Assignment Three Research Report (Individual) On Theory, Policy and Implementation of Corporate Governance and/or Sustainability to a Business Sector
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Anglo-AmericanCorporateGovernance.pptxCHAPTER FOUR
ANGLO-AMERICAN CORPORATE GOVERNANCE
INTRODUCTION
This session sets out the essential elements of the Anglo-American approach to corporate governance.
The cycle of crisis and reform that has proved most pronounced in the Anglo-American market based system is considered with regard to the reform path of the United States, United Kingdom and Australia and New Zealand.
The impact of the doctrine of shareholder value upon the workings of the governance system is investigated, and the direction of the increasingly financially driven markets of these countries considered.
The excitement of the new web based economy that transformed the corporate landscape is discussed, and the experience of the long high tech boom of the 1990s, and the shorter finance driven boom of the 2000s are considered.
The resulting Enron failure which precipitated a series of similar corporate collapses, the dramatic fall of the NASDAQ, and the catastrophic global financial crisis of 2007/2008 are put into context.
The prolonged regulatory aftermath of the Sarbanes–Oxley Act and Dodd-Frank Act, and renewed efforts at reform in the UK and Australia are reviewed.
Anglo-American Corporations
Market Based Systems of Governance
The outsider systems of corporate governance of the United States and the United Kingdom are among the longest established and have influenced much of the rest of the world. This is because of the strength of the US and UK capital markets, and the vast growth of their investment institutions that have become increasingly active internationally.
The Anglo-American outsider system is at the heart of agency theory, and associated corporate governance principles and company law elaborated over the last century, that have proved deeply influential in defining the activity and purpose of corporations internationally.
The central characteristics of the market-based outsider model of corporate governance are:
■ diffuse equity ownership with institutions having very large shareholdings;
■ shareholder interests are considered the primary focus of company law;
■ there is an emphasis on effective minority shareholder protection in securities law and regulation;
■ there is a stringent requirement for continuous disclosure to inform the market.
Table 4.1 US Institutional Ownership Equities (2002-2010) US $Billions
US Boards of Directors
In the United States the board of directors is entrusted with the important responsibility to monitor the company on behalf of shareholders. However, in the US boards of directors are often dominated by the company management.
Attempts have been made to achieve greater accountability by introducing a majority of non-executive directors, but according to Lorsch and MacIver (1989), outside directors have limited time, knowledge and expertise in the companies that they are responsible for in principle (and in the past the executive management were often happy to keep this so).
Non-executives often lacked any group cohesion of their own, but felt a need to fit into the values of the companies they join the board of. The OECD (1995:22) comments: “It is generally conceded in English-speaking countries boards have great difficulty in fulfilling the oversight function in a meaningful way, because they have traditionally worked on a collegial basis under the dominance of senior management. Until recently one tier boards have, more often than not, tended to ratify strategic decisions of management.”
There are many ironic paradoxes in the Anglo-American approach to corporate governance, which corporate regulation over two centuries has never fully resolved.
The CEO, Chairman and President…
US Boards of Directors
A century of legal and regulatory effort has been invested in the US to achieve some resolution to what Swanson (1996:417) defines as “The major governance problem … the intricate balance between maximising the efficiencies necessary to create wealth and ensuring that the controlling parties are accountable to those with a stake in the enterprise.”
However, the assumption that this equilibrium has been reached in the Anglo-American model of corporate governance in anything other than a partial and temporary way is a little optimistic.
Furthermore, as Cheffins demonstrates with regard to the UK, as the only major industrial country to evolve along similar lines of ownership and control to the US, the resolution of this corporate governance equilibrium has scarcely been achieved there either.
In this light, it is surprising that the Anglo-American model of corporate governance has been so energetically canvassed worldwide as the route other countries should take towards resolving their corporate governance problems.
US Corporate Regulation
The regulation of corporate governance in the United States has occurred when a crisis has caused potential breakdown in the financial and industrial system, resulting in a raft of legislative interventions in the banking and securities industries (Figure 4.1).
The 1929 great crash was a defining moment in US history, not only did the collapse cause widespread financial catastrophe, it undermined public belief in the integrity of financial and equity markets, and ushered in the long depression that scarred the optimism and endeavour of the American people.
Following the Wall Street crash there was a banking panic that led to the closing of the banks for an extended period just after Roosevelt took office in 1933. The Glass-Steagall Act (1933) and the Banking Act (1933) divided investment banking from commercial banking.
The framework of securities legislation in the US consists of a series of related but separate statutes that are administered by the Securities and Exchange Commission. The Securities Act (1933) was concerned with distributions of securities. It specifies the information companies must provide when issuing securities in the public markets. It requires prospectuses with a significant amount of affirmative disclosure including financial and other significant information to be provided for investors before public sale.
Securities Act
1933
Securities Exchange Act 1934
Glass-Steagall Act
1932
Glass Banking Act
1932
Investment Company Act 1940
Taft-Harley Act
Labour Management Relations 1947
Investment Advisers Act
1940
Trust Indenture Act
Regulation on Debt Securities for Public Sale 1940
Wagner Act
National Labour Relations 1935
Public Utility Holding
Company Act 1935
Social Security Act
1935
Securities Act
1935
Employment Retirement Income Security Act 1974
Foreign Corrupt Practices Act 1977
Landum-Griffin Act
Labour Management Reporting
and Disclosure 1959
Bank Holding Company Act 1956
NYSE/Nasdaq
Listing Standards 2004
Sarbanes-Oxley Act
2002
Gramm-Leach-Billey Act
Financial Services Modernization 1999
Divided Investment Banking form commercial banking (repealed by Gramm-Leach-Billey Act 1999
Levin-McCain-Fitzgerald-
Durbin-Dayton Act 2002
Dodd-Frank
Wall Street Reform and Consumer Protection Act 2009
US Reform of Corporate Governance Regulation:1932–2010
Source: Clarke T. 2017
US Corporate Regulation
The Securities Exchange Act (1934) created the Securities and Exchange Commission (SEC), empowered with broad authority over all aspects of the securities industry including the power to register, regulate and oversee brokerage firms, transfer agents, and clearing agencies, as well as securities self-regulatory organisations such as the NYSE and NASDAQ. This was concerned with publicly traded stocks after they were issued, and has been amended on numerous occasions.
As Figure 4.2 demonstrates there is a pattern discernible in corporate governance regulation not only in the United States but around the world that during periods of recession, market failure and corporate collapse, legislation is introduced to deal with evident weaknesses in corporate governance. However, during times of expansion and economic confidence, corporate governance concerns are often neglected as both corporates and investors concentrate on the business of accumulating wealth.
Figure 4.2 US corporate governance Legislation and the S&P Index, 1920–2010
Trust Indenture Act (1939)
Bank Holding Act (1958)
Gramm- Leach- Billey (Act 1999)
Sarbanes- Oxley Act (2002)
Investment Company
Act (1940)
Levin- McCain-Fitzgerald-Durbin- Dayton (Act 2002)
Foreign Corrupt Practices (Act 1977)
NYSE/Nasdaq Listing Rules (2004)
Global Financial Crisis 2007-2010
Dot-Com Bust
NASDAQ 2002
Enron/WorldCom
Collapses 2001-2002
Dodd –Frank Wall Street Reform
and Consumer Protection Act 2009
G20 Regulatory
Response 2009
12
Delaware
Within the framework of securities law established at the federal level, US company law is the responsibility of the individual states. While this may be intended to allow a degree of local autonomy and responsiveness, as businesses may decide in which state they can be incorporated, the prospect of regulatory competition is real. The state of Delaware has undoubtedly won this competition and plays a vital role as the national company law maker in the United States.
