The Role of Corporate Governance during Credit Crunch - Term Paper Example

The Role of Corporate Governance during Credit Crunch Table of Contents Chapter 1 2 1.1.Failure of Investment Banks 2 1.1.1.Bear Stearns Companies Inc. 2 1.1.2.Lehman Brothers Holdings Inc. 3 1.2.Analysis of the Failure 4 1.2.1.The Role of Corporate Governance 4 1.2.1.1.SWOT Analysis 6 Chapter 2 8 2.1. Unaffected Investment Banks 8 2.1.1.Grupo Santander 8 2.1.2.J. P. Morgan 9 2.1.3.Goldman Sachs Group Inc. 9 2.2. The Shielding Factors 10 2.2.1.The Role of Corporate Governance 10 2.2.1.1.SWOT Analysis 11 References 15 Chapter 1 1.1. Failure of Investment Banks It has been a global observation that one of the major ingredients of the recent global recession was the collapse of the American banking system, in the context of which, financial analysts as well as the general populace are of the unanimous agreement that every possible step should be taken in order to avoid the failure of large banks (Gros, 2009). As the banking system succumbed and few of the leading players led the show, it is necessary to analyse the correlation of prevailing corporate governance and the menacing credit crunch. 1.1.1. Bear Stearns Companies Inc. Bear Stearns, which used to be the fifth largest among American investment banks, had experienced a 93% slump in its share price prior to being sold at a meagre $2 per share in 2008. This breathtaking financial mishap had sent out the signals that the nation’s economy was approaching an alarming crisis (Waggoner & Lynch, 2008). The crash came as a shock because the organisation, despite having a healthy capital, “could not meet its obligations” (Norris, 2008). According to the chief of the American apex bank, Timothy Geithner, the unprecedented collapse of Bear Stearns could herald a series of erratic and severe effects for the operation of the American financial system as well as the national economy (Berman, 2008). The criticality of this failure could lead to a frenzied situation by shaking the confidence of investors in similar companies. Owing to the exceptionally high pressures that the world economy as well as the financial systems experience, the injury caused by the collapse could be harsh and unmanageable (Beams, 2008). 1.1.2. Lehman Brothers Holdings Inc. Lehman Brothers was plagued with a high leverage whose total worth cannot be quantified, and hence it was prone to be insolvent even if its assets were slightly devaluated. Under the unfavourable circumstances of global recession, the main drawback of Lehman Brothers that had surfaced as a bad scar was that the company had pushed itself into a zone of self deception over the years. Like most of the financial institutions, Lehman Brothers too failed to pay necessary attention to its asset value. Despite complicacies related to valuation of assets, the management had always made it a point to present a healthy picture of the company’s financials. Though it’s not quite a rare occurrence that corporate behemoths often find themselves trapped in the quicksand of the zone of self deception, it was quite shocking when Lehman did the same thing because its financial reports never gave any hint about the looming danger. Moreover the company paid its employees handsomely in the years preceding the crash (Siris, 2008). The effects of the collapse were felt mostly by the shareholders as they form the baseline of corporate structure, while the debtors were safe. 1.2. Analysis of the Failure The recent global recession and the collapse of financial giants like Bear Stearns, Lehman Brothers, American Insurance Group were largely simultaneous occurrences. Back in 2007, on 12th June, rumour had had been spread that two hedge funds of Bear Stearns started melting thereby heralding worldwide panic. Soon after the collapse of Bear Stearns, Lehman Brothers followed suit in 2008. The problems for most of the organisations were in connection to subprime mortgages and then proliferated into the areas of construction loans, leveraged buyouts and even credit cards. On a close analysis it can be observed that in the pre recession era the financial systems around the world were exceptionally healthy and the overall picture was that of a buying frenzy. Consequently it was reflected mainly in the housing prices and leveraged buyouts. The sudden collapse taught us in the hard way that markets were highly interlinked and at the same time internationalised (Sloan, 2009). 1.2.1. The Role of Corporate Governance Owing to their criticality to the national economy, investment banks depend heavily on the levels of confidence that their shareholders have in them. The sudden collapse of Bear Stearns had a ravishing effect on its trustworthiness. This had a multiplicative effect on similar companies as well. On a large scale it was observed that stakeholders and investors were losing interest in doing business with these firms (Brown, 2008). As the problem of credit crunch was not an exceptionally novel one, it was widely perceived that the firms under discussion lacked efficient corporate governance. It has been observed that certain companies lacked the provision of majority vote and simply required a plurality for electing directors and hence complacent boards cocooned in zones of self deception could not be transformed by any means. The firms also exhibited an inherent vice in the form of unavailability of access. To some extent this was intentional as the