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Latest Research on Shareholder Engagement: A CICA Directors Briefing by Robert Adamson and Andrew MacDougall

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A CICA Directors Briefing by Robert Adamson and Andrew MacDougall

Lessons From the Financial Crisis: Governance Gaps and Strategies for the Future

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Presented by

SFU Centre for Corporate Governance and Risk Management and
the Shareholder Association for Research & Education

Join presenters:

Damon Silvers
Director of Policy and Special Counsel for the AFL-CIO

and

Edward Waitzer
Jarislowsky-Dimma-Mooney Chair in Corporate Governance at
the Schulich School of Business and Osgoode Hall Law School and
Senior Partner at Stikeman Elliott LLP

With Moderator
Robert Adamson
SFU Centre for Corporate Governance and Risk Management

For a discussion on lessons from the financial crisis.

Topic Highlights:

  • The US Experience: The role of the SEC in the 2008 global financial crisis
  • Gaps in Canadian regulation
  • A call for regulatory reform and an end to short-termism
  • The role and priorities of the regulator
  • Restoring trust and confidence in investing in markets
  • Changes needed to the capital markets to encourage responsible investment
  • What lies ahead, and the impact on institutional investors

When:
Wednesday, May 19, 2010  4:00 PM – 6:00 PM

Where:
Segal Salon, Segal Graduate School of Business
500 Granville Street
Vancouver, British Columbia

Agenda:
Refreshments and Networking: 4-4:30pm
Presentation: 4:30-6pm

Fee:
$20.00

Please click here to register.

The G20 and Global Approaches to the Regulation of Finance: Zeitgeist for the Times or Just Apparition of the Moment

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By Robert Adamson, Executive Director, Centre for Corporate Governance and Risk Management, Segal Graduate Business School, Simon Fraser University, Vancouver CANADA

April 1, 2009

The winds of change are blowing in London as the G20 prepares to meet. Unfortunately no one knows when the winds will stop and who will be swept away. There are many views, however, on how and where to take cover. Many countries, particularly the European countries, are agitating for agreement on global and coordinated regulatory measures to improve both the macro and micro prudential regulation of banks, other financial institutions and capital markets in general. Other countries, particularly the United States, are more focused on the imperatives of a global and coordinated approach to stimulus to revive a rapidly deteriorating economy.Others countries like China, India, Brazil and Russia come to London with complex and different problems but united in their insistence on gaining a more vocal and powerful place in the governance of the international financial system. China, in particular, is voicing concern about financial mismanagement, massive debt loads that countries like the United States and the UK are assuming and a status quo that leaves one of the largest and still growing economies on the periphery of global financial management. The G20 will have to attempt to reconcile these competing views and strategies and work toward some meaningful consensus on how to address the myriad of problems that confront the present and future of the financial system. But can the G20 possibly arrive at some consensus and strategy for a global approach to financial system management?  And perhaps, more importantly, is that where the international community should be focusing its efforts?

These are not, of course, new debates. There have been numerous crises that have inspired international discussions and initiatives that have led to a nascent regulatory framework, at least for select financial institutions. While Bretton Woods was the first meaningful international effort at financial system coordination and led to the creation of the World Bank and the IMF, the international community has developed a much more elaborate global financial architecture since then. There are institutions, agencies and informal networks many of which attempt to share information, promote improved policies, and identify problems that could compromise the health of individual state systems or global capital markets. In some cases these initiatives are state-centred while, in other cases, industry associations have led efforts at cooperation, financial management and information sharing. The Financial Stability Forum, the G20 and Finance Ministers Forums, the World Bank and IMF and the Basel Frameworks I and II represent the diverse institutional avenues for financial management at the international level.

While various financial governance institutions and agreements exist, they collectively and individually have lacked the ability to identify and manage risks in the financial system. Even if there are forums for discussion and information exchange, or basic non-binding agreements dealing with issues such as capital adequacy such as Basel II, these current approaches and institutions can easily be found wanting, particularly given the evidence of their failure to warn about the storm clouds in the world of finance that collected over many years. Furthermore,  even if these institutions were prescient enough to see some of the problems before they happened, they appear not to have had the political will and institutional clout to ensure that there was a meaningful audience for and response to their warnings.

