Yesterday I spent the day in Baltimore for meetings at Johns Hopkins University. While there, I managed to sit in on a lecture by the Dean of Dartmouth College’s Tuck Business School (Paul Danos) discussing his thoughts on the financial crisis and lapses in corporate governance.
Everyone has been blaming the wrong people for the current financial crisis.
Media and government have lambasted Wall Street CEO’s and Executives who earned fortunes over the past few years [in retrospect] seemingly at the expense of their investors. How can Wall Street execs live with themselves? is the ubiquitous war cry everywhere we turn — a discussion of excessive compensation and ethics underlies much of this anger.
However, this logic is faulty. Such excessive executive compensation is really not an issue of ethics; after all, who looks at a large paycheck they’ve earned legally and questions whether it is ethical for them to cash it and reap their due reward for high performance, risk taking and long hours? The answer is no one in any industry!
The concept of greed is the same it’s always been.
The persons truly at fault are not executives accepting payments for what their contracts allowed; rather, it is largely the fault/failure of the Board of Directors.
It was/is the Boards who approved those checks and failed to consider that executive compensation could ultimately not be in alignment with the longer-term success of investors. Agency problems were never considered appropriately. Clawback provisions should have been considered under various scenarios. Where were these models? Where was the desire for a deeper understanding of process? Outcome? Outliers?
Ultimately Boards failed in their appointed duty to understand and consider the impacts of complex and leveraged investment instruments within an ever increasingly complex system. This crisis, more than anything else, resulted from poor stewardship.
One of the most interesting things Danos noted is that while SOX regulations have made a huge difference in terms of accountability and transparency for most publicly traded companies, somehow financial firms have been exempt. Overall, most publicly traded companies (and their boards) are much more cognizant of the need to play by the rules; why was this not the case for banks?
To be a Board member is a to assume a position of great responsibility. You must think on a scale much larger than firm-level; this is not a job based on micro economic principles. Boards can’t allow themselves to blindly follow CEOs. They must question. Board Members must aim for a richer understanding of their firm and its people, processes and products within the greater economic, environmental and global system(s). The fact that board members at financial institutions never asked for models showing the possibility of black swan situations is unacceptable.