companies did not want their shareholders to exert any pressure on the membership of their boards (Brown, 2008). Though there were problems related to lack of transparency, opacity of trading mechanisms, the prime concern turned out to be that of regulatory overload. As Arthur Levitt puts it forward, “management and boards of directors of these financial services firms, such as Bear Stearns and probably others, failed to put in place adequate risk management systems” (Brown, 2008), thereby highlighting the importance of corporate governance. Other serious drawbacks of these companies were observed to have arisen out of leniency of their management and that of their boards of directors per se (Walker, 2009). With reference to a 2009 report by David Walker, it may be pointed out that both Bear Stearns and Lehman Brothers failed to satisfy the requisites of sound corporate governance. In case of Bear Stearns it was observed that supervision of operations was lacking (Mehra, n.d., P. 82). Regulatory flaws had led to the collapse of this erstwhile financial behemoth as well as the hedge funds that were associated with it. The fall of the iconic Lehman Brothers had left its shareholders wondering about the roles that the board of directors were supposed to play (Thornton, 2008). Risk associated with the governance of Lehman Bother had been rated as high by eminent researchers. In complete incoherence with Walker’s recommendations, the majority of its directors were above 70 years old and had average membership tenure of more than 15 years (Thornton, 2008). Quite obviously, they lacked the KSAs that were required to set strategic directions for a company. 1.2.1.1. SWOT Analysis Strengths: Bear Stearns, on account of being a leading American investment bank having an industry exposure of more than three quarters of a century, had been successful in developing a prominent presence across global markets. The financial behemoth followed the best industrial practices in terms of customer service, marketing, and technology. In terms of the management structure, the firm maintained horizontal differentiation which was perceived to be successful (Dawkins, et al., n.d.). Lehman Brothers had a stronger heritage on account of its being established in 1850. Prior to its fateful collapse, it became one of the largest investment giants of Wall Street (The New York Times, 2010). According to Standard & Poor’s perspective, “Lehman had a strong franchise across its core investment banking, trading, and investment management business (Standard & Poor’s-a, 2008). The company also had sufficient liquidity in contrast to relatively higher impediments and it had also had an ability to generate earnings. Weaknesses: Bear Stearns had been primarily focusing on European markets and as a result it failed to pay attention to the growing potentiality of the markets in Asian nations. It had been unsuccessful in meeting the terms laid out by the Securities & Exchange Commission. The firm had also failed to abide by certain political rules. Major damage was done to its image because it lacked an educational programme (Dawkins, et al., n.d.). The major weakness of Lehman Brothers was that on account of operating in a business that calls for high confidence of shareholders, it was prone to a phenomenon called “negative market sentiment” (Standard & Poor’s-a, 2008). The effects were more pronounced in case of Lehman Brothers because of its colossal stature. Opportunities: In the aftermath of the overwhelming financial crisis, both the firms should focus on the Asian markets as these are growing economies. They should also identify potential opportunities in the BRIC (Brazil, Russia, India and China) nations. Both Bear Stearns as well as Lehman Brothers should have utilised their heritage to tap new markets. They should also have focussed more on augmenting their core competencies as those had proved to be profitable for both the companies in the past. As far as Bear Stearns is concerned, the company could provide investment as well as asset management services to the Chinese investors (Dawkins, et al., n.d.). Moreover, both the companies could redesign their Human Resource Policies in order to strategically hire and train new employees. They should also have attempted at substantially developing and delivering personalised services. Threats: The main threat that Lehman Brothers had been facing prior to its collapse was that the major hedge funds that were associated with it were trying to snap ties with the troubled firm (Thomas, Jr., 2008). Another major threat was that the companies had lost their credibility and goodwill. Though they had recently been integrated through take over initiatives, they should take measured steps to ensure a successful journey. Perhaps the greatest threat for these companies was the level of product diversification that is required for catering to the requirements of a wider customer base. Given the financial position of these companies such a move would have been quite difficult and hence these firms had gradually buckled under the pressures imposed by global recession and in turn went into liquidation. Chapter 2 2.1. Unaffected Investment Banks In the backdrop of the global financial crisis there had been a proliferation of failed investment banks. However, in contrast to leading failures like Bear Stearns and Lehman Brothers, players such as Grupo Santander, J. P. Morgan and Goldman Sachs Group Inc. have managed to remain unaffected. It is worthwhile to analyse these firms as they stand out as successful players in the same industry that had witnessed quite a few major failures. This chapter will aim at correlating the success of these financial forerunners with the tenets of their corporate governance. 