considerable skills in avoiding business endeavors that would risk the survival of their institutions. He found it illogical that the industry engaged in the risky practices that led to the failure or near failure of so many financial institutions. But, were their decisions really so illogical? It may be that the boards and CEO’s knew that they were risking the long term survivability of their businesses but they also knew that, at least for a short but indeterminate period of time, these risky business practices such as sub-prime mortgages and high leverage ratios would return significant profits. Any CEO who took the long term view and avoided the profitable short term risk would find his firm under-performing competitors resulting in lower share prices, lower CEO pay and the distinct possibility that he would be replaced and not survive in his position long enough for his caution to be proven the correct strategy.