Though Delaware has achieved such a dominant position of market power in the regulation of corporations, there is little chance that US company law will become part of federal jurisdiction in the near future. Delaware has accumulated the greatest expertise in the determination of company law, which is an important part of its attraction. But all states, and particularly Delaware, are subject to insistent pressures from corporate management for example in the development of anti-takeover legislation, and the danger of regulatory capture is very real.
As McCahery and Vermeulen argue:
“The US legal system traditionally views company law in general as a l ocal matter reserved to the states’ governments. Consequently, the corporation statutes of some states may differ appreciably from those of most other states on many critical matters.”
The US Junk Bond Era
Hostile takeovers are often regarded as the most brutal but effective way to bring financial market pressure to bear on poorly performing management. In the US and UK at least, takeovers are thought to discipline and replace inefficient managers, and the ever-present threat of takeover pressures managers to remember to service the interests of shareholders (though not in Europe where hostile takeovers are rare).
In the 1980s an explosion of debt-financed takeovers backed by investment banks threatened even large well-established companies. Hostile takeovers were justified as necessary restructuring according to free cash flow theory (servicing takeover debt is supposed to spur the reallocation of resources to their most efficient uses, ensuring the paying out of surplus cash flow over time rather than maintaining the existing excessive retention levels).
However, this became a speculation in firms themselves as financial rather than productive assets, as low debt firms were seen as takeover targets to be filled with debt (Kaufmann and Englander 1993). For a time in the 1980s junk bond debt leveraged buy-outs seemed like a tsunami likely to engulf established companies:
“Until 1977 virtually all new issues of publicly traded bonds in the United States carried a Standard and Poor’s investment grade rating of BBB or better. Although some low-grade bonds were traded in secondary markets, they were “fallen angels”, bonds originally issued with an investment grade rating but subsequently downgraded to below investment grade. During 1977, Drexel Burnham Lambert began making substantial initial public offerings of low-grade bonds. From 1977 through 1989, the market for low-grade bonds grew from $1.1 billion to a total outstanding stock of $205 billion, about one quarter of all marketable corporate debt in the United States” (Allen and Herring 2001:30; Blume et al. 1991).
Junk Bond King Michael Milken and Drexel Burnham Lambert
The US Junk Bond Era
In the US as the likelihood of takeover became more imminent with the invalidation of state anti-takeover laws in 1982, and the availability of increasingly sophisticated financial instruments to leverage takeovers became more prevalent, with the possibility of major corporations being broken up, incumbent corporate management took defensive action. From 1983 shareholders were asked to approve shark repellents, corporate charter amendments intended to erect barriers to takeover, and poison pills entitling shareholders to purchase shares at a deeply discounted rate should a takeover occur without board approval.
The aggressive and often unethical practices of the junk bond investment banks caught up with Drexel Burnham Lambert, the most profitable investment bank on Wall Street in the mid-1980s, as it pleaded guilty to six felony charges in 1989 and agreed to pay $650 million in fines to the government. Drexel conducted 50 per cent of the trading in junk bonds, and when Michael Milliken the chief architect of the low-grade bond market was indicted on racketeering and securities fraud, Congress ruled that the thrift institutions which at that time had a substantial holding should liquidate their portfolios of low-grade bonds.
UK Corporate Governance
The UK with the US developed the Anglo-Saxon model of corporate governance to the fullest degree, and has been active in the export of the model to many countries for nearly two centuries, commencing when the UK was the workshop of the world in the nineteenth century, but continuing during the more pressing times for the UK economy in the period after World War II when its post-colonial institutions still had influence.
The UK has the largest and most influential investment institutions relative to the size of its economy, and companies more dependent upon the equity market than any of the large industrial economies (Table 4.2).
Both UK financial institutions and equity markets are among the most internationalised in the world, with investors from the rest of the world holding a significant amount of total equity, and the majority of equity from 2012 (Figure 4.3) (however this is slightly misleading as some of the international financial institutions that own these shares are based in London).
Table 4.2 Share ownership in the UK 1998-2014
Figure 4.3 Rest of the World Shareholdings in the UK (End year position for selected years 1963 to 2014)
UK Corporate Governance
As in the US the corporate governance debate in the UK was originally sparked by the weak performance of domestic companies, the lack of accountability of executive management, and the fact that management compensation appeared unrelated to performance (OECD 1995:28).
As in the United States, the 1980s deregulation of financial markets in the UK released a huge growth in the activity of international financial institutions centred in the City of London, though the benefit of this for the rest of the UK economy remained in some doubt.
More general concerns included: the standards of the audit and accountancy professions (Cadbury 1992); the lack of accountability, disclosure and transparency of boards to shareholders (Monks and Minow 1991); concerns over the adequacy of board structures and processes (Lorsch and MacIver 1989); the quality of directorial competencies; the apparent lack of corporate social responsibility; the destabilising impact of the growth of merger and acquisition activities (Pound 1992); the short term basis of corporate performance (Gregg et al. 1993); the spate of business fraud; and the evident weakness of corporate self-regulation.
These problems were exacerbated by the development of more complex corporate structures and as a result modern company law was unable to keep pace with modern corporate reality (Hopt 1984).
UK Corporate Governance
These concerns galvanised the London Stock Exchange, accountancy profession and Financial Reporting Council into establishing a committee on the Financial Aspects of Corporate Governance. The committee was chaired by Sir Adrian Cadbury, and formulated the Cadbury Code of Best Practice, which subsequently has inspired similar corporate governance codes in many countries of the world.
This comply or explain provision was a brilliant innovation in corporate governance which was adopted internationally in other codes, as having set out a series of principles of good practice, companies were given the opportunity if they felt it necessary to explain why their practice in a specific aspect of governance was different.
Once disclosed to investors and the wider public, they could then decide whether this was a convincing enough reason for the company to differ. Thus there was the possibility for intelligent engagement by companies in applying the code, and the flexibility to be different if a convincing argument could be made, which allowed necessary room for some differences at least in the governance of companies (and perhaps for the development of new good practices).
In fact most large companies quickly complied with almost all of provisions of the code, as both investors and companies sought the comfort of a tick-box approach, though occasionally the investment community did accept comply or explain exceptions.
Sir Adrian Cadbury & Catherine Livingstone
UK Corporate Governance
The central recommendations of Cadbury (1992) were:
■ There should be a clearly accepted division of responsibility at the head of the company, ensuring a balance of power and authority.
■ Boards should include non-executive directors of sufficient calibre and number to carry significant weight in the board’s decisions.
■ Boards should have a formal schedule of matters specifically reserved to it for decision to ensure that the direction and control of the company is firmly in its hands.
■ Non-executive directors should bring an independent judgment to bear on issues of strategy, performance and resources, including key appointments and standards of conduct.
UK Corporate Governance
■ The majority of non-executive directors should be independent of management and free from any business or other relationship.
■ Non-executive directors should be selected through a formal process and both this process and their appointment should be a matter for the board as a whole.
■ Executive remuneration should be subject to the recommendations of a remuneration committee made up entirely or mainly of non-executive directors.
■ An audit committee comprising of at least three non-executives should be established.
■ The directors should report on the effectiveness of the system of internal financial control, showing the business as a going concern.
UK reform of corporate governance regulation:1992–2012
Source: Adapted from Taylor, B. (2004).