As many countries coming to the G20 observe, the current financial crisis provides an unusual opportunity and credible argument for reforming these inadequacies of global finance, its institutions and the way we collectively analyse and respond to risk. While there is little consensus on what form a new global financial regulatory architecture should have, there is a significant list of perceived problems and gaps in the current architecture that many governments want to correct. These problems range from the absence of coordinated macro and micro prudential oversight for banking institutions, absence of regulation for non-bank financial institutions (shadow-banking), the excesses of executive compensation, lack of disclosure and transparency about assets, uncoordinated and misleading accounting practices that fail to capture asset values, and financial products like derivatives that do not trade transparently through an exchange or clearinghouse.

These gaps and flaws in governance arguably all contributed to the current financial crisis.  More information and evidence is needed to know exactly how and why, but there are already good arguments to suggest that there are many features of our current financial system that can and should be improved. Regardless of what the evidence reveals, or how equivocal it is, there is also a palpable crisis of confidence in the financial system. The crisis in confidence permeates the system: from those who work within the system and from those who look at it from the outside.  From the inside, intrabank lending still remains weak, credit is difficult to get even for good businesses and promising financial transactions, counterparties are suspicious of each other, assets values on bank books remain unknown or dubious, and major institutional investors are remaining on the sideline awaiting how all these issues play out. From the outside, confidence and perception are also working against the financial system and the markets. Consumers and taxpayers are angry that the crisis occurred, despair as their investments, pensions, home values and jobs evaporate, and are quick to blame any or all of the possible culprits. The strange and stark reality is that no one knows exactly what happened and which of the many potential causes was to blame, or which combination of things: risky financial instruments such as CDOs, hedge funds, naked short selling, mark to market accounting and the list goes on. But whoever and whatever is to blame, there is a desire among many to reconstruct a financial system that is more reliable and resilient than the current one. While there are still market players and beneficiaries that merely want to return to the good times of profits, growth and unbridled financial entrepreneurialism, others want to ensure that the system is sustainable, robust and has the integrity to withstand the numerous challenges that lie ahead in the future of global capitalism.

This type of systemic change will not be easy to achieve. It requires more sophisticated techniques for risk management at both the firm and governmental level. It requires many possible regulatory reforms including new regulation, more intelligent old regulation, and the courage and insight to not regulate when regulation is more likely to be counterproductive than beneficial.  And perhaps most difficultly, change to the financial system requires some form of institutionalized global cooperation. Capital markets are increasingly global and complex and beyond the reach of any one state or regulator. The days of one country- including the United States- being able to set the rules and standards for financial conduct, are disappearing if not gone. While national regulation will continue to set out rules that many others beyond its borders will follow, national regulation will become less influential if only due to the increasing number of financial players like China and India that will create their own rules.

There are signs of an informal coalition of states who will advocate strongly for change at the national and global level. There are already many proposals advocating for coordinated supervision of financial institutions, improved information sharing, and new or improved regulatory frameworks for financial institutions that currently operate outside of most regulators’ view. Hedge funds, credit rating agencies and derivatives markets feature prominently on the agenda of many states, particularly EU states like France and Germany. Beyond these “easy” targets, there will be mention of excessive leverage of banks and particularly shadow-banks and the need to regulate or supervise capital adequacy beyond agreements already reach through Basel I and II.

While many of the proposals that G20 countries have promoted leading up to this week’s meeting outline useful change to the international financial architecture, it is reasonable to be skeptical about the sincerity of the reforms being proposed. Though it may come as a surprise to even the most cynical of political observers, the G20 has often been more about posing and posturing for domestic audiences than it has been about meaningful policy reform. Coordinated change at the global level is difficult and carries consequences for the independence of nation states and their financial sovereignty that many states are unwilling to accept.

There is also reason to be skeptical of the feasibility of global financial reform. Collective action at the global level is particularly challenging. It not only carries the burden of evidence to illustrate that the proposed reforms would work, it also carries the burden of creating the resources to make it work. And extra resources are in short supply at the moment.  Our experience with global coordination on international issues has indeed not been a happy one. The looming environmental catastrophe of climate change with all its social, economic and political consequences has still not been enough to catalyse a powerful and proactive international response. If the international community has not been able to coalesce around the climate change story, it is much less likely that the arcane and complex world of derivatives, leverage and global capital markets will capture and sustain our attention.

