Introduction
The corporate governance is the mechanisms that involve the rules, processes and the practices to which an organization is directed and controlled. Therefore, it is a process of balancing the interests of many stakeholders in an organization, which mainly includes the customers, financers, management, suppliers and the community. It provides the foundation and framework for achieving the company goals and objectives, and it looks at every part of the management including their actions, performance measure and corporate disclosure. It is a field in economics that investigates on how to motivate and secure the efficient administration of the corporations by the use of the incentives like the legislations, contracts and organizational design.
Principle agency theory as it relates to the corporate entity- it is important in understanding all the political and economic systems
The principle agency theory creates the environment for the agent and ensures that they act as the principle agents.it includes the attainment of good information and enough financial incentives. The principle agent problem is initiated when the principal develops an environment where the agent incentives do not align with its own. Therefore, the corporate governance is the combination of all mechanisms that ensure that the agent or management controls the business for the interest of diverse shareholders while mitigating the conflicts of interest(Monks & Minow, 2004, p. 54). The agency theory is relevant in explaining the actions of numerous stakeholders in the corporate governance. The focus of the theory of the agent and principal relationship has created the risk because of the information asymmetries. The separation of the ownership causes the managers to take the actions that may not maximize the shareholders profits and hence, the mechanisms are necessary (Monks & Minow, 2004, p. 54).
The corporate companies that are quoted in the stock markets are complex hence; they receive funds from the substantial investment. The shareholders delegate the duties to the professionals who run the company on their behalf (Monks & Minow, 2004, p. 54). Therefore, the directors or the agents have the fiduciary responsibility to the principal or shareholders of the organization and it is described in the company law.
Economic crash of 2008 which institutions played which role
The world faced the dangerous situation crisis in 2008 after the great depression of 1930. The problem began in 2007 and became the primary geopolitical setback for Europe and the United States. In 2000, the economic growth was grinding ahead in North America, and it is signified by the companies hiring, the rise of new offices towers in Calgary and Toronto including the U.S. the housing market are increasing on both sides of the borders. The failure to save the largest investment banks, the Lehman Brothers Holdings Inc from collapsing was the primary cause. The company went under the financial problems of the great depression was on(Krugman, 2009, p.45). The effects of the 2008 recession were great, rising unemployment and panic.
The event was contributed by multiple factors, which pulled down several financial players. The Bank of America brought the American mortgages that accounted almost 20% of the American mortgages that collapsed in 2006 (Png & Saw Centre for Financial Studies, 2008, p. 87). Another investment bank, the Bear Stearns was sold to the JPmorgan Chase where the stockholders lost approximately 90% of their investment, most people around the America country lost confidence in the rest of the banks.
The government took control over the Fannie Mae and the Freddie Mac, the two largest mortgages in the U.S that held the China and other countries notes. Notably, the market believed in the implicit that allowed the two companies to borrow in the market at the lower rates than other financial institution. Therefore, the agency debt of the two companies become larger than U.S Treasury bonds which added up to large debt(Png & Saw Centre for Financial Studies, 2008, p. 87). The U.S Congress were the strong supporters of the two companies despite the red flags and warnings by many; they continued to allow the companies to increase in risk and size and encouraged them to purchase the increasing number of the lower credit quality loans. In Russia and China, the recession was growing at the fast rate and the British had to take over the Northern Rock, the largest British mortgage company.
The major banks reported the huge losses, and they were no longer lending money due to the value of the assets. The short sellers sold large amounts of stock to the threatened companies reducing the share price and causing more panic. The bank like Lehman Brothers that is one of the oldest and largest was declared bankrupt and no one was to rescue. Its collapse had the multiplier effect internationally, it weakened other banks increasing the level of distrust and fear, and the bankers increasingly reduced lending. Many firms had borrowed the money and pledged the assets they owned as the collateral and in turn, the lenders demanded more collateral to refill the gap and the borrowers had to sell assets to raise the emergency cash. They encountered the downward spiral since the assets they sold were falling and the more sales meant that the price was falling (Krugman, 2009, p.45). The Merrill Lynch was sold at $51 billion to the Bank of America, the price that is approximately half of its original figure when the AIG insurance failed to keep its terms of service. The other economies abroad like the economies of Germany, China and Japan, were all locked in recession
What role did Gramm-leach Bliley Act of 1999 (repeal large part of Glass-Steagall Act of 1933) play?
The Act requires the financial institutions and other companies who offer the consumer financial services and products like the insurance, investment plans and financial pieces of advice to explain their information-sharing practices to their loyal customers and hence protect their sensitive data (Matthew Bender (Firm), 2000, p. 65).
The act was meant to spur greater competition and protect the rights of the consumers while guaranteeing expanded financial firms that would meet the needs of the American communities. It also makes the changes to the U.S financial structure that will allow them to invent the free and new economy. The Act repealed the Glass-Steagall Act that was developed since the emergence of the Great Recession.It restricted the link between the banks and the security firms. The banks played the role in buying and selling of the mortgages backed by the credit default swaps, the securities with other explosive financial derivatives (Matthew Bender (Firm), 2000, p. 90). Therefore, without the watering down and the repeal of the Glass-Steagall, the banks would have barred from these activities. The market and derivatives would have been very small, and U.S might not have felt the need to rescue the institutional victims. The act differentiated the causative agents of the recessions and set the new rules for the new competition. Therefore, most organizations had new chance to start things afresh and the recession was minimized.