Need for Guidance
Review
Findings
Consolidate
Hampel Report
Committee on
Corporate Governance 1998
Combined Code
London Stock Exchange
1998
RSA Tomorrow’s
Company Enquiry
1992-1995
Turnbull Report
Risk Management and Internal controls 1999
Myners Report
Institutional Investment in
UK: A Review 2001
Statement of Principles
Institutional Shareholders’
Committee 2003
Modern Company Law
Review 1998-2001
Department of Trade and Industry
Sarbanes-Oxley Act
US Legislation 2002
Jaap Winter Report
Regulatory Framework for
Company Law in Europe (EC) 2002
CGAA Report
Audit and Accounting
Issues 2003
DTI Report
Review Regulatory Regime
Of Accountancy Profession 2003
Higgs Report
Role and Effectiveness of Non-executive Directors 2003
New Combined Code
Financial Reporting Council 2003
Modern Company Law
Reform 2005
Walker Review
(BoFIs) 2009
Walker Report
On Private Equity 2007
UK Combined Code
(Updated) 2006
Turnbull
(Revised) 2005
FSA Abolished (by 2012)
UK Corporate Governance Code
Stewardship Code for Institutional Investors
Audit Firm Code 2010
Davies Review
(Women on Boards) 2011
Review Findings
Consolidate
Cadbury Report
Financial Aspects
Corporate Governance 1992
Greenbury Report
Executive Remuneration
1995
Smith Report
Audit Committees
Combined Code Guidance 2003
1990s
2000s
Index
Cadbury Report 1992
Greenbury Report 1995
Hampel Report 1998
Combined Code 1998
Turnbull Report 1999
Myners Report 2001
Modern Company Law 2001
Statement of Principles 2003
JAAP Winter Report 2002
Dot-com Bust NASDAQ 2002
US Sarbanes –Oxley Act 2002
Global Financial Crisis 2008
CGAA Report 2003
Higgs Report 2003
New Combined Code 2003
Modern Company Law 2005
Walker Report 2007
Walker Review 2009
Davies
Review
WOB 2011
FSA Abolished by 2012 in
UK CG Code 2010
Stewardship Code 2010
Enron/WorldCom Collapses 2001-2002
Tomorrow’s Company Report 1995
UK Regulatory Reform FTSE 100 Index 1990-2011
Source: Clarke T. 2010
26
Australia and New Zealand Corporate Governance
Australia and New Zealand’s approach to corporate governance follows the Anglo-Saxon model. They are shareholder economies in which private enterprise is about maximising returns for investors. “Those who own equity dominate because the law has traditionally equated the interests of the company with those of shareholders. Australian corporate law traditionally falls for the most part within these parameters” (Ford 2001: para. 8.130).
Australia has a well-established stock market, and a greater number of listed companies per million people than either the US or the UK. However, according to Cheffins (2001) Australia has some distinctive features in its development of an outsider model of corporate governance that distinguishes it from the US and UK.
Whereas the majority of large companies in these countries are quoted on the stock exchange, in Australia only a minority of the top 500 companies have shares traded on the stock exchange. Furthermore, ownership structure is more concentrated in Australia than in the US or UK, with only 11 out of the 20 largest publicly quoted companies in 1999 classified as ‘widely-held’ (that is they did not have a shareholder who owned 10 per cent or more of the equity).
Australia and New Zealand Corporate Governance
Since neither large companies nor small companies could be claimed to be generally ‘widely-held’ it could be concluded the separation of ownership and control has taken hold to only a limited degree in Australia.
This view is put forward more strongly by Dignam and Galanis (2004) who through an examination of share ownership patterns, institutional investor activism, private rent extraction, the market for corporate control and blocks to information flow, insist the corporate governance system of Australia’s listed market in fact has many of the characteristics associated with insider systems:
■ significant blockholders engaged in private rent extraction;
■ institutional investor powerlessness;
■ a strong relationship between management and blockholders, which results in a weak market for corporate control;
■ a historic weakness in public and private securities regulation, which allows the creation and perpetuation of crucial blocks to information flow (2004:26).
Australia and New Zealand Corporate Governance
Lamba and Stapledon discovered not only a large number of block-holders in Australian companies, but that private blockholders had an incentive to remain:
“There is a positive and highly statistically significant relationship between the level of related party transactions and whether the blockholder is a widely held corporate entity or a family entity … Interestingly, there is no relationship between the level of related party transactions and the likelihood of the block-holder being a government entity, that is, either the Commonwealth of Australia, a State of Australia, or an overseas government.
Thus, higher levels of private benefits are directly related to the likelihood that the controlling blockholder will either be a corporate entity or a family entity, but not a government entity … In particular, where private benefits are comparatively high, the company is more likely to have a blockholder with a controlling stake.” (2001: n.5)
Australian Reform of Corporate Governance Regulation, 1992–2015
Bosch Report
Corporate Practices and Conduct 1995
The Audit Office Mission
1997
AIMA Guide and Statement of Recommended Practice 1995
Performance Audit Report
Vol. one: In Principle 1997
Sarbanes-Oxley Act
USA Legislation 2002
IFSA Corporate Governance
1999
SAI Governance
Guidelines
2003
The HIH Commission Report 2003
CAMAC Guidance for Directors
Corporations Amendment Bill 2011
For Improving Accountability on Director and Executive Remuneration
Corporate Law Economic Reform Program CLERP
Audit Reform and Corporate Disclosure 2004
Independent Working
Party into Corporate Governance
Strictly Boardroom 1993
Performance Audit Report
Vol. two: In Principle 1997
Harwath Corporate Governance Report 2002
ASX Corporate Governance Council
Revised Principles of Good Governance and Best Practice Recommendations
Second Edition 2007
CAMAC Diversity on Boards of Directors Report 2009
CAMAC Aspects of Market Integrity Report 2009
PCI Executive Remuneration in Australia Report
2010
ASX Corporate Governance Council
Revised Principles of Good Governance and Best Practice Recommendations
Fourth Edition 2015
ASX Corporate Governance Council
Principles of Good Governance and Best Practice Recommendations 2003
ACSI Corporate Governance Guidelines
For Superannuation Fund Trustees and Corporations 2003
Source: Clarke T. 2017
Development of Corporate Governance Reform in Australia : ASX 100 (1984- 2011)
Source: Clarke T. 2010
31
Shareholder Value Orientation
During the 1990s the Anglo-Saxon shareholder value based approach to corporate governance became reinvigorated in the US, UK, Australia, New Zealand and other countries that adopted this model.
This model also began to have a stronger influence in European and Asian economies that formerly sustained more stakeholder or collective conceptions of corporate governance.
In the context of global competition, international investment patterns, and the aggressive growth of international mergers and acquisitions, assuming the primary objective of releasing shareholder value often seemed the only sure way not only for international business success, but for corporate survival itself.
The shareholder value view upholds a property conception of the company. In its most extreme form, as developed by the Chicago School of law and economics, the company is treated as a nexus of contracts through which the various parties arrange to transact with each other.
Walmart Shareholdholders Meeting
Shareholder Value Orientation
This theory claims the assets of the company are the property of the shareholders, and managers and boards of directors are viewed as the agents of the shareholders with all of the difficulties of enforcement associated with agency relationships.
Though the shareholder value orientation is assumed to be an eternal belief, firmly rooted in law, with strong historical foundations, none of this is anything more than a recent ideological convenience. Shareholder value in its current manifestation was a construct of financial economists in the 1980s, and meant to deal with the lack of shareholder value orientation widely apparent in US industry at the time.
Historically, American corporations have demonstrated a broad conception of the orientation towards a wide constituency of stakeholders necessary in order to build the enterprise. Over time and with the increasing market power of large corporations, managements’ sense of accountability might have become overwhelmed by complacency and self-interest.
However, to attempt to replace self-interested managers, with managers keenly focused entirely upon delivering value to shareholders, is to replace one form of self-interest with another.
Ford AGM Shareholders
Shareholder Value Orientation
Any broadening of the social obligations of the company was dangerous according to the shareholder value school of thought, “Few trends could so thoroughly undermine the foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible” (Friedman 1962:113).
The difficulty is whether in trying to represent the interests of all stakeholders, company directors simply slip the leash of the one truly effective restraint that regulates their behaviour – their relationship with shareholders. These views were expressed with vigour by liberal economists, and enjoyed the support of leading business leaders and senior politicians.