And there is yet more to consider and weigh. Even if circumstances have given birth to new opportunities for change that previously seemed impossible, there is good reason to be cautious and deliberate about the change that is pursued. There are no simple or immediate answers about how regulation of finance should be used and how global decision-making for global capital markets should be institutionalized. Prudence and perspective are useful in the discipline of regulatory reform but both may prove to be a luxury that the urgency of the moment does not accommodate. As a result, prudence and perspective may need to guide rather than dictate whether useful action can be achieved now or whether any change must wait until later. That is to say that choices may need to be made about which changes can proceed immediately guided by useful information and good policy, which proposed changes require more information and study, and which changes are just not politically or otherwise feasible even if there is strong argument for change.

Amidst these competing concerns and instincts, there is an urgency for reforming global finance, its excesses and the way it serves the global community. The crisis has created an opportunity that may soon evaporate as banks and market players regroup and regain their clout, coherence and the confidence of market actors. Confidence may return to markets and its participants not because of change in the financial marketplace but rather because of our desire and ability to prefer the comfort of the status quo to the potentially turbulent world of reform. Making these reforms even more difficult is the complex psychology that rules markets including our remarkable collective ability to forget the problems of the past when markets are improving or booming. Our focus quickly migrates from despair to hope stoked by the opiates of growing stock values, pensions, home values and the irrational exuberance of the day.

While proponents of global action face formidable challenges, not everything remains in favour of stasis and against reform. For those who oppose change and prefer the comforts of the status quo and its privileges, they will have to swim against the tide of public outrage and the desire for more scrutiny of the world of finance, banking and all of its excesses. Whether for good reasons or bad, the ways of the past, the status quo, the “normal”, may not reappear, not in the short-term and perhaps not in the longer term either. The financial system may have to reinvent itself and prove itself anew to be able to deliver on its promise of meaningful wealth generation and growth. It may also have to prove that the wealth generation and growth pursued through markets is for the benefit of all and not just some. The promise of the market cannot just be a theoretical concept. It must resonate in theory and in fact for more people around the world and over a longer period of time. Financial markets and practitioners cannot rely on asset bubbles to generate wealth and interest: particularly when these bubble events are growing in severity and number and always end rather badly. The financial system cannot survive on bubbles that eventually bust leaving only a privileged few to benefit along the way. Whether global action and regulatory oversight will be the new zeitgeist for our financial future is unknown. But our opportunity to make real choices about our future and its principles is more possible now than it has been in a very long time. Hopefully neither the geists, the shadows in the closet or the formidable nature of the task will make us recoil to the comfort of the status quo.

G20, NATO summit – Issues, Experts & Ideas

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Reviving the global economy

World leaders meeting in London have agreed to inject $1 trillion into the world economy in an attempt to curb the global financial crisis. SFU business professor Robert Adamson specializes in corporate governance and risk management and has just returned from London.He can talk about the challenges G20 leaders face as they work to address the varied needs and agendas of different countries and consider whether new strategies for global financial systems management might work.

Robert Adamson, 778.782.5267, 604.657.1213 (cell); radamson@sfu.ca
(Adamson is Executive Director, Centre for Corporate Governance and Risk Management at the Segal Graduate School of Business)

NATO to mull Afghanistan conflict

After the G20 summit, Prime Minister Stephen Harper will join U.S. President Barrack Obama at a crucial 60th anniversary meeting of NATO leaders Friday in Strasbourg where Afghanistan is sure to top their agenda. Obama recently ordered 21,000 more U.S. troops to the country, bringing its total complement to some 55,000, while NATO has another 30,000 allied soldiers there, including 2,500 from Canada. Alexander Moens is a professor of international relations at SFU and an expert on U.S. foreign policy. He can comment on the NATO meeting and how it could affect what lies ahead for both the U.S. and Canada and their allies in the troubled region.

Alexander Moens, 778.782.4361; alexander_moens@sfu.ca

The G20 and Global Approaches to the Regulation of Finance: Zeitgeist for the Times or Just Apparition of the Moment

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The winds of change are blowing in London as the G20 prepares to meet. Unfortunately no one knows when the winds will stop and who will be swept away. There are many views, however, on how and where to take cover. Many countries, particularly the European countries, are agitating for agreement on global and coordinated regulatory measures to improve both the macro and micro prudential regulation of banks, other financial institutions and capital markets in general. Other countries, particularly the United States, are more focused on the imperatives of a global and coordinated approach to stimulus to revive a rapidly deteriorating economy. Others countries like China, India, Brazil and Russia come to London with complex and different problems but united in their insistence on gaining a more vocal and powerful place in the governance of the international financial system. China, in particular, is voicing concern about financial mismanagement, massive debt loads that countries like the United States and the UK are assuming and a status quo that leaves one of the largest and still growing economies on the periphery of global financial management. The G20 will have to attempt to reconcile these competing views and strategies and work toward some meaningful consensus on how to address the myriad of problems that confront the present and future of the financial system. But can the G20 possibly arrive at some consensus and strategy for a global approach to financial system management?  And perhaps, more importantly, is that where the international community should be focusing its efforts?

