This is the Expert Comment contributed by Philip Armstrong, Head of the Global Corporate Governance Forum, to the recent UNCTAD publication Corporate Governance in the Wake of the Financial Crisis: Selected International Views.
Politicians, policy-makers, regulators, business leaders, and others have made considerable efforts to remedy the circumstances that led to the global financial crisis. These efforts have relied largely on the implementation of more regulations and more revisions to corporate governance standards.
Absent from the reform discussions is the role that ethics should have played in how boards reached critical decisions that had a calamitous impact on the world’s financial markets. Perhaps the closest has been the Walker Report in the United Kingdom, which explored concerns around the behavioral conduct of bank boards in its enquiry into the meltdown of the UK banking sector.
The challenge for the global business community is to seize the moment now (while institutional and investor support for reform remains strong) and build broader, more assertive adherence to corporate governance best practices.
Chief among boards’ priorities is their need to recommit to high ethical standards, especially since many were compromised over the past two decades to the point that public trust and confidence in business is very low, especially in the banking sector. Ethics should not be an issue that applies only to corporate boards, either. There is much blame to pass around for the financial crisis, including investors and regulators; they, too, should re-examine their ethical standards and decision processes.
Value systems in business have been shaken; in some instances, they appear to have collapsed, none more so than in the banking sector it would appear. In hindsight, too much effort has seemingly been spent on checking the boxes in support of compliance with rules and regulations. Too many directors sidelined ethical issues that could have better informed the fundamental business decisions they made, decisions that had a profound effect on the global economy. In some cases, difficult decisions essential to abiding by the spirit of codes of conduct and regulations were conveniently avoided or simply ignored.
The extent to which senior management, with their boards’ approval, enriched themselves at the expense of their investors’ long-term interests is but one example among many that underscores why the moral compass of business leaders needs to be recalibrated. Regulators, under political pressure, should well heed this point, too, as should those investors who gleefully rode the wave of superior profits to the disregard of their own stewardship responsibilities. Too many investors disregarded obvious signals that should have alerted them to problems, especially poor selection of board directors.
How can ethics be re-introduced as part of the moral compass for boards and other institutions critical to the stability and welfare of our financial markets and global economy?
First, this re-introduction surely can’t be about rules alone. Boards must play a leadership role in promoting an ethical business culture, with the chairman and CEO setting the “tone at the top.” This must be demonstrated – in practice and conduct – to ensure that the right decisions are made and ethical standards are rigorously observed without exception.
More time must also be devoted to board induction and director development, particularly in such complex sectors as banks and financial institutions. This effort should not only cover relevant laws, regulations and codes that govern the business; it should also include a comprehensive understanding of the financial structure of the business and such key performance issues as market environment, strategies, and major risks.
At the Global Corporate Governance Forum, we are helping to address this need by developing board instruction on bank risk governance, drawing on lessons from the financial crisis, which focuses on the special features of banks and the role of directors. This module, an extension of our globally acclaimed Corporate Governance Board Leadership Training Resources, follows the journey of a newly appointed bank director as he or she acquires the understanding, skills and insights required for handling the particular challenges posed by financial markets and banking, despite his or her extensive experience as a board director in industry.
Mandatory rules have a role, too, with needed reforms to ensure that boards and senior management are more closely aligned with investor and shareholder interests. Granted, there are limits to what laws and regulations can do to halt the opportunistic behavior of individual decision-makers. A good example is the enactment of the Sarbanes-Oxley law in the United States. This put into place major reforms in securities laws that toughened audit and disclosure requirements. Yet, these laws did not avert the problems that have taken place in investment banks and other financial institutions, including excessive leverage and other reckless governance practices.
Tougher requirements can inform boards’ ethical responsibilities for compensation-setting, risk management, investment strategy and accounting practices. The advent of a Stewardship Code for institutional investors in the United Kingdom shows us that governance responsibilities extend beyond companies and their boards. The various elements of our financial markets should seek to address a number of serious structural deficiencies and perverse incentives highlighted by the global financial crisis, otherwise we run the risk of simply getting back to business-as-usual all too soon and set ourselves up for another crisis in the not too distant future.