More practically, such views reflected how US and UK companies were driven in the period of the 1980s and 1990s, and often continue to be driven in this way in the present day, with an emphasis upon sustaining share price and dividend payments at all costs, and freely using merger and takeover activity to discipline managers who failed in their responsibility to enhance shareholder value.
Shareholder Value Orientation
Financially driven managers fitted well into an increasingly financially driven market environment of the 1990s with equity values, targets of current and future earnings, and an intensified interest in share price against the background of the longest bull market and economic upswing in history.
This financialisation of business activity in the Anglo-American regime denoted a profound change in orientation involving a concentration on financial results, with a shift of focus from production markets to capital markets, with the danger of the concentrated forces of the capital market far more mobile and threatening, than the old forces of the product market of dispersed consumers.
This shift in focus had great implications for the competitiveness of much of US and UK manufacturing industry in the 1980s, and was to provide an unstable platform for future business development (Froud et al. 2000).
An excessive focus on immediate market returns, often serves to simply increase the extent and cynicism of market manipulation (Redmond 2005:854).
Shareholder Value Orientation
At times in the 1970s and 1980s it appeared that the market-based shareholder value orientation was damaging the US and UK economies as the relentless pursuit of short term returns was associated with downsizing, loss of market share, and sometimes the abandoning of whole industries to overseas competitors with longer investment horizons.
Towards the end of this period Michael Porter (1992) wrote a report for the US Council on Competitiveness on Capital Disadvantage: America’s Failing Capital Investment System, in which he contrasted the fluid capital investment system of the US, with the dedicated capital investment system of Germany and Japan.
While the US system focused purely on financial goals and measures and short term performance, the German and Japanese systems were characterised by long term investment in industrial strategies to boost productivity and capability.
However as the industrial fortunes of the respective countries appeared to reverse in the 1990s, these lessons were forgotten, and shareholder value ideology was mightily reinforced as the unquestioned doctrine of the western corporate world.
The New Economy
Just at the time in the late 1980s when it looked as if the American economy was about to enter a long period of gradual decline, much as Britain experienced a century earlier, suddenly the US staged a remarkable recovery.
Reasserting its place at the forefront of the information technology, software and media revolution, the US economy in the 1990s achieved higher productivity and sustained growth without a rise in the rate of inflation. As competitors in Europe and Japan faltered, the US was portrayed as a new economy with attributes that not only defied economics but confounded history, an economy that:
■ grows without apparent threat of recession;
■ continues to expand without increasing inflation;
■ constantly restructures itself for greater efficiency and productivity;
■ replenishes and revitalises itself through new technology and capital investment;
■ functions without excessive debt, either public or private;
■ maintains a balanced budget;
■ increasingly becomes globalised and export driven (Weinstein 1997).
The Enron Shock
Many large US corporations in the 1990s became caught up in this get-rich-quick approach to business. Most notable among them was Enron which transformed itself from a small gas pipeline company into the largest energy trader in the world.
Effectively it abandoned interest in producing or transporting energy, but simply made itself the key trader in electronic energy markets. Enron then attempted to transfer this asset light model into the telecommunications business creating new markets for bandwidth.
Enron’s business model appeared to be based on brilliant innovation, but it was the dramatic and sustained profit growth that really captivated investors. Achieving this explained Enron’s intense focus on its credit rating, cash flow and debt burden.
The company’s asset light strategy amounted to disposing of assets to engage in financial engineering, and ultimately led to actions taken by Enron to move billions of dollars in assets off its balance sheet to separate but affiliated companies.
The Rise and Fall of Enron
The Enron Shock
“To accomplish its objectives, Enron had been relying increasingly on complicated transactions with convoluted financing and accounting structures, including transactions with multiple special purpose entities, hedges, derivatives, swaps, forward contracts, prepaid contracts, and other forms of structured finance.
While there is no empirical data on the extent to which US public companies use these devices, it appears that few companies outside of investment banks use them as extensively as Enron. At Enron, they became dominant; at its peak, the company apparently had between $15 and $20 billion involved in hundreds of structured finance transactions.” (Senate 2002:8)
When the company encountered business problems, in the effort to convince the market that rising revenues and profits would continue indefinitely at Enron, it created off-balance sheet entities to hide tens of billions of liabilities and boost reported earnings. For a while this deception worked, but when Enron had to restate its earlier reported earnings, the end came very quickly (Figure 4.8).
ENRON Clips
https://www.youtube.com/watch?v=DgRLlqEvOT8
https://www.youtube.com/watch?v=H2f7FunDuTU
ENRON Smartest Guys in the Room:
The Enron Ride:
Figure 4.8 Enron’s Rise and Fall 1998-2001
WorldCom’s Fall
The euphoria the new economy was built upon was suddenly punctured in 2001/2002 by the spectacular sequence of US corporate crises involving Enron, WorldCom, Tyco International, Adelphia Communications, Global Crossing, Quest Communications, Computer Associates, and Arthur Andersen and others.
The collapse of Enron, the largest bankruptcy in US history, led to thousands of employees losing their life savings tied up in the energy company’s stock. Federal indictments charged Enron executives with devising complex financial schemes to defraud Enron and its shareholders through transactions with off-the-books partnerships that made the company look far more profitable than it was (see Case Study 1).
WorldCom’s rise and fall on the back of the telecoms and Internet boom of the late 1990s was even more precipitous than that of Enron (Figure 4.9). WorldCom ironically named one of Fortune magazine’s most admired global companies in 2002, wrongly listed over $3 billion of its 2001 expenses, and $797 million of its first quarter 2002 expenses as capital expenses, which were not reflected in the company’s earnings results.
Figure 4.9 The Rise and Fall of WorldCom 1998-2002
Sarbanes–Oxley Act
In the emerging mosaic of new laws, regulations and listing rules that have emerged as a result of the Enron experience, promising to impose new corporate governance standards on the boards of companies, it will be the Sarbanes– Oxley Act which will have the most enduring implications not just for US companies, but for overseas companies whose securities are traded in the United States.
Specific provisions of Sarbanes– Oxley and the recommendations of NYSE, implemented immediately include:
■ Annual reports must be accompanied by CEO and CFO certifications that the report fully complies with reporting requirements and fairly presents in all material respects companies financial results (s. 906).
■ CEO and CFO must certify statements concerning the company’s internal accounting controls and disclosure controls and procedures.
Sarbanes-Oxley Act Being Signed into Law by President George W. Bush
Sarbanes–Oxley Act
■ Personal loans to directors and officers are prohibited.
■ If a company restates its accounts due to material non-compliance of the company, as a result of misconduct, its CEO and CFO must reimburse the company for any bonus or equity, or incentive based compensation paid, and for any profits from sales of the company’s securities realised during the 12 month period after the first publication of the accounts.
■ The act provides protection for employees who assist in investigations or proceedings that involve violations of US federal securities laws and fraud statutes.
■ The Act also empowers the SEC to adopt rules to require the NYSE and NASDAQ to prohibit the listing of a company’s securities unless the company has an audit committee comprised entirely of independent directors, which meets certain requirements to its responsibilities and operation.
New listing standards published by NYSE and NASDAQ
The new listing standards published by NYSE and NASDAQ in the light of the new legislation, embody in significant respects, what were best practices internationally:
■ populating boards with a majority of independent directors;
■ tightening standards of independence;
■ further restricting audit committee composition and adopting new responsibilities for audit committees;
■ instituting wholly independent compensation and nominating/governance committees and adopting specific responsibilities for these committees;
■ convening regular meetings restricted to the non-management directors;
■ performing regular board and committee evaluations;
■ publishing company-specific governance guidelines and codes of conduct and ethics.