These are not, of course, new debates. There have been numerous crises that have inspired international discussions and initiatives that have led to a nascent regulatory framework, at least for select financial institutions. While Bretton Woods was the first meaningful international effort at financial system coordination and led to the creation of the World Bank and the IMF, the international community has developed a much more elaborate global financial architecture since then. There are institutions, agencies and informal networks many of which attempt to share information, promote improved policies, and identify problems that could compromise the health of individual state systems or global capital markets. In some cases these initiatives are state-centred while, in other cases, industry associations have led efforts at cooperation, financial management and information sharing. The Financial Stability Forum, the G20 and Finance Ministers Forums, the World Bank and IMF and the Basel Frameworks I and II represent the diverse institutional avenues for financial management at the international level.

While various financial governance institutions and agreements exist, they collectively and individually have lacked the ability to identify and manage risks in the financial system. Even if there are forums for discussion and information exchange, or basic non-binding agreements dealing with issues such as capital adequacy such as Basel II, these current approaches and institutions can easily be found wanting, particularly given the evidence of their failure to warn about the storm clouds in the world of finance that collected over many years. Furthermore,  even if these institutions were prescient enough to see some of the problems before they happened, they appear not to have had the political will and institutional clout to ensure that there was a meaningful audience for and response to their warnings.

As many countries coming to the G20 observe, the current financial crisis provides an unusual opportunity and credible argument for reforming these inadequacies of global finance, its institutions and the way we collectively analyse and respond to risk. While there is little consensus on what form a new global financial regulatory architecture should have, there is a significant list of perceived problems and gaps in the current architecture that many governments want to correct. These problems range from the absence of coordinated macro and micro prudential oversight for banking institutions, absence of regulation for non-bank financial institutions (shadow-banking), the excesses of executive compensation, lack of disclosure and transparency about assets, uncoordinated and misleading accounting practices that fail to capture asset values, and financial products like derivatives that do not trade transparently through an exchange or clearinghouse.

These gaps and flaws in governance arguably all contributed to the current financial crisis.  More information and evidence is needed to know exactly how and why, but there are already good arguments to suggest that there are many features of our current financial system that can and should be improved. Regardless of what the evidence reveals, or how equivocal it is, there is also a palpable crisis of confidence in the financial system. The crisis in confidence permeates the system: from those who work within the system and from those who look at it from the outside.  From the inside, intrabank lending still remains weak, credit is difficult to get even for good businesses and promising financial transactions, counterparties are suspicious of each other, assets values on bank books remain unknown or dubious, and major institutional investors are remaining on the sideline awaiting how all these issues play out. From the outside, confidence and perception are also working against the financial system and the markets. Consumers and taxpayers are angry that the crisis occurred, despair as their investments, pensions, home values and jobs evaporate, and are quick to blame any or all of the possible culprits. The strange and stark reality is that no one knows exactly what happened and which of the many potential causes was to blame, or which combination of things: risky financial instruments such as CDOs, hedge funds, naked short selling, mark to market accounting and the list goes on. But whoever and whatever is to blame, there is a desire among many to reconstruct a financial system that is more reliable and resilient than the current one. While there are still market players and beneficiaries that merely want to return to the good times of profits, growth and unbridled financial entrepreneurialism, others want to ensure that the system is sustainable, robust and has the integrity to withstand the numerous challenges that lie ahead in the future of global capitalism.

This type of systemic change will not be easy to achieve. It requires more sophisticated techniques for risk management at both the firm and governmental level. It requires many possible regulatory reforms including new regulation, more intelligent old regulation, and the courage and insight to not regulate when regulation is more likely to be counterproductive than beneficial.  And perhaps most difficultly, change to the financial system requires some form of institutionalized global cooperation. Capital markets are increasingly global and complex and beyond the reach of any one state or regulator. The days of one country- including the United States- being able to set the rules and standards for financial conduct, are disappearing if not gone. While national regulation will continue to set out rules that many others beyond its borders will follow, national regulation will become less influential if only due to the increasing number of financial players like China and India that will create their own rules.

