BlogsSomething more is needed
Boards did not understand the risks and shareholders did not prevent them
By Paul Moxey | Published 11:46, 06 April 11
There is now a climate of opinion which accepts that changes are needed. A ‘Big Society’ would demand it. The reforms since Enron and WorldCom proved useless in preventing banks taking extreme risks and gambling with our economies. Again, boards did not understand the risks being taken and shareholders did not prevent this or hold boards to account. If anything, the focus on short term results by investors encouraged boards to take more, not less, risk. These institutions which failed or suffered billions in losses complied with best corporate governance practice and thought they had leading edge risk management.
The US Securities Exchange Commission and ratings agencies thought Lehman’s approach to risk was particularly good. In Switzerland, the external auditors of UBS reported in January 2007 that "group risk reporting processes were adequate to ensure that the key risks reported by the business groups were adequately included in the group risk reporting”, and that "group risk reporting processes were not complex in their execution and were performed by experienced professionals." Audit committee members probably took comfort from that.
There was compliance with the form - but not the substance - of good governance. Practice was wrong. The problems were primarily with culture, human behaviour and incentives and motivation or if you like - greed and turning a blind eye.
How do we get the right behaviour? Michel Barnier, internal markets commissioner at the Europe Commission responsible for the latest European consultation on governance, said in a recent speech “I am clear we will not be able to rely only on voluntary codes”. Perhaps not, but can we rely any better on rules? Regulation has unintended consequences.
Rules and policies specify what those in authority say should happen. CULTURE determines what ACTUALLY happens, and whether rules are followed, bent or ignored. Behaviour is also influenced by incentives. If you have a culture where winning is everything, and makes people rich when they do, then many people will do anything to win and ignore rules and ethics.
Codes, rules and measurement systems focus on observable individual and corporate behaviour. But it is individual and corporate values that determine individual and corporate behaviour. We need to get smarter in how we seek to encourage the right behaviours.
Part of getting smarter is understanding how incentives influence the various stakeholders. Who had a real incentive to prevent the financial crisis? Besides all of us, it is actually almost no one. The stakeholders were pursuing their own agendas. Management and senior traders in banks were all making too much money to worry about the stability of the system. Politicians wanted the good times to go on. No one would thank regulators for spoiling the fun. Unfortunately, even accountants and auditors were obliged to follow auditing and reporting standards which we know now were not perfect.
Today, as we experience the aftermath of the financial crisis, it seems that something more is needed. Businesses, particularly the financial sector, need to be responsible citizens. They need society, they cannot operate without it, they have a moral duty not to harm it. Capitalism and ‘Big Society’ can, and should be, complementary to each other.
As part of a series of papers on the theme ‘risk and reward’, ACCA has just published a collection of individual perspectives in ‘risk and reward: shared perspectives’. These look at how investor groups see the significance of risk. They consider how behavioural risk impacts on the public as well as the private sector. Several contributions address the application and measurement of ethical principles and consider how those principles might impact on performance. The first chapter, ‘Capitalism and the concept of the public good’, explores how capitalism works, or not, in the public interest.
The US Securities Exchange Commission and ratings agencies thought Lehman’s approach to risk was particularly good. In Switzerland, the external auditors of UBS reported in January 2007 that "group risk reporting processes were adequate to ensure that the key risks reported by the business groups were adequately included in the group risk reporting”, and that "group risk reporting processes were not complex in their execution and were performed by experienced professionals." Audit committee members probably took comfort from that.
There was compliance with the form - but not the substance - of good governance. Practice was wrong. The problems were primarily with culture, human behaviour and incentives and motivation or if you like - greed and turning a blind eye.
How do we get the right behaviour? Michel Barnier, internal markets commissioner at the Europe Commission responsible for the latest European consultation on governance, said in a recent speech “I am clear we will not be able to rely only on voluntary codes”. Perhaps not, but can we rely any better on rules? Regulation has unintended consequences.
Rules and policies specify what those in authority say should happen. CULTURE determines what ACTUALLY happens, and whether rules are followed, bent or ignored. Behaviour is also influenced by incentives. If you have a culture where winning is everything, and makes people rich when they do, then many people will do anything to win and ignore rules and ethics.
Codes, rules and measurement systems focus on observable individual and corporate behaviour. But it is individual and corporate values that determine individual and corporate behaviour. We need to get smarter in how we seek to encourage the right behaviours.
Part of getting smarter is understanding how incentives influence the various stakeholders. Who had a real incentive to prevent the financial crisis? Besides all of us, it is actually almost no one. The stakeholders were pursuing their own agendas. Management and senior traders in banks were all making too much money to worry about the stability of the system. Politicians wanted the good times to go on. No one would thank regulators for spoiling the fun. Unfortunately, even accountants and auditors were obliged to follow auditing and reporting standards which we know now were not perfect.
Today, as we experience the aftermath of the financial crisis, it seems that something more is needed. Businesses, particularly the financial sector, need to be responsible citizens. They need society, they cannot operate without it, they have a moral duty not to harm it. Capitalism and ‘Big Society’ can, and should be, complementary to each other.
As part of a series of papers on the theme ‘risk and reward’, ACCA has just published a collection of individual perspectives in ‘risk and reward: shared perspectives’. These look at how investor groups see the significance of risk. They consider how behavioural risk impacts on the public as well as the private sector. Several contributions address the application and measurement of ethical principles and consider how those principles might impact on performance. The first chapter, ‘Capitalism and the concept of the public good’, explores how capitalism works, or not, in the public interest.
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