New York Stock Exchange: Grasso’s fall
The sad fate of Dick Grasso the former chair and CEO of the New York Stock Exchange is a salutary lesson for anyone involved in corporate governance. On 25 May 2004 Eliot Spitzer the New York State Attorney General launched a lawsuit against Grasso, charging him with deception, conflict of interest and the receipt of excessive pay.
Grasso resigned from the NYSE in September 2003 after his vast pay package became public (Figure 4.10). He insisted his compensation was justified; however, shock waves went through the exchange when it was revealed he would be receiving a lump sum payment of $139.5 million.
The Securities and Exchange Commission chair immediately fired a letter to the NYSE Board demanding an explanation for this large sum. The Exchange launched its own inquiry and on 28 January 2005 the State Supreme Court Justice Charles E. Ramos declared the Webb Report should be made public.
The document details board meetings and other events leading to the award of Grasso’s pay package. It maintained he received unreasonable levels of compensation and benefits, and blamed the NYSE board members for failing to monitor properly Grasso’s activities.
Dick Grasso CEO New York Stock Exchange 1995-2002 (Responsible for NYSE Listing Rules)
53
Figure 4.10 NYSE’s annual profit vs. CEO Dick Grasso’s annual compensation ($ millions)
Dick Grasso Refuses to Return Compensation: Prosecuted by New York Attorney General
55
Corporate Governance Reform in Australia
In Australia during the same period two corporate collapses occurred at One-Tel and HIH which were in context, if not in scale, almost as spectacular as those that had occurred across the Pacific.
The A$5 billion HIH Insurance failure in 2001 was the largest bankruptcy in the country ever. As a consequence, for a period much of the insurance industry in Australia was jeopardised, and many people found it difficult or impossible to obtain public liability insurance or professional indemnity insurance, and their livelihoods were threatened.
A royal commission into the affair was called, and the CEO and a parade of executives and directors were called to give evidence over a 12 month period of what was probably the most intensive cross-examination ever experienced by Australian executives.
What transpired was a catalogue of accounting, actuarial and auditing failure, unrestrained executive greed, the complete failure of the board to monitor or even know what was occurring, excessive CEO powers, poor business decisions, and a consistent failure to exercise the responsibilities of a public company.
Australian Corporate Governance
Rules-based and principles-based approaches
Largely influenced by the US legislation, over the following years almost every country in the developed and developing world tightened up their corporate governance regulations considerably. It was clear that the monitoring and enforcement of corporate governance would be a great deal more active in the future than it may have been in the past.
However, instead of the ‘rules-based’ approach of Sarbanes–Oxley the regulators in many countries including the UK, Canada, Australia and Hong Kong opted for a ‘principles-based’ approach to the reform of corporate governance.
The advantage of ‘playing by the rules’ is that this requires all members of a community to exhibit minimum standards of practice.
Yet, in order to gain acceptance by a majority of members, the standards enforced by rules have to be essentially the minimum acceptable practices. The worry about rules is that as soon as they are enforced, imaginative ways are invented to get around the rules without breaking them.
The Global Financial Crisis: Failures of Regulation and Governance
However diligent the process of corporate governance reform was in the Anglo-American economies in the post-Enron period of 2002-2007, and whatever the respective merits of the US black letter law approach as in Sarbanes Oxley, or the principles based approach as in the UK Combined Code, nothing prepared the US or UK regulators, boards, lawyers or accountants, or executives themselves for the sudden and dramatic onslaught of the global financial crisis
The crisis exposed critical and dangerous weaknesses in Anglo-American regulation, governance and risk management which brought the international economy teetering to the brink of complete collapse.
The global financial crisis was a multidimensional, interconnected, and systemic crisis
The G20 (Financial Stability Board),the International Monetary Fund (IMF), the
(OECD), the European Union (De Larosiere Report), the United States (Dodds−Frank Act), the United Kingdom, Australia, and other countries’ analysis and prescriptions recognised this was a systemic crisis requiring systemic solutions.
The Global Financial Crisis: Failures of Regulation and Governance
Among the causes of the crisis were international macroeconomic imbalances, institutional and risk management failure, corporate governance failure, and regulatory, supervisory and crisis management failure. Understanding the compounding impact of these interconnected series of failures is the key to understanding the scale and intensity of the crisis.
Financial insecurity rapidly became contagious internationally as fears of a global economic recession became widespread and stock markets around the world crashed. This financial crisis was larger in scale than any crisis since the 1930s Great Depression, involving bank losses conservatively estimated in October 2008 by the IMF (2008) as potentially $1,400 billion, eclipsing earlier crises in Asia, Japan and the US.
The Global Financial Crisis
Relative to gross domestic product (GDP), the financial sector in all of the industrial countries grew considerably in the last two decades of financial deregulation, innovation and globalisation.
The size of financial assets in both the United States and the United Kingdom had more than doubled in 20 years.T he massive growth of the UK finance sector and also the sustained growth of the European finance sectors involved the adoption of similar financial innovation and exotic instruments, as in the United States.
British and European financial institutions had also succumbed to the temptations of high leverage (in some cases higher than the Wall Street investment banks), minimal risk management, and a fascination with the returns that new financial securities and speculative industries − most notably the property sector− might deliver.
In the UK the financial sector became gargantuan, with assets around nine times GDP (Figure 4.12), a multiple more than double that of the US finance sector.
Figure 4.12 Scale of Financial Assets in Multiples of Gross Domestic Product
The Global Financial Crisis
A concentration on financial services was considered in the United States and the United Kingdom as an essential part of the new economy, and was associated with rapid market growth, high profits and very high salaries for a privileged few dealing in the most exotic financial securities.
Fuelling the whole process of financialisation were volcanic eruptions of debt. When Alan Greenspan became Chairman of the Federal Reserve in 1987 public and private debt in the US totalled $10.5 trillion, but after his departure in 2006 it had quadruped to $43 trillion.
A debate has continued for some time about the costs and benefits of the financialisation of advanced industrial economies
The Global Financial Crisis
Competing definitions of ‘financialisation’ include:
• the ascendancy of ‘shareholder value’ as a mode of corporate governance (Aglietta and Reberioux, 2005);
• the growing dominance of capital market financial systems over bank-based financial systems;
• the increasing political and economic power of a particular class grouping: the rentier class for some (Hilferding, 1910/1981);
• the explosion of financial trading with a myriad of new financial instruments
• the “pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production’ (Krippner, 2005)
• the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies (Epstein, 2005: 3).
De-Regulation
Financial institutions are critical to the operation of any economy, and traditionally subject to a framework of firm regulation; however, as the financialisation of the US and international economy proceeded, paradoxically, the regulatory touch lightened considerably. In the words of one US finance expert, in the years before the crisis:
“We were developing a system of very large, highly levered, undercapitalised financial institutions – including the investment banks, some large money centre banks, the insurance companies with large derivative books and the government-sponsored entities….Regulators believe that all of these are too big to fail and would bail them out if necessary. (Einhorn 2008a: 16−17; 2008b).
The abolition of the Glass−Steagall Act in 1999 paved the way for a regulatory loosening of the US financial system, enhanced in 2004 by a new SEC rule intended to reduce regulatory costs for broker-dealers that were part of consolidated supervised entities.
De-Regulation
The verdict of the US National Commission (2011: xviii) was that 30 years of deregulation and reliance on self-regulation by financial institutions had stripped away the safeguards that might have helped avert the catastrophe:
“…There was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner. The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards.
The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk” (2011: xvii).
De-Regulation
The essential reason why the financial institutions were prepared to abandon prudential standards, and risk management, was that there was too much money to be made by throwing caution to the winds.