There are signs of an informal coalition of states who will advocate strongly for change at the national and global level. There are already many proposals advocating for coordinated supervision of financial institutions, improved information sharing, and new or improved regulatory frameworks for financial institutions that currently operate outside of most regulators’ view. Hedge funds, credit rating agencies and derivatives markets feature prominently on the agenda of many states, particularly EU states like France and Germany. Beyond these “easy” targets, there will be mention of excessive leverage of banks and particularly shadow-banks and the need to regulate or supervise capital adequacy beyond agreements already reach through Basel I and II.

While many of the proposals that G20 countries have promoted leading up to this week’s meeting outline useful change to the international financial architecture, it is reasonable to be skeptical about the sincerity of the reforms being proposed. Though it may come as a surprise to even the most cynical of political observers, the G20 has often been more about posing and posturing for domestic audiences than it has been about meaningful policy reform. Coordinated change at the global level is difficult and carries consequences for the independence of nation states and their financial sovereignty that many states are unwilling to accept.

There is also reason to be skeptical of the feasibility of global financial reform. Collective action at the global level is particularly challenging. It not only carries the burden of evidence to illustrate that the proposed reforms would work, it also carries the burden of creating the resources to make it work. And extra resources are in short supply at the moment.  Our experience with global coordination on international issues has indeed not been a happy one. The looming environmental catastrophe of climate change with all its social, economic and political consequences has still not been enough to catalyse a powerful and proactive international response. If the international community has not been able to coalesce around the climate change story, it is much less likely that the arcane and complex world of derivatives, leverage and global capital markets will capture and sustain our attention.

And there is yet more to consider and weigh. Even if circumstances have given birth to new opportunities for change that previously seemed impossible, there is good reason to be cautious and deliberate about the change that is pursued. There are no simple or immediate answers about how regulation of finance should be used and how global decision-making for global capital markets should be institutionalized. Prudence and perspective are useful in the discipline of regulatory reform but both may prove to be a luxury that the urgency of the moment does not accommodate. As a result, prudence and perspective may need to guide rather than dictate whether useful action can be achieved now or whether any change must wait until later. That is to say that choices may need to be made about which changes can proceed immediately guided by useful information and good policy, which proposed changes require more information and study, and which changes are just not politically or otherwise feasible even if there is strong argument for change.

Amidst these competing concerns and instincts, there is an urgency for reforming global finance, its excesses and the way it serves the global community. The crisis has created an opportunity that may soon evaporate as banks and market players regroup and regain their clout, coherence and the confidence of market actors. Confidence may return to markets and its participants not because of change in the financial marketplace but rather because of our desire and ability to prefer the comfort of the status quo to the potentially turbulent world of reform. Making these reforms even more difficult is the complex psychology that rules markets including our remarkable collective ability to forget the problems of the past when markets are improving or booming. Our focus quickly migrates from despair to hope stoked by the opiates of growing stock values, pensions, home values and the irrational exuberance of the day.

While proponents of global action face formidable challenges, not everything remains in favour of stasis and against reform. For those who oppose change and prefer the comforts of the status quo and its privileges, they will have to swim against the tide of public outrage and the desire for more scrutiny of the world of finance, banking and all of its excesses. Whether for good reasons or bad, the ways of the past, the status quo, the “normal”, may not reappear, not in the short-term and perhaps not in the longer term either. The financial system may have to reinvent itself and prove itself anew to be able to deliver on its promise of meaningful wealth generation and growth. It may also have to prove that the wealth generation and growth pursued through markets is for the benefit of all and not just some. The promise of the market cannot just be a theoretical concept. It must resonate in theory and in fact for more people around the world and over a longer period of time. Financial markets and practitioners cannot rely on asset bubbles to generate wealth and interest: particularly when these bubble events are growing in severity and number and always end rather badly. The financial system cannot survive on bubbles that eventually bust leaving only a privileged few to benefit along the way. Whether global action and regulatory oversight will be the new zeitgeist for our financial future is unknown. But our opportunity to make real choices about our future and its principles is more possible now than it has been in a very long time. Hopefully neither the geists, the shadows in the closet or the formidable nature of the task will make us recoil to the comfort of the status quo.