2.1.1. Grupo Santander Santander stands at the second position closely following HSBC and hence commands a significant weight in the global banking industry. The company has recently taken a rebranding initiative and integrated three of its leading businesses in the UK. The company is expected to save approximately £180 million through this major step (BBC News, 2009). Unlike many of its tainted competitors, Santander attaches utmost importance to corporate governance and considers it to be an element of competitive advantage. The group also pays significant importance to its shareholders and organisational transparency. It is interesting to note that the company pays continuous attention to these two aspects and incorporates them in its information management as well as decision making (Santander, n.d.). Quite obviously, this company enjoys high levels of shareholders’ confidence in it and thus, it tends to augment its goodwill from strength to strength. 2.1.2. J. P. Morgan This organisation is one of the dominating investing banks in the global scenario. It commands a large client base which includes corporations, states, banks, educational institutions and investors spread around the globe. Apart from offering financial services, the company also provides a strategic advice and other allied services and strives to achieve global leadership in all the businesses which it undertakes. J. P. Morgan aims at contributing to world markets and supporting the steady growth of the global economy. It also extends credit to firms across the world in order to support their growth initiatives (J. P. Morgan, n.d.). The company has institutionalised integrity and fosters immense faith in its corporate governance policy laid out by its board of directors. The company also re evaluates this policy at intervals as it is subject to continuous evolution (JP Morgan Chase & Co.-a, 2009). It goes beyond saying that this aspect had been the mainstay of its viability during the financial crisis. 2.1.3. Goldman Sachs Group Inc. Like Santander and J. P. Morgan, Goldman Sachs also strongly believes that corporate governance is highly significant for the sustenance and growth of the organisation. The company believes that corporate governance helps to ensure an effective and accountable organisational environment and thus enhances credibility. During recession it was largely observed that most of the failed companies lacked stable corporate governance and consequently they lost the confidence of shareholders. The business principle of Goldman Sachs that states, “Our assets are our people, capital and reputation, and if any of these is ever diminished, the last is the most difficult to restore” (Goldman Sachs, 2010) substantially explains the success of this company. 2.2. The Shielding Factors With reference to shielding factors, a retrospect into the ‘Analysis of Failure’ in Chapter 1, will be helpful. On comparing the companies discussed in this chapter to those that were analysed in Chapter 1, it can be observed that the most prominent difference between these two groups of organisations lie in levels of confidence that they enjoy from their stakeholders who are mostly investors. The companies like Santander, J. P. Morgan and Goldman Sachs have strong corporate governance which enables them to focus on the areas that enhance their credibility. This serves as the strongest shielding factor in the backdrop of financial crisis because the companies play in a business area that involves a lot of financial risk. It is quite clear from the comprehensive analysis of these firms that corporate governance makes a marked difference in the way they operate and manifest customer satisfaction. 2.2.1. The Role of Corporate Governance In economies that reflect characteristics of open market, efficient corporate governance is a necessity in order to balance the wide range of environmental influences. These influences are most diverse and acute in the context of banks (Walker, 2009). It is extremely important to establish a strategic balance between critical factors such as regulatory policies and restraints, and strategic decisions that are so designed as to be beneficial for the shareholders. Under circumstances of financial crises, companies generally trend to buckle under huge pressure and hence fail to meet both these ends if they lack stable corporate governance. At the same time organisations should maintain transparency about their financial status and accounting methods. One major tenet of corporate governance is that it allows access to the stakeholders, and in turn enhances clarity as well as credibility. All the three investment banks discussed under Chapter 2 have been observed to satisfy these requisites unlike Bear Stearns and Lehman Brothers which barred access to their Shareholders. Thus, it can be again inferred that corporate governance has a nourishing effect on the organisations. Santander, J. P. Morgan and Goldman Sachs have successfully incorporate corporate governance practices that comply with the recommendations given by David Walker. Santander realises the fact that the participation of shareholders in corporate events can be enhanced through efficient practice of corporate governance and this in turn can help them influence organisational activities. As the company has shareholders across the globe, it has a constant focus on enhancing the effectiveness of transnational voting schemes (Broadridge, 2007). J. P. Morgan justifies its success by declaring, “We remain committed to maintaining strong governance practices and to doing the right thing” (JPMorgan Chase & Co.