As the US Congress, the Financial Crisis Inquiry Commission (2010) revealed that the global financial crisis brought a tumultuous end to six years of galloping inflation in both financial institutions profitability, and in the inflation of the market capitalization of the S&P 500 Index (Figures 4.13 and 4.14). The scale of the disaster, one sage commented, demonstrated the unerring capacity of Wall Street to have a once-in-a-lifetime catastrophe approximately every six years.
Figure 4.13 Corporate Profits of Financial Industries (US$ billion)
Source: Adapted from US Congress Financial Crisis Inquiry 2011
Figure 4.14 S & P 500 Index 2000- 2010 (Demonstrating the unerring capacity of the US market to have a once-in-a-lifetime catastrophe approximately every six years)
Source: Adapted from US Congress Financial Crisis Inquiry 2011
Ratings Agencies and Risk Management
At the height of the speculative frenzy around exotic derivatives both the credit ratings agencies and essential risk management failed. As international financial markets have expanded, the role of the credit ratings agencies (CRAs) have proved critical. The International Organisation of Securities Commissions (IOSCO) claims that:
“CRAs assess the credit risk of corporate or government borrowers and issuers of fixed-income securities.
CRAs attempt to make sense of the vast amount of information available regarding an issuer or borrower, its market and its economic circumstances in order to give investors and lenders a better understanding of the risks they face when lending to a particular borrower or when purchasing an issuer’s fixed-income securities.
A credit rating, typically, is a CRA’s opinion of how likely an issuer is to repay, in a timely fashion, a particular debt or financial obligation, or its debts generally (2003: 1).”
Ratings Agencies and Risk Management
Yet the question asked by everybody when the financial crisis erupted was how could
asset-backed securities containing subprime mortgages and other high-risk debt possibly be given AA credit ratings by Standard and Poor’s or Moody’s? The answer was, again, that financial innovation had outpaced regulatory prowess. As the US National Commission (2011: xxv) into the financial crisis concluded:
“This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms.
In our report, you will read about the breakdowns at Moody’s, examined by the Commission as a case study. From 2000 to 2007, Moody’s rated nearly 45,000 mortgage-related securities as triple-A.
This compares with six private-sector companies in the United States that carried this coveted rating in early 2010. In 2006 alone, Moody’s put its triple-A stamp of approval on 30 mortgage-related securities every working day.
The results were disastrous: 83% of the mortgage securities rated triple-A that year ultimately were downgraded. The ratings agencies instead of monitoring rigorously the growth of financial markets and instruments had become junior partners in this enterprise.”
Risk Management
Similarly the risk management of the investment banks had failed to keep pace with the speed of innovation of new financial securities particularly derivatives.
Financial businesses activities in rapidly changing markets are highly sensitive to variance, and it might be expected that as the financial services industries have grown inexorably and financial products become more complex, that the sophistication of risk management techniques will have developed in parallel.
However, the reality is that innovation in financial products has far exceeded the capacity of risk management measurement and monitoring tools to gauge risk.
The most widely employed risk management tool is Value at Risk (VaR), which measures how much a portfolio stands to make or lose in 99% of the days, but dangerously this measure ignores what might happen at the moment of greatest risk.
Yet VaR was the tool international finance industries relied upon in transactions involving billions of dollars.
Risk Management
The US National Commission (2011: xviii) was convinced the dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of the financial crisis. The assumptions at the time were that the instincts for self-preservation within financial firms would shield them from excessive risk-taking without a need for regulatory restraint that might stifle innovation– as the Commission argued the reality was very different:
“Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding. In many respects, this reflected a fundamental change in these institutions, particularly the large investment banks and bank holding companies, which focused their activities increasingly on risky trading activities that produced hefty profits.
They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products….Financial institutions and credit rating agencies embraced mathematical models as reliable predictors of risks, replacing judgment intoo many instances. Too often, risk management became risk justification” (2011: xviii).
Incentives
The final and most critical part of the explanation of why investment banks and other financial institutions took such extreme risks with highly leveraged positions in complex securities, neglecting risk management, governance principles and often basic business ethics, was that they were highly incentivized to do so.
Massively incentivized irresponsibility became the operating compensation norm in the financial community, as banks and fringe financial institutions chased the super profits available as global financial markets expanded exponentially:
“The management teams at the investment banks did exactly what they were incentivized to do: maximize employee compensation. Investment banks pay out 50% of revenues as compensation. So, more leverage means more revenues, which means more compensation. In good times, once they pay out the compensation, overhead and taxes, only a fraction of the incremental revenues fall to the bottom line for shareholders.” (Einhorn 2008a:11; 2008b).
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
While the accumulated vast cost of the global financial crisis was being realised the commitment to establish a new international financial regulatory framework increased.
As the costs of all forms of intervention to alleviate the crisis by the US government ballooned out to $7.7 trillion dollars (including credit discounts, credit extensions, securities lending, term auction facilities, portfolio funding, money market funding, TARP, assistance to specific institutions, economic stimulus packages, and homeowner assistance), The general market assistance and specific rescue packages for individual financial institutions amounted to almost $11 trillion worldwide by October 2008.
Though these funds could be regarded as a temporary investment in the financial economy, with the hope of recouping much of the funds back at a later stage, this was an optimistic view when the crisis spread to other sectors of the economy.
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
As the financial crisis impacted upon the real economy the fears of a prolonged recession grew, with US industrial production falling further than it had for over 30 years, and for example the US automotive industry becoming increasingly precarious announcing further major redundancies and looking for support from the federal government (including support from the assistance intended for financial institutions, since the automotive companies had also become finance companies).
The International Labour Organisation in Geneva estimated that up to 20 million people in the world would lose their employment as a consequence of the financial crisis, and that for the first time in a decade the global total of unemployed would be above 200 million (Associated Press, 21 October 2008).
The prospect of the whole world falling into recession at the same time became possible, something not witnessed since the 1930s.
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
A series of measures were proposed by Gordon Brown, then Chancellor of the UK Government, who recognised a deeper problem in the failure of the international banks:
Improving risk disclosure by financial institutions was fundamental, together with stricter rules on bank liquidity and leveraging.
Ensuring banks take bigger stakes in any loans they pass on to others through securitization might constrain irresponsible innovations.
Establishing a central clearing house for complex derivatives could help to discipline their use.
Increased supervision and regulation might include new standards for off-balance sheet accounting, and supervision of the largest international banks and insurance companies.
Reforming executive compensation structures that encouraged excessive risk-taking, and aligning reward with long term value creation was another imperative.
vi) Finally a capacity to police the potential for future dangers to the international economy, and the means of cooperation for future crises were important (The Times 16 October 2008).
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
Salient regulatory weaknesses revealed in the financial crisis identified by the G20 included:
Weaknesses in Underwriting Standards
Lack of Oversight of Systemic Risks
Lack of Oversight of Unregulated Pools of Capital
Weak performance by Credit Rating Agencies
Pro-cyclical Tendencies Fed by Regulatory and Accounting Frameworks
Shortcomings in Risk Management Practices
Financial Innovation Outpacing Risk Management
Weaknesses in Disclosure
Weaknesses in Resolution Procedures
Lack of Transparency in Various OTC Markets (G20 WG: 2009:iv – v)
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
After a series of meetings the leaders of the G20 economies agreed in Washington to embark on an extensive and ambitious program of reform of the international financial markets including:
Strengthening Transparency and Accountability
strengthening financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions.
Enhancing Sound Regulation
strengthening regulatory regimes, prudential oversight, and risk management, and ensuring that all financial markets, products and participants are regulated or subject to oversight, as appropriate to their circumstances.
Promoting Integrity in Financial Markets
THE G20: A NEW GLOBAL REGULATORY ARCHITECTURE?
Promoting Integrity in Financial Markets:
committing to protect the integrity of the world’s financial markets by bolstering investor and consumer protection, avoiding conflicts of interest, preventing illegal market manipulation, fraudulent activities and abuse, and protecting against illicit finance risks arising from non-cooperative jurisdictions.