Jon Stewart vs. Jim Cramer – Exposing the role of the stock tip in the current financial crisis

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I am a religious follower of the Daily Show with Jon Stewart. His succinct and insightful summaries of important topics enable ordinary people like me to get at issues which seem otherwise purposely complicated to keep us in the dark. In watching the recent media-created “feud” between Jon Stewart and CNBC’s Jim Cramer I was able to articulate my frustration with the stock market in the current financial crisis.

As the market unravels and fingers are pointed at the investment houses that concocted and pushed substance-less derivative schemes, and at governments for allowing this in their hands-off approach to what they believed was a rational system; few are pointed at some of the mechanisms that gave rise to and continue to reward the behavior that led to the crash in the first place.

Most firms strive to be recognized as performers in the market, and to attract shareholders. Attraction drives up share price. To sustain attraction and share price, firms must continue to be recognized. Much of this is based on the confidence firms portray in their ability to achieve next quarter’s performance targets. To achieve these projections, firms frequently undertake activities to meet short-term targets, irrespective of whether these activities are intrinsically sustainable, ethically sound, or economically justified. Recent events show that when firms are doing well and projecting future growth, their means of achieving this growth is seldom questioned as shareholders sit back happily contemplating their increasingly valuable share portfolios.

And many firms seem to get away with this year after year. Others, however, like Bernie Madoff, are less lucky; bringing down hundreds, sometimes thousands and even millions, as their ill-conceived strategies unravel. This is playing out across the world in the current economic recession. Firms that have for years implemented strategically flawed growth schemes in pursuit of market support and share price inflation, like Starbuck’s, are hitting the skids as customers’ wallets shrink and revenue projections – and thus shareholder happiness – are threatened.

Disappointing their shareholders is a major concern for these firms. As a result of firms’ histories of unrealistic projections, they are unable to explain to their hundreds of thousands of nameless, faceless owners that their previous growth plans were ill-conceived, and that this opportunity must be taken to adjust their strategies and downgrade their revenue projections. Such actions would quickly result in shareholder flight and rapid stock price devaluation leading to take-over threats.

And while these explanations are inevitable and plans to redress previous bad decisions crucial, these firms dig themselves deeper, making even worse decisions going forward in order to clutch at the last straws of investor confidence. Firms move from high-value to low-cost strategies without any apparent consideration of their ability to execute or gain from such moves in the longer term. Massive cost-cutting actions being taken almost across the board by firms hit by the crisis involve recklessly dispensing of the people who enabled the firms to succeed in the first place. And while getting rid of these people might allow firms to sustain revenue projections in the short term, it puts these firms in jeopardy as they confront rivals head-on, and as they end up opening up the market to smaller, more agile, entrants. The move to cost-based competition strips most firms’ of their original competitive advantage, limiting their ability to survive into the future – and virtually precluding them from succeeding in an economic upswing where they will be one among many, devoid of a strategy that would enable them to deliver the level of service they once offered.

So who’s really to blame for this value-destroying business model? The government has put in place regulations that encourage and demand transparency. And executives implement the plans for which they are rewarded. These executives’ incentive schemes are driven and approved by shareholders, who dictate to executives their expectations in terms of short-term measures such as quarter-on-quarter share price growth and p/e ratios. Therefore, if the model of growing firms through dodgy, baseless, and shareholder-pleasing activities is to stop, then it is firms’ governance models that must be restructured.

Firms’ focus should move away from satisfying the expectations of fickle investors. Governance models should move to rewarding on-average-market-beating-performance, where the average is taken over several years, or several industry cycles, rather than daily or quarterly. That means attracting and catering only to investors who are prepared to sit tight during downturns, and protect firms that stick to their strategic guns in revenue slumps, from share price collapse and hostile take-over threat.

This does not mean simply changing executive compensation packages, or passing increasingly onerous transparency regulation (although this is undoubtedly essential). It means revisiting the entire, flawed shareholder model. For example, floors on the number of stocks in a firm a shareholder can own should be instituted. Minimum lengths of time for which shares must be held before selling, and minimum time between trades, should be required. Perhaps ceilings on the dividends firms are allowed to issue should be considered. All of these suggestions can be quickly argued and perhaps easily dismissed; but it is clear that something is fundamentally wrong with the governance model in place today. And unless something is done to correct this model, it is only a matter of time after we recover from this meltdown that we find ourselves in a similar situation all over again.

