Corporate Governance Failures
Malice in Wonderland?
Simon Gray
Managing Director – AGORA Consulting
INCEIF Lecture – 4th September 2014
Kuala Lumpur
Perspective?
 “If
I had a word of my own, everything would be nonsense.
Nothing would be what it is because everything would be
what is isn’t. And contrary-wise; what it is is wouldn’t be,
and what it wouldn’t be, it would. You see?”
- Alice
 “Fraud
and deceit abound in these days more than in
former times!”
- Sir Edward Cole (1602)
What’s on the menu..!

Strictly Boardroom
 Understand importance of good corporate governance
 Key Principles of corporate governance

Malice in Wonderland
 Failures of governance at many financial institutions
 Nice documents, regular meetings, lovely committees are no
use if largely lip service
 Good theory – bad practice
 Human fallibility
 Remuneration structures wrong

Faith in the Future
 Force better standards of corporate governance through tougher
on-site examinations
 Realistic remuneration – end of jam today and risk tomorrow
culture
Definition

Set of Policies, Practices, Procedures, Laws and Customs
under which a company is administered and controlled

Includes the interrelationships among the many
stakeholders involved: Shareholders, Board of Directors,
Management, Employees, Customers, Creditors,
Suppliers, Regulators

Ensure Accountability

Shareholder protection
Context

Corporate governance has been practiced for as long as
there have been corporate entities.

Yet study of subject is < half a century old

Phrase “corporate governance” scarcely used until 1980s

Adam Smith – Wealth of Nations

Shakespeare’s Merchant of Venice
History

4th Century BC – Arthasastra – ancient Indian book of political realism.
Comprised of 15 books with book 11 entitled The Conduct of Corporations. Sadly
the tome then goes on to recommend the use of spies, destruction of enemies &
world domination.

10th Century AD - “Governance” is an ancient word, used since the time of
Chaucer. But the phrase “corporate governance” is new!!

16th Century - Shakespeare – Merchant of Venice

19th Century– laid foundations for modern corporations / century of entrepreneurs

20th Century – the century of management – vast growth in management
theories, consultants, gurus and management teaching
 1983 – it appeared as the title of a paper in Perspectives on Management
 1984 – it appeared as the title of a report in the American Law Institute on the
Principles of Corporate Governance and also as the title of a book Corporate
Governance – practices, procedures and powers in British companies and their
board of directors.

21st Century – promises to be the century of governance – as the focus swings to
the legitimacy and effectiveness of the wielding of power over corporate entities
world wide
Code breaking..!

1992 – Cadbury Committee
 Code of Practice on Corporate Governance
 importance of independent non-executive directors
 independence defined a “independent of management and
free from any business or other relationship which could
materially interfere with the exercise of independent
judgment, apart from their fees and share-holding.”
 Audit Committees
▫ Cadbury represented a significant breakthrough in
corporate governance thinking
▫ Replicated elsewhere
Remuneration (1)

1995 - Greenbury report
 Focus on directors remuneration
 Full disclosure
 Code of best practice
 Remuneration Committees (including independent outside
directors to advise)
Remuneration (2)

1998 – Hampel Committee
 Reported on outcome of Cadbury and recommended
combining Cadbury and Greenbury
 But committee staffed largely of directors of major public
companies and their professional advisors saw no reason to
criticise contemporary corporate governance, nor to
advocate measures which might limit directors’ powers to
make unfettered decisions or widen accountability
• more on remuneration later
Key change in corporate governance
 The
naughty 90’s
 dynamic flexible new corporate structures, often global, replaced
the stable, often regional, corporate groups of the post war years
 massively complex networks of subsidiary companies and
strategic alliances with cross-shareholdings of shares, crossdirectorships, chains of leveraged (and often public) funding,
dynamic and ever changing operational and financial linkages
throughout the added-value chain
 conflicts with accountancy firms taking on more consulting roles
 “client focussed” – euphemism for increased attempts to sell
clients a significant bundle of non-auditing services
 political indifference – laissez-faire
 shareholder indifference
 record number of new offerings to capital markets
Rapid growth spawns greed
 Bad
behaviour not new but world changed in 1990s
 From 1990 – 2001
 worker pay increased 42%; corporate profits increased 88%,
S&P 500 index increased 248%; and CEO pay rose a
whopping 463%
 Earnings
restatements, a serious step taken to correct
inconsistencies, increased dramatically
 1997, 116 firms restated their earnings
 2001, 270 firms restated their earnings
“managements growing incentive, willingness, and ability
to manipulate earnings” – McNichols (Stanford
University)
Dominant CEO
 Queen
of Hearts: Now then, are you ready for your sentence?
Alice: But there has to be a verdict first.
Queen of Hearts: Sentence first! Verdict afterwards.
Alice: But that just isn't the way.
Queen of Hearts: [shouting] All ways are...!
Alice: ...your ways, your Majesty.
 Cheshire
Cat: All ways here you see, are the Queen’s ways!
Lehman Brothers