How the corporate governance or principle agency theory played or not played within the framework
The financial crisis of 2007-2008 caused many financial institutions to collapse and was later bailed out by the governments globally (Monks & Minow, 2004). It is established that all the failures were attributed to corporate governance, which included lax board oversight and inadequate executive compensation that arose to aggressive risk taking. When the governance reforms are thought to restore stability of world financial systems, there is insufficient evidence that shows corporate governance participated in the failure of the financial institutions.
The primary role of the corporate governance was disciplining executive officers for the losses that that happened during the crisis. And their role by the financial institutions in risk taking. However, the independent boards and institutional investors on low profitability did not replace the poor performing chief executive officers(CEOs) during the crisis. It is suggested that the CEO turnover is crucial than the shareholder losses for firms that have bigger independent boards and a larger ownership institutionally (Krugman, 2009). This is dee to the shareholder value. The pressure from the boards and investors for short-term profitability encouraged the managers to sacrifice the ling-term investments for short-term to earn profitability. If the pressure from the boards helped the large firms with more independent and institutional investors, they would have suffered enormous losses during the crisis (Monks & Minow, 2004). It is further argued that the compensation contracts that had a huge emphasis on annual bonuses enhanced the executives to focus on short-term results. The firms that had CEO compensation contracts that relied on the annual bonuses suffered massive losses and ought to have taken lesser risks.
Hypothesis
In this analysis, we will focus on the large financial firms globally since the crisis was on a global scale. Data of the CEOs are gathered, board details, ownership structure, and CEO competition. The majority of the listed companies in the United States were held widely. In Europe, many companies took place closely. The CEO replacements in the institutions faced with the crisis did not follow the right procedure. It is evident that many firms exhibited higher CEO turnover than the non-financial companies in the crisis period. The CEO turnover rates varied from country to country. For instance, Citigroup, Merrill Lynch, and Wachovia all in the United States (Monks & Minow, 2004).
Implications for the economy
The CEO turnover is critical to the poor performance of firms with the independent board of directors and larger institution ownership. It is lesser sensitive to poor performance for the firms with exclusive ownership.
How the principle agency theory has driven these developments
In measuring the CEO compensation, information on compensation is obtained from the compensation structure for the fiscal year 2006. The CEO compensation is measured as the relative importance of incentives versus the fixed CEO’s pay package. From research, it is established that there was a significant increase in CEO turnover during the crisis for the financial firms. The logit model had been used to regress CEO turnover on shareholder losses, corporate governance, and shareholder losses (Monks & Minow, 2004). The performance analysis indicated that the shareholders’ losses are associated with the increased probability of the CEO turnover. The shareholder losses and the board independence suggest that more outsider-dominated boards achieved to hire new management since the previous management reflected poor performance measured by the need to raise external capital and loss to the market value during the crisis (Krugman, 2009).
The boards or the investors enhance pressure to focus on short-term profits and eventually facilitated the managers to increase investment in risky assets. The factors associate with the losses attributed to the shareholder losses. The effect of corporate governance on the risk exposure of financial firms before the crisis shows that firms with higher institution ownership have high default risk. More independent boards are associated with higher equity-to-assets ratios (Monks & Minow, 2004). This shows directors, due to the threat of lawsuits and other penalties, addressed the type of risk-taking that is identified by market participants. The overall results analyzed indicated that the investors and the board failed to curb the risk before the crisis.
Conclusion
The management structure is to be blamed for the 2008 crisis due to their lack of the information. The government, on the other hand, takes considerable responsibility for the crisis due to their negligence and continuing to finance the collapsing companies. The Gram bill was established to give the consumers and the investors the assurance through the more information sharing activities. Strong monitoring by boards or investors reflects the discipline of the executives after the crisis commenced. The institutional shareholders are associated with the high executive turnover-performance sensitivity and huge losses. The outside pressure in need for short-term profitability by taking more risks, which at the end lead to losses. The companies with institutional ownership take more risks and lead to losses. The firms with higher institutional ownership took more risks that led to enduring more risks before the crisis began. In the terms of the board composition, external survey and monitoring by independent board members is important in disciplining the higher management for poor delivery during the crisis.
References
Krugman, P. R. (2009). The return of depression economics and the crisis of 2008. New York: W.W. Norton.
Matthew Bender (Firm). (2000). Financial services modernization: Analysis of the Gramm-Leach-Bliley Act of 1999. New York, NY: Matthew Bender.
Monks, R. A., & Minow, N. (2004). Corporate governance. Malden, MA: Blackwell Pub.
Png, I., & Saw Centre for Financial Studies. (2008). Financial crisis 2008. Singapore: Saw Centre for Financial Studies.
