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Corporate Governance And Regulation Failure In Credit Crunch Finance Essay

Corporate governance is a very complicated subject to bring up for discussion. The reason why corporate governance is such a complicated and difficult issue is because the human factor is involved. When doing complicated equations one can be sure that there will be an answer, there are just certain steps to follow in order to reach that answer, but when one has to solve a problem involving human emotions and feelings the task becomes much more daunting. Implementing a corporate governance chain is not an easy task, but when the right steps are followed and everyone involved understands all the procedures and know there responsibilities it should be a rather effective system. The business environment as a whole also contributes to the difficulty of implementing a management chain such as corporate governance successfully. Corruption and dishonesty is the order of the day, and people are more and more looking out only for them, disregarding everyone else. The problem comes in when the correct procedures are not followed and responsibilities are ignored, leaving the corporate governance chain vulnerable. It is human nature to be self orientated and to be focused on survival, but when there is nothing holding these human traits in check many problems could come to the surface. The likelihood is that the corporate governance structure that were in place at large organisation and banks before the Global Credit Crunch were not effective enough and people could use their own judgement, looking after only themselves and disregarding everyone else. Corporate governance and regulation did fail in the lead up to the Global Credit Crunch, and in this piece an explanation will be given on exactly why this is true.

Definitions of Corporate Governance

Johnson, Scholes and Whittington (2008:133) defines Corporate governance as being concerned with the structures and systems of control by which managers are held accountable to those who have a legitimate stake in an organisation.

Another commonly used definition of corporate governance is “the system by which companies are directed and controlled” (Cadbury Committee, 1992).

Gabrielle O’Donovan in her article “A board culture of corporate governance” defines corporate governance as “an internal system encompassing policies, processes and people, which serve the needs of shareholders and other stakeholders, by directing and controlling management activities with good business, savvy, objectivity and integrity.” (Why the “Credit Crunch” May Be Good for Corporate

Governance [S.a].)

Corporate Governance explained

In most cases and in most organisations corporate governance is the different guidelines that managers and employees follow in order to ensure that any decisions to be made or actions to be taken be done in an ethical and correct manner (Boddy 2005:152). Corporate governance entails that managers not only look out for their own interests but act in the best interests of both shareholders and stakeholders (Boddy 2005:152). In a perfect world institutions, corporations, organisations, managers and employees should take responsibility for everything they do, and through corporate governance it is possible to control and keep track of everything these above mentioned entities does and does not do (Boddy 2005:152).

There are many reasons why it is important for organisations to use and implement corporate governance, but three main points stand out.

The separation of ownership and management control of organisations. This means that in any organisation there is a certain chain of management and style of governance, this chain representing the group that may have a major influence on the organisation either through the overall management of the organisation, or through shared ownership of the organisation (Johnson, Scholes & Whittington 2008:133).

Corporate scandals are a major influence in the implementation of corporate governance. More than the implementation of corporate governance it is the fact of how people interact with each other within this governance that is important. If people don’t interact with one another in the correct manner there will be a distinct possibility that the corporate governance would be ineffective and inefficient (Johnson, Scholes & Whittington 2008:133).

Increased accountability to wider stakeholder interests simply means that organisations should not only be accountable for owners and managers, but to a wider social interest as well (Johnson, Scholes & Whittington 2008:133).

In any industry or organisation, no matter what is manufactured or sold there will always be the question of incentives. The corporate governance chain is normally used to effectively and efficiently manage these incentives, but when board members and managers drive strategy becomes remote from the ultimate beneficiaries of the company, it is possible that major problems could arise (Johnson, Scholes & Whittington 2008:135):

Misalignment of incentives and control. This takes place due to the fact that one group in the organisation may not have the same expectations as the next group. Every group and person has its own interests to look after and this may not coincide with the upper managers or board member’s view of what takes priority or what is important (Johnson et al 2008:135).

Self –interest. Every person has a sense of self preservation and survival, but sometimes this might take over and a person becomes solely interested in his or her own well being, at cost of the organisation and beneficiaries (Johnson, Scholes & Whittington 2008:133).

In a perfect world corporate governance would be the perfect manner in which to ensure that all organisational structures are in place, that all beneficiaries receive their rightful “cut” from the organisation, and that everyone in the organisation from the CEO to the lowest level managers and employees act in an ethical and morally correct manner. While this is the ultimate aim of corporate governance, one sadly has to count in the human factor. People are of nature focussed on enhancing their own situation, and while some people are able to control this urge and operate in an ethical correct manner, sadly there are people who cannot and who forget about ethics completely. When the focus is solely on self preservation, the ineffectiveness of corporate governance becomes evident, and mismanagement becomes a common occurrence.

There is a distinct possibility that corporate governance completely failed in the lead up to the Global Credit Crunch.

According to Anup Shah [S.a]. the Global Credit Crunch has been coming for a while. Shah [S.a]. explains that because of the financial crisis international stock markets have collapsed, financial institutions have had to close their doors and governments have had to come up with rescue operations to bail out their financial systems. Shah [S.a]. also states that these institutions being bailed out by government may have been the very institutions that caused the Global Credit Crunch in the first place.

Major causes of the Global Credit Crunch

According to Adnan Khan [S.a]. one of the main causes was the fact that Banks were lending money to high-risk customers who were unable to pay the Banks back, resulting in the Banks granting them sub-prime loans.