Of course, none of this will work unless the financial markets and those responsible for their effective functioning (such as policy-makers, regulators, and market participants) demonstrate that good corporate governance practices are determined by the ethical exercise of significant authority and responsibilities on which society’s welfare depends.
Full report is available for download at the UNCTAD website.
Absent from the reform discussions is the role that ethics should have played in how boards reached critical decisions that had a calamitous impact on the world’s financial markets. Perhaps the closest has been the Walker Report in the United Kingdom, which explored concerns around the behavioral conduct of bank boards in its enquiry into the meltdown of the UK banking sector.
The challenge for the global business community is to seize the moment now (while institutional and investor support for reform remains strong) and build broader, more assertive adherence to corporate governance best practices.
Chief among boards’ priorities is their need to recommit to high ethical standards, especially since many were compromised over the past two decades to the point that public trust and confidence in business is very low, especially in the banking sector. Ethics should not be an issue that applies only to corporate boards, either. There is much blame to pass around for the financial crisis, including investors and regulators; they, too, should re-examine their ethical standards and decision processes.
Value systems in business have been shaken; in some instances, they appear to have collapsed, none more so than in the banking sector it would appear. In hindsight, too much effort has seemingly been spent on checking the boxes in support of compliance with rules and regulations. Too many directors sidelined ethical issues that could have better informed the fundamental business decisions they made, decisions that had a profound effect on the global economy. In some cases, difficult decisions essential to abiding by the spirit of codes of conduct and regulations were conveniently avoided or simply ignored.
The extent to which senior management, with their boards’ approval, enriched themselves at the expense of their investors’ long-term interests is but one example among many that underscores why the moral compass of business leaders needs to be recalibrated. Regulators, under political pressure, should well heed this point, too, as should those investors who gleefully rode the wave of superior profits to the disregard of their own stewardship responsibilities. Too many investors disregarded obvious signals that should have alerted them to problems, especially poor selection of board directors.
How can ethics be re-introduced as part of the moral compass for boards and other institutions critical to the stability and welfare of our financial markets and global economy?
First, this re-introduction surely can’t be about rules alone. Boards must play a leadership role in promoting an ethical business culture, with the chairman and CEO setting the “tone at the top.” This must be demonstrated – in practice and conduct – to ensure that the right decisions are made and ethical standards are rigorously observed without exception.
More time must also be devoted to board induction and director development, particularly in such complex sectors as banks and financial institutions. This effort should not only cover relevant laws, regulations and codes that govern the business; it should also include a comprehensive understanding of the financial structure of the business and such key performance issues as market environment, strategies, and major risks.
At the Global Corporate Governance Forum, we are helping to address this need by developing board instruction on bank risk governance, drawing on lessons from the financial crisis, which focuses on the special features of banks and the role of directors. This module, an extension of our globally acclaimed Corporate Governance Board Leadership Training Resources, follows the journey of a newly appointed bank director as he or she acquires the understanding, skills and insights required for handling the particular challenges posed by financial markets and banking, despite his or her extensive experience as a board director in industry.
Mandatory rules have a role, too, with needed reforms to ensure that boards and senior management are more closely aligned with investor and shareholder interests. Granted, there are limits to what laws and regulations can do to halt the opportunistic behavior of individual decision-makers. A good example is the enactment of the Sarbanes-Oxley law in the United States. This put into place major reforms in securities laws that toughened audit and disclosure requirements. Yet, these laws did not avert the problems that have taken place in investment banks and other financial institutions, including excessive leverage and other reckless governance practices.
Tougher requirements can inform boards’ ethical responsibilities for compensation-setting, risk management, investment strategy and accounting practices. The advent of a Stewardship Code for institutional investors in the United Kingdom shows us that governance responsibilities extend beyond companies and their boards. The various elements of our financial markets should seek to address a number of serious structural deficiencies and perverse incentives highlighted by the global financial crisis, otherwise we run the risk of simply getting back to business-as-usual all too soon and set ourselves up for another crisis in the not too distant future.
Of course, none of this will work unless the financial markets and those responsible for their effective functioning (such as policy-makers, regulators, and market participants) demonstrate that good corporate governance practices are determined by the ethical exercise of significant authority and responsibilities on which society’s welfare depends.
Full report is available for download at the UNCTAD website.
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