-b, 2008). The company had made it clear in simple words that a strong foundation of corporate governance had helped it assail the rough tides of recession. In a striking resemblance with Santander and J. P. Morgan, Goldman Sachs too has exhibited a strong affinity for corporate governance, which it believes will manifest an organisational framework that is best suited to satisfy its shareholders (Goldman Sachs Asset Management, 2003). This initiative definitely speaks about the company’s futuristic vision towards attaining global leadership. 2.2.1.1. SWOT Analysis Strengths: The primary strength of all these three banks is their corporate governance. These banks have been steadily successful in enlarging their shareholder bases both in terms of number as well as diversity and have proved to be successful industry leaders in nearly each area of operation. They largely recognise their employees and shareholders to be their most significant assets and do not take any step to jeopardise their positions. It has been observed that these investment banks have aligned their business networks so meticulously that even during the excruciating global recession that brought leading players on their knees, investors did not lose faith in them. Moreover, another stronghold of these three giants is their core competencies which they maintain religiously and also strive to augment on a regular basis to meet the changing business needs as well as shareholders’ expectations. These companies have a diversified geographic presence and business profiles. They also exhibit strong well coordinated management structures which add to their competitive advantage. Moreover they have a clear focus on strategies that help them operate profitably. Most importantly, they have efficient risk management abilities (Standard & Poor’s-b, 2009). Weaknesses: When it comes to business size and degree of diversity, these three banks command awe. They have an organisational network that spans the globe. In the aftermath of the recession, they should identify their weaker arms that are not being able to generate sufficient profits, and should sever them. In the presence of weak business divisions the competitive advantages of the organisations may be adversely affected because of the environmental sensitivity that prevails. Owing to their scale of operations it has been observed that most of their business units are exhibiting deterioration of asset quality. Moreover, their focus on expansion acquisitions has an inherent element of execution risk (Standard & Poor’s-b, 2009). Opportunities: These banks have an exceptionally high quotient of competitive advantages and hence they have the potentiality to modify most of the business scenarios into their opportunity. They can aim at achieving organic growth and expanding their business activities in the BRIC nations as they are the growing economies that have an intense need for development. They can also actively diversify their business portfolio into more profitable areas. They can also diversify more into the area of insurance with a restructured manpower and cater to customer needs that may have arisen as an offshoot of the financial crisis. These successful organisations should continually focus on augmenting their core competencies and utilise them as efficient tools to seek and subsequently make the optimal use of opportunities that they may come across in the course of business activities. Threats: Though these companies have performed well enough to escape the threats posed by the financial crisis, they may become prone to be shoved into a zone of self deception. Financial regulations that are in the offing may also put these banks on a tight rope. Political interventions in the form of a newly proposed tax will be inflicted on the liabilities of banking organisations (Eavis, 2010). As is the case with any competitive industry, the financial industry too has a high levels of inter organisational rivalry. This factor has to be duly considered while taking an expansion decision as each country has its own financial structure that is characteristically dominated by certain indigenous organisation(s). Thus, before extending their operations in BRIC nations and the European subcontinents, each of these companies should devote considerable decision making time to analyse the business environment in the locations of their choice. It is safe to suggest that these firms have sufficient levels of inherent strengths to counter the threats from rivals and even ranges of substitute products and services owing to their prominently strong heritage. References 1. BBC News. May 27, 2009. Santander Scraps UK Bank Brands. [Online]. Available at: http://news.bbc.co.uk/2/hi/8069648.stm [Accessed on: February 22, 2010]. 2. Beams, N. June 30, 2008. Fed Minutes Show Extent of Bear Stearns Crisis. World Socialist Web Site. [Online]. 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