As Jon Stewart begins to put names and faces to some of the institutions that enabled and supported the demise into economic crisis, I hope that others begin to understand their part in a system that seemed destined to lead us here. Instead of calling on President Obama for bail-outs to perpetuate current practices, North Americans should take the opportunity to evaluate and redevelop the model of public ownership itself, and make changes before people begin making money again and forget that there was ever a problem in the first place.

By Lisa Papania
17 March 2009

Strategic Governance for Sustainable Competitive Advantage

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In the strategy literature, corporate governance is an “important factor affecting the firm’s performance and long-term survival” (Filatotchev, Toms & Wright, 2006: 257). Research on board size and independence – posited to help firms reduce managers’ self-interested behavior, and manage transaction costs and resource dependencies (Boone et al., 2007; Filatotchev et al., 2006; Lynall, Golden & Hillman, 2003) – has focused on the showing that positive effect of these variable on firm performance (Forbes & Milliken, 1999; Huse, 2000; Johnson, Daily & Ellstrand, 1996). As a result, the notion that rules firms limit managers’ opportunism has had many policy implications, including informing the Sarbanes-Oxley Act of 2002 (Boone et al, 2007; Denis & McConnell, 2003). – Lisa Papania

For the full text PDF click here

Stakeholders, Social Activities and Fannie and Freddie

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My research interest in the how firms address social issues led me recently to engaged in a research project to investigate the relationship between the level of firms’ acknowledgment of outside entities– broadly referred to as stakeholders, and including various groups such as shareholders, employees, customers, communities, NGOs, governments – and firms’ likelihood of long-term survival.Stakeholders are critical to firms’ success, because without their support firms cannot do business, and will fail. – Lisa Papania

For the full text PDF click here

Madoff Madness: Another Lesson in Corporate Governance and Risk Management (Did It Have to Come So Soon?!)

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So how is it possible that some of the largest banks in the world, with the most sophisticated risk management teams, and with elaborate processes for conducting due diligence, have been caught up in one of the greatest financial frauds ever? Bernard Madoff, founder of Bernard L. Madoff Investments, was arrested last week for defrauding investors – banks and corporate institutions – who funded charitable and nonprofit organizations, of around $50 billion. While the investors lost billions in the scandal, the funded charities and education facilities are struggling to survive the aftermath.

One would think that risk management and due diligence at financial institutions would be up to the task of revealing what was fundamentally a ponzi scheme. One would also think that these same financial institutions had learned at least some lessons over the last months about what review and oversight is needed to protect their lending, particularly when billions are at stake and many more billions have already been lost.

Where too were the regulators? Does no regulator have the mandate and obligation to investigate and preempt this type of massive fraud? With all the high profile events of corporate and financial industry fraud, and with regulator claims that new regulations would help prevent future occurrences, what went wrong? Have we really made so few improvements in the law and regulatory oversight that what is being described as an “epic” example of investor fraud can still occur? Whatever improvements that were made were apparently not enough. At least not enough to catch Bernard Madoff. But why?

As usual, many parts of the system failed and many people are potentially to blame. At the institutional level, many of those institutions who should have been conducting their own review and due diligence failed in that task. The internal review processes at the firm level failed. We don’t yet know why, but they failed. And it is important to note that the investors that invested in Madoff’s hedge fund were not small unsophisticated investors but included large banks and funds including Royal Bank of Scotland (RBS), Banco Santander, and HSBC. Regulators also failed. Though hedge funds in the United States are not regulated, hedge fund managers are regulated by the Securities and Exchange Commission. While Madoff had been registered with the SEC for several years, the SEC apparently did not have the time to audit the books of the small and secretive investment-adviser business that Madoff ran on the side. Third party due diligence also failed.  Many investors invested in Madoff’s fund through third parties and while these third parties should and do have their own due diligence procedures in place, they failed. It is still unclear whether the procedures were not followed or whether the procedures are not sufficient to catch the type of fraud that Madoff perpetrated. The bottom line is that all of these governance and risk management procedures were not adequate to catch a massive multi-billion dollar fraud.