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8 independent Board members
One noted as the worst CEO of all time by national
magazine
Theatrical producer
Retired Navy Admiral
Energy Company
British Mobile
Spanish TV
Professional Board Member
Financial Firm
Members average age 67
Dominant CEO
Negligent risk committee
FOF’s
Merrill Lynch

10 Board members
 2 Academics
 4 Real Estate and Investor
 Brewer
 Insurance Executive
 Lawyer
 Retired Navy Admiral
 Average age 62
 O’Neil was a dominant CEO
 Revolving door of talent at upper echelons
 Poor risk management
 Bad strategy
 FoO
Bear Stearns

9 non-executive Directors
 2 Equity investors
 Priest
 Toy Executive
 Oil Executive
 Mobile Phone Executive
 Professional Board Member
 Lawyer
 Academic
 Age from 59 – 80
 Absent CEO and non delegation policy
 No business strategy
 No capital planning
 Absence of effective supervisor demands a sterling Board
AIG
Did not understand risk of credit default swaps
 Outsized position
 No reserves
 Skirted regulatory controls
 Dominant CEO who micro-managed and was force to
leave – no management succession

Northern Rock
Dominant CEO
 Failure to understand products
 Weak Board
 No plan “B”

“It is only in the rinse cycle that you see just how dirty the
washing was. We are in the rinse cycle.”
- Warren Buffet
The Fix
Remuneration
 Institute of International Finance
 Compensation Reform in Wholesale Banking 2010 –

Progress in implementing Global Standards (Sept 2010)

Basel Committee on Banking Supervision
 Principles for enhancing corporate governance (Oct 2010)

Longer term view re incentivisation
Finally – faith and the future…! (1)


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Corporate Governance Policy for Financial Institutions should be
covered by regulatory requirements
Should apply to all banks
Fitness and Propriety of Directors
Clear delegations of authority and responsibility at senior management
level and through the organisation
Strong framework of operational controls
Financial supervisors need to undertake a robust assessment of
governance and have the power to intervene as necessary
All violations of safe and sound practices must be brought to Board’s
and management’s attention with clear time frame for resolution
There should be a clear separation of duties and authority between
Chair and CEO or President
Finally – faith and the future…! (2)

Non-executive directors must have a mix of relevant skills compatible with
the bank’s business lines

The Board clearly understands the risks undertaken by the organisation and
seeks professional outside guidance periodically

There is a clear strategy for the bank and definitive risk parameters for
executives and staff to follow

Operational controls and policies, practices and procedures are in line with
the strategy and risk tolerance of the institution

The Board should be using all the tools at its disposal to maintain rigorous
oversight over the institution including audit, supervisory authorities and
outside counsel

Supervisors should have experts dedicated to assessing proper governance

Supervisory authorities should keep the industry informed of emerging
good practice
But….!
Time will tell if new initiatives will succeed
 Shari’a Governance?
 History paints a bleak picture
 21st Century the Century of Corporate Governance
 “It is clear that good corporate governance makes good

sense. The name of the game for a company in the 21st
Century will be to conform while it performs.”
- Mervyn King
Cautious optimism
 The buck stops with supervision…!

• Let us not forget the many positive elements the financial
innovation has brought – liquidity, job creation (direct
and indirect) and a massive increase in invisible earnings.
Going in the right direction?
“Would you tell me, please, which way I ought to go from
here? “
“That depends a good deal on where you want to get to,”
said the Cat.
I don’t much care where…” said Alice
“then it doesn’t matter which way you go,” said the Cat.
“…so long as I get somewhere,” Alice added as an
explanation.
“Oh you’re sure to do that, said the Cat, “if you only walk
long enough.”
Thank You