Reinforcing International Cooperation
ensuring national and regional regulators to formulate their regulations and other measures in a consistent manner. Regulators should enhance their coordination and cooperation across all segments of financial markets, including with respect to cross-border capital flows. Reforming International Financial Institutions
Reforming International Financial Institutions:
committing to advancing the reform of the Bretton Woods Institutions so that they can more adequately reflect changing economic weights in the world economy in order to increase their legitimacy and effectiveness. In this respect, emerging and developing economies, including the poorest countries, should have greater voice and representation. The Financial Stability Forum (FSF) must expand urgently to a broader membership of emerging economies, and other major standard setting bodies should promptly review their membership.
Wall Street Reform: The Dodd Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act after prolonged legislative battles was finally passed by the Obama administration in 2010, as a bulwark against the excesses that led to the global financial crisis. Named after U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank, as its name suggests the Act idealistically was intended to reassert some balance between the rapacious financial interests of Wall Street and the neglected consumers and workers of Main Street USA.
Dodd-Frank is the most comprehensive financial regulatory reform adopted in the US, intended to strengthen regulation and oversight of the financial system and reduce the danger of financial crisis. The legislation has sixteen titles covering every aspect of finance from banking stability to mortgage reform (Table 4.4 ).
Because of its comprehensiveness and complexity, the legislation required a considerable number of additional rules, studies and reports to be prepared over a four year period, which allowed ample time and opportunity for the legislation to be successively diluted of the intended impact on major investment and commercial banks, hedge funds, private equity, broker dealers, credit rating agencies, insurance companies, and large asset managers.
President Obama Signing the Dodd-Frank Act
The Dodd Frank Act
The Dodd Frank Act
The question arises whether this massive swathe of legislation, however well intentioned, once denuded of much of the intended impact by the well-funded Wall Street lobbyists in Washington, will have the intended effect?
The global financial crisis and its aftermath consisted of multiple and compounding failures in financial markets, institutions, regulation, and governance.
The “animal spirits” unleashed in unfettered securities markets, massive incentivization of risk taking and leverage, and the abandonment of effective governance and ethical commitments occurred in a regulatory vacuum (Akerlof and Shiller 2009).
Governments were convinced that lightening the burden of regulation was the means to promote more dynamic financial markets and business development.
The realization of the consequences of unchecked systemic risks has prompted national governments and international agencies into a major series of regulatory reforms and interventions in financial markets and institutions, the effect of which remains to be discerned .
The Libor Rate-Fixing Scandal
Any belief that the considerable efforts by government to rescue and reform financial institutions and markets would lead to sustained stability and security in the sector, was rudely dispelled in a prolonged sequence of bank scandals and market failures in the years following the financial crisis.
The banking crisis segued into a sovereign debt crisis in Southern Europe with governments facing challenges in funding their activities.
This was quickly followed by seismic eruptions in the mainstream financial institutions with the revelations surrounding the London Interbank Offered Rate (“LIBOR”) rate fixing.
A total of $10 trillion in loans and $350 trillion in derivatives worldwide were indexed to LIBOR.
As the U.S. Financial Stability Oversight Council (established by the Dodd–Frank Act to identify risks to financial stability, promote market discipline, and respond to emerging threats) highlighted:
LIBOR Involved all Major International Banks
LIBOR $400 Trillion Rate Fixing
The Libor Rate-Fixing Scandal
As the U.S. Financial Stability Oversight Council (established by the Dodd–Frank Act to identify risks to financial stability, promote market discipline, and respond to emerging threats) highlighted:
“Recent investigations uncovered systemic false reporting and manipulations of reference rate submissions dating back many years. This misconduct was designed to either increase the potential profit of the submitting firms or to convey a misleading picture of the relative health of the submitting banks.
These actions were pervasive, occurred in multiple bank locations around the world, involved senior bank officials at several banks, and affected multiple benchmark rates and currencies, including LIBOR, EURIBOR, and the Tokyo Interbank Offered Rate (TIBOR).
Each of the banks that faced charges engaged in a multi-year pattern of misconduct that involved collusion with other banks” (FSB 2013:137).
S & P Top 10 By Market Capitalisation ( June 2017)
| Apple Inc. | AAPL | Information Technology US$ 753 billion |
| Microsoft Corp | MSFT | Information Technology US$ 563 billion |
| Amazon.com Inc | AMZN | Consumer Discretionary US$ 487 billion |
| Facebook Inc A | FB | Information Technology US$ 499 billion |
| Johnson & Johnson | JNJ | Health Care US$ 355 |
| Exxon Mobil Corp | XOM | Energy US$ 337 billion |
| JP Morgan Chase & Co | JPM | Financials US$ 324 billion |
| Berkshire Hathaway B | BRK.B | Financials US$ 428 billion |
| Alphabet Inc A | GOOGL | Information Technology US$ 657 billion |
| Alphabet Inc C | GOOG | Information Technology |
S & P Top 10 By Market Capitalisation ( July 2017)
Apple Inc. AAPL Information Technology US$ US$ 753 billion
Alphabet Inc A GOOGL Information Technology US$ 657 billion
Alphabet Inc C GOOG Information Technology
Microsoft Corp MSFT Information Technology US$ 563 billion
Facebook Inc A FB Information Technology US$ 499 billion
Amazon.com Inc AMZN Consumer Discretionary US$ 487 billion
Berkshire Hathaway B BRK.B Financials US$ 428 billion
Johnson & Johnson JNJ Health Care US$ 355
Exxon Mobil Corp XOM Energy US$ 337 billion
JP Morgan Chase & Co JPM Financials US$ 324 billion
Apple Inc: An Iconic Corporation
Apple Inc. is the richest and most iconic corporation in the world.
As the world’s most valuable brand early in 2015 at $247 billion, Apple was the first US corporation in history to reach a market capitalisation of $700 billion, almost twice the market capitalisation of Google and Microsoft combined (Fortune 10 February 2015; Guardian 28 May 2015).
In the final quarter of 2014 with the launch of the iPhone 6, Apple made profits of $18 billion, the largest quarterly return of any US corporation ever.
By 2015, Apple had accumulated liquid assets of $195.5 billion much of it in the Nevada-based asset management corporation Braeburn capital established by Apple executives, and Apple Inc is well on the way to becoming one of the world’s best capitalised asset managers.
Apple market capitalisation 2006-2012
Apple Share Price Video
Apple gross margins and operating profit 2005-2011
Apple Cash and Investments 2008-2012
Global Value Chain Disaggregation: The Stress of Apple’s Success
Source Adapted from Mudambi (2007)
Apple Inc: An Iconic Corporation
Yet while Apple was enjoying a meteoric rise as the world’s most iconic business, increasing evidence was emerging of the tragic consequences of unresolved human rights, environmental and ethical dilemmas in the Apple supply chain in China.
In a stark illustration of how extreme inequality continues to disfigure the operation of global value chains, it appears that the beauty of Apple’s brilliant design and highly polished products ultimately rests upon the suffering of 1.2 million young workers in electronic sweatshops where human rights, labour standards, environmental safety and business integrity are routinely ignored.
It is the case that since these abuses in its supply chain were first brought to Apple’s attention in 2006, the company has made continuous efforts to eradicate problems and enforce higher standards in all of its suppliers.
Advancing Inequality in the United States
There is another serious aspect to the massive incentivisation that has occurred in recent years in the finance sector, and the reckless abandon in which this is pursued, and that is this is in the context that although the United States is the most prosperous country on earth, it is typified by mounting, severe and very visible inequality.