Another reason highlighted by Adnan Khan [S.a] was that Banks would turn the debt described in the first point into tradable commodities, which resulted in debt becoming a product that could be bought or sold.

Adnan Khan [S.a] describes the Credit Crunch as what happens when banks stopped lending money to each other and consequently created a freeze on the financial markets, creating panic and resulting in many large financial organisations closing down.

Terry Carrol (2008) of QFINANCE stated that the financial crisis i.e. the Global Credit Crunch was a direct result of the corporate governance of financial institutions, corporations and banks. Terry Carrol (2008) also raises the issue of morals being completely ignored. He states that the people to blame for the crises like some executives and board members walk away without loosing anything, but the investors that did not do anything wrong loose all their money. Mr. Carrol (2008) argues that if there had been better governance from the boards, that the problem could have been handled and managed before it got completely out of hand.

Anne-Catherine Husson-Traore (2009) CEO of Novethic argues that there were three major flaws in corporate governance that may have lead to the crises. She states that firstly many companies had risk management systems that were not effective enough. Secondly she touches on the issue of the impossible high levels of executive pay, resulting in extreme outrage by the shareholders and community. The third issue raised by Anne-Catherine Husson-Traore (2009) is the freedom of organisations to regulate them. They had the opportunity to do whatever they liked and make any decision no matter how morally incorrect it might have been.

Paul Sweeney (2008), a member of the Irish Congress of Trade Unions stated that that the world is currently in the midst of a serious crisis. Mr Sweeney (2008) placed the blame directly on ineffective corporate governance and greed.

One of the main contributors to the inefficiency of corporate governance is the facts that in many large corporations’ executives do not know exactly to whom they are responsible creating confusion among executives resulting in them only looking out for their own interests (Johnson et al 2008:135). This can create a significant problem firstly for the organisation, and secondly for the shareholders and ultimately the stakeholders as a whole. Executives focussing only on their own wellbeing can possibly result in mismanagement, ultimately causing malpractice, shoving the corporation in a pool of unethical activity. This analogy might be somewhat harsh, but it is highly possible that this could have been one of the many contribution factors to the failure of corporate governance and regulation leading up to the Global Credit Crunch.

Corporate governance is an extremely important tool if an organisation is to be managed effectively and efficiently. Corporate governance is needed in order for the owner(s), directors, shareholders and board members to ensure that every process that is done is done so in the best interest of the shareholders or anyone that has a financial interest in the organisation (Johnson et al 2008:137).

In the case of the Global Credit Crunch there was clearly not enough control or supervision of the corporate governance in banks, as they were lending large sums of money to anyone, even though the banks knew the people would not be able to pay them back (Adnan Khan [S.a].). Banks were solely interested in making as much money as possible, disregarding any moral issues. This could have been due to them ignoring corporate governance, or possibly that there was no clear corporate governance set out. There are five reasons why the corporate governance chain of the banks might have operated ineffectively (Johnson et al 2008:137):

Five reasons for the ineffective operation of corporate governance:

Banks being unclear as to who the beneficiaries are

Power not being divided equally between the higher management positions

Different higher management positions might not have the same access to important information

Top management only looking after themselves, only pursuing their own interests and disregarding any other beneficiaries

Creating targets and using means that only reflect their interest not the interests of the beneficiaries

According to the information above there are clearly many issues regarding corporate governance. It is clear that executives and higher management at the banks and large corporations to blame for the Credit Crunch did not adhere to corporate governance, or perhaps corporate governance was so ineffective that the ability to manifest ethics and morals was lost somewhere in the process. Corporate governance is as yet not as effective as it should be, making it a flawed system susceptible to failure.

Conclusion

It is now clear that corporate governance failed in the lead up to the Global Credit Crunch, in fact according to many accounts is seems as if the failure of corporate governance might have been one of the major causes of the Global Credit Crunch. Banks were lending money to high risk clients without any guarantee that they would be able to pay the banks back, shareholders and beneficiaries were completely disregarded and top management were only concerned with their own wellbeing. The corporate governance failed and human nature took over, causing a complete disregard for morals and ethics. While this fact was not true at every single organisation, it was still a very big problem at a majority of organisations, especially at banks. The inefficiency of corporate governance was especially visible when the Credit Crunch became public, as many of the organisations had to let employees go in order to survive-the fact was that many employees that had nothing to do with management procedures were let go, while the top management who were in most cases to blame for the crises in the first place retained there positions with no reprimand whatsoever. The Global Credit Crunch was without a doubt a great shock for the world, and it had and will still have greatly effect the economy of every country in the foreseeable future, but many experts believe that the Credit Crunch may actually have been a good thing for corporate governance. According to Terry Carrol (2008) there are some positive effects that the Global Credit Crunch might have on corporate governance in the long run. Mr Carrol (2008) states that most organisations are likely to learn from there mistakes and improve on there overall way of doing business. He also suggests that all the flaws of the corporate governance chain have been made clear and all the shortcomings identified thanks to the Credit Crunch. For any system to work effectively it is important that all the shortcomings are identified, making it possible to now improve on the corporate governance chain and create a more effective and efficient system. Even though corporate governance may have been one of the most telling factors that lead to the Global Credit Crunch, it is important to look towards the future, making sure that the same mistakes are not made again, and that corporate governance is built up to the effective and efficient system it was meant to be.


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