But institutional failures were not the only systemic failures. Investors themselves have made it easier for hedge funds and other investment vehicles to operate outside of discerning eyes. In raging bull markets, investors want to partake of the market’s relentless ride. And where funds are beating the market, investors line up to enter the promised land of financial reward. During this recent bull market, it was difficult to access hedge funds such that investors had little leverage to demand detailed information about how a hedge fund was using its funds and how it was beating the market. Since hedge fund details are not considered public domain and no laws require disclosure, most hedge fund managers chose not to reveal this information, and investors were left to make their investment choices based on investment return and reputation of the hedge fund manager. In Madoff’s case, he was well-known having served as Chairman of the Board of the NASDAQ and around for a long time having run his Bernard Madoff Investment Securities LLC since 1960s. Perhaps more importantly for many investors, he had developed a reputation for consistently exceeding market returns. Far too few people were dissuaded by the lack of transparency and disclosure around Madoff’s fund or the intermittent warnings from both objective observers and rivals.

As Madoff made off with billions, many investors are left only with another hard lesson about corporate governance, risk management and transparency. As if there have not been enough hard lessons already. One of those lessons is that some financial investment vehicles remain unregulated, or at least inadequately regulated. While some laws exist to protect investors, regulatory agencies often have neither the time nor resources to enforce those laws. The more cynical would suggest that these regulatory agencies also often lack the will to seek out the information that is required to enforce the rules and to protect investors. Hedge funds are among those inadequately regulated areas. Regulatory change will be required to improve this situation. Some changes have already been implemented in other parts of the world such as the new regulations for hedge funds adopted by the Financial Services Authority (FSA) in the United Kingdom. More far-reaching proposals have been put forward to promote transparency in the hedge fund industry and for other financial vehicles; and those proposals should be seriously considered.

In the meantime, investors should begin to perform their own due diligence. Transparency and disclosure should be the norm for all investments and investment managers. Where that transparency does not exist, as with many hedge funds, investors must be willing to insist on material disclosure. Where none is forthcoming, they should walk away. For those investors who are convinced that the risks are worth the potential rewards, they are doing a disservice to other investors who want (and in some cases actively advocate for) more meaningful, material and timely disclosure for all investment vehicles, including hedge funds. The Canadian Pension Plan avoided exposure to the Madoff madness since their Investment Board has standards for disclosure that Madoff’s fund did not meet. More institutional investors should do the same.  If more investors (large and small) insist on improved transparency and disclosure, these frauds will be more difficult to perpetrate against unsuspecting investors. Furthermore, this increased scrutiny will also assist the regulator -however its role is redefined and expanded- to further limit the inevitable attempts to defraud investors. Without the increased scrutiny of large and small investors, and without an expanded mandate for the regulators, this type of fraud will persist. And in these trying economic times, the situation is likely to get worse.  Caveat emptor!

By Robert Adamson

December 15, 2008

Global Financial Meltdown: What Lies Ahead for Corporations, Investors and Global Markets

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presented by The Centre for Corporate Governance and Risk Management and SHARE

DATE: Friday, December 5, 2008
VENUE: Segal Graduate School of Business, 500 Granville St. (at Pender)

Speakers:

Michael O’Sullivan
Michael O’Sullivan is the President of the Australian Council of Superannuation Investors (ACSI) and also a member of the Board of Governors of the International Corporate Governance Network, the Australian Council of Trade Unions (ACTU), and a representative of the Oceania Region on both the World and Asian Pacific Regional Executives of FIET. Michael is currently the Deputy Chairman of CARE Superannuation Fund. He was one of the first to urge UNI to consider the influence which could be wielded by pension funds for better corporate governance and higher standards of corporate social responsibility.

Raj Thamotheram
Raj is a Responsible Investment specialist who has worked in the investment world for nearly 9 years. His current job is to develop specialist responsible investment funds and be the catalyst for mainstreaming of Responsible Investment at the organization level. He helped to launch the Institutional Investor Group for Climate Change, “Managing pension funds as if the long term really did matter” competition, Pharma Futures, Enhanced Analytics Initiative, Marathon Club, International Roundtable on Executive Remuneration, Principles of Responsible Investment, the first fund in Europe focused on human capital management as a source of alpha and, most recently, the Network for Sustainable Markets.

Video

Click the launch the Global Financial Meltdown video

Photo Gallery


Robert Adamson (left); Raj Thamotheram (centre); Michael O’Sullivan (right)


Michael O’Sullivan: Australian Council of Superannuation Investors


Raj Thamotheram: Network for Sustainable Markets


Robert Adamson: Executive Director, Centre for Corporate Governance and Risk Management


Raj Thamotheram (left); Robert Adamson (centre); Michael O’Sullivan (right)