While CEO salaries inflated through the roof, in recent years average earnings in America actually went down. Almost all forms of financial assets are extremely unequally distributed in the United States with ownership heavily concentrated in the richest 1per cent of the population, or at best in the richest 10 per cent (Figure 4.15)
The richest 1 per cent of the population own 64 per cent of financial securities, and 61% of business equityThe richest 10 per cent own 81 per cent of trusts, 81 per cent of stocks and mutual funds, and 80 per cent of non-home real estate.
In contrast 90 per cent of the population own only 6 per cent of financial secutrities, 8 per cent of business equity, 19% of trusts, 19% of stocks and mutual funds, and 21 per cent of non-home real estate.
Figure 4.15 US Distribution of Investment Assets 2010
Advancing Inequality in the World
An issue that has received little attention in corporate governance is the extreme range of inequality of wealth that is developing in the world with the present institutional structure and market processes.
Oxfam and Credit Suisse illustrate that there is a category of the super-rich who have wealth comparable to the GDP of many countries, and that the wealth of the super-wealthy is advancing very rapidly: for example the 388 richest billionaires in the world in 2010 had the same wealth as the total wealth of 50 per cent of the world’s population Figure 4.16).
But by 2014 the richest 80 billionaires had as much wealth as the total wealth of 50 per cent of the world’s population.
The United States dominates the ranks of the super-rich in all categories from billionaires to ultra-high net worth (UHNW) individuals (US$50 million plus), to millionaires (Credit Suisse 2015: 26-7). The United States has 46 per cent of the global millionaires, and has 48 per cent of the UHNW rich.
A claim could reasonably be made that not only is inequality becoming extreme within the United States, but that the United States is leading the world towards increasing inequality.
Figure 4.16 Share of global wealth of the top 1% and bottom 99% respectively (Source: Adapted from: Credit Suisse Global Wealth Report 2015; Credit Suisse Data 2000-2014; Oxfam Issue Briefing, Wealth: Having it All and Wanting More, January 2015)
Conclusions
This saga of Anglo-American corporate governance crisis and reform does not convey the inherent superiority of this system above all others that the proponents of the Anglo-American approach proclaim.
Nor does the extreme inequality that has become endemic in the Anglo-American system, particularly in the United States.
The undoubted success of the Anglo-American economies in the twentieth century which distinguished them as among the most prosperous in the world, was nonetheless punctuated by periodic corporate governance failure, sometimes almost of a catastrophic nature.
The capacity of the system for reform and regeneration is very real, but also the apparently inherent instability and volatility in this increasingly market based system.
Whether current reforms will reduce the frequency of market and corporate failure remains to be seen. How well the Anglo-American system can respond to the increasingly critical demand for corporate social responsibility and sustainability is another pressing question at this stage,
200220032004200520062007200820092010
Equities \1
Holdings, total
124381663918940206362433925576156782000323293
Household sector \2
516167887484809396449627577773218514
State and local governments
7985909710611286122115
Federal government
0000001896743
Rest of the world \3
122216751905203924482812180724363091
Commercial banking
3152024354173037
Savings institutions
293028262525232220
Property-casualty insurance companies
149178197200227236193220228
Life insurance companies
7099191054116213651465100212081423
Private pension funds
158920972338244227252673160018361983
State and local government retirement funds
105714211601171619262014123815501779
Federal government retirement funds
46809911313814986119134
Mutual funds
218730513694417649905477301441364801
Closed-end funds
3453821061221467490101
Exchange-traded funds
98146219286402574474670854
Brokers and dealers
75101129158186225109124117
Type of investor
|
|
% |
£ billion |
||||
|
|
1998 |
2010 |
2012 |
1998 |
2010 |
2012 2014 |
|
Rest of the world |
30.7 |
43.4 |
53.2 |
460.9 |
760.9 |
935.1 928.6 |
|
Insurance companies |
21.6 |
8.8 |
6.2 |
325.5 |
153.8 |
109.2 101.8 |
|
Pension funds |
21.7 |
5.6 |
4.7 |
325.8 |
98.7 |
82.7 51.7 |
|
Individuals |
16.7 |
10.2 |
10.7 |
250.8 |
179.0 |
187.2 206.2 |
|
Unit trusts |
2.0 |
8.8 |
9.6 |
30.1 |
153.8 |
167.9 155.2 |
|
Investment trusts |
1.3 |
2.1 |
1.7 |
19.2 |
37.5 |
30.7 31.1 |
|
Other financial institutions |
2.7 |
12.3 |
6.6 |
40.4 |
215.0 |
115.3 123.0 |
|
Charities, church, etc |
1.4 |
0.8 |
0.6 |
20.4 |
14.9 |
10.7 20.1 |
|
Private non-financial companies |
1.4 |
2.3 |
2.3 |
20.9 |
40.1 |
39.8 34.7 |
|
Public sector |
0.1 |
3.1 |
2.5 |
1.4 |
54.4 |
44.1 50.2 |
|
Banks |
0.6 |
2.5 |
1.9 |
8.4 |
44.3 |
33.6 22.3 |
|
|
|
|
|
|
|
|
|
Total 100 |
100 |
100 |
1503 |
1752 |
1756 1726 |
|
% £ billion
1998 2010 2012 1998 2010 2012 2014
Rest of the world 30.7 43.4 53.2 460.9 760.9 935.1 928.6
Insurance companies 21.6 8.8 6.2 325.5 153.8 109.2 101.8
Pension funds 21.7 5.6 4.7 325.8 98.7 82.7 51.7
Individuals 16.7 10.2 10.7 250.8 179.0 187.2 206.2
Unit trusts 2.0 8.8 9.6 30.1 153.8 167.9 155.2
Investment trusts 1.3 2.1 1.7 19.2 37.5 30.7 31.1
Other financial institutions 2.7 12.3 6.6 40.4 215.0 115.3 123.0
Charities, church, etc 1.4 0.8 0.6 20.4 14.9 10.7 20.1
Private non-financial companies 1.4 2.3 2.3 20.9 40.1 39.8 34.7
Public sector 0.1 3.1 2.5 1.4 54.4 44.1 50.2
Banks 0.6 2.5 1.9 8.4 44.3 33.6 22.3
Total 100 100 100 1503 1752 1756 1726
_____________________________________________________________________
___
Heading Description
_____________________________________________________________________
____
Financial Stability Creating a Financial Stability Council (FSC) to
identify users and respond to existing and
emerging systemic risk of bank holding
companies and large nonbank financial
companies.
Orderly Liquidation Authority Provides recommendations for receivers hip that
may be made by the secretary of the Treasury or
Federal Reearve and Federal Deposit Insurance
Corporation (FDIC) or Securities and Exchange
Commission (SEC) for the financial companies
in default.
Advisers of Hedge Funds Eliminates the private advisor exemption and
requires the investment adviser to maintain
records and reports
Insurance Monitors the insurance industry and identifies
issues contributing to system risk
Regulation of Bank & Savings General Accountability Office (GAO) to study
elimination of exceptions, for thrifts, loan
companies, and credit banks
Wall Street Transparency SEC and Commodity Futures Trading
Commission (CFTC) share authority for
regulation of over the counter swaps that are
required to be submitted for clearing must be
traded on through exchange or swap execution
facility
Claring and Settlement Supervision FSC to design financial market utili ties and
payment; and Federal Reserve to prescribe
uniform risk management standards for the
payment and settlement activities.
Investors Protection SEC is granted authority to promulgate rules to
establish fiduciary duty
Consumer Financial Portection Bureau that comprises the consumer protection
functions of different agencies to be resident
within the Federal Reserve
Mortgage Reform To create laws/rules requiring mortage
originators to be qualified, registered, and
licenced.
___________________________________________________________
____
58
56
54
52
50
48 Top 1%
Bottom 99% 46
44
42
40
58
56
54
52
50
48
Top 1%
Bottom 99%
46
44
42
40
