Reasons Which Attributed towards the Global Financial Crisis - Research Paper Example

Table of Contents 1.introduction 3 2.Background of the crisis 3 3.Reasons leading to global crisis and lack of governance 4 3.1 Poor risk management 4 3.2. Lack of Interference 5 3.3. Over reliance on the bull market 5 3.4. Shortcoming on the management side 5 3.5. Lack of backup plan 6 3.6. Remuneration system which had inherent risk 6 3.7. Lack of transparency 7 3.8. Lack of shareholding pattern 7 3.9.Lack of disclosures 8 3.10. Inefficient accounting policies 8 3.11.Improper evaluation of assets 9 3.12. Lack of risk policies 9 3.13. Misguided information from the rating agencies 10 5. Conclusion 11 6. References 12 1. Introduction The world has been engulfed in a global crisis and economies are looking for ways to come out of the downturn. The prime reason for it has been the recession which has engulfed the entire globe. The recent economic crisis and debacles have highlighted the importance of corporate governance. Corporate governance was an aspect which was ignored by all economies which resulted in the economies faltering. The situation started with the US housing market and slowly led to liquidity crisis. A look into the reasons which attributed towards the global financial crisis is looked into to try to draw findings as how the corporate governance issues were ignored. The entire findings throw light on lack of corporate governance on reforms, disclosure, regulations, banking sector failures and so on. The essay presents the different areas related to it and also highlights the importance being laid to corporate governance now in the evolving times. This thus helps to understand the pattern that is prevalent and also presents a picture for future development of all economies. 2. Background of the crisis The crisis started from the bubble burst and slowly engulfed the entire globe and corporate governance emerged the biggest problem out here. With boundaries disappearing among countries the effect passed on. This impacted the growth rate and made the economy take a dip. This resulted in growth rate being negative and giving rise to unemployment (Ryuhei, 2009). The beginning of the crisis “started with the bubble burst when assets prices started to tumble which created panic and reduced consumption”. (Ryuhei, 2009) This instilled fears in the minds of the people and reduced capital expenditure which transformed into increased unemployment. (Ryuhei, 2009) The final result was that banks and financial institution started facing liquidity problems. (Kirkpatrick, 2009) An example in this direction is Enron which failed due to lack of governance and liquidity. (Coffee, 2008) Some of the factors which have contributed towards it are lack of reforms, improper disclosure, and lack of policies and over reliance of certain sectors. Also the situations that banks had to face and the ignorance by banks on the corporate governance perspective contributed towards the crisis (Ryuhei, 2009). 3. Reasons leading to global crisis and lack of governance The paper now examines various reasons which lead towards the global financial crisis and throws light on how corporate governance was given least importance. Lack of proper reforms and measures to ensure disclosure and principles (Silva, 2004) could be seen as a reason which led to such a crisis. 3.1. Poor risk management Banks were unable to manage risk. Banks has invested a lot of money in CDO’s and similar investment avenues. The impeccable growth shown by the market made banks rely on it. Corporate governance was ignored by the banking institutions and risk factor was ignored. (Kirkpatrick, 2009) Banks didn’t rely on the fundamentals to trace details about each investment avenues and felt that rating of AAA and AAA- were sufficient for investment purposes. (Moxey & Priddy, 2008) The failure on the part of banks to monitor the investment exposed them to higher risk which made banks lose money and effected the performance of the economy. 3.2. Lack of Interference The lack of interference from world banking bodies like “World Bank and other banks mitigate to reduce risk were not present” (UN Conference, 2009). Lack of other bodies and reforms over exposed the banks. The policies of the bank countered each other. This gave no uniformity and to take a common path to come out of the global financial crisis was difficult. 3.3. Over reliance on the bull market Poor risk management by economies is also seen from the fact that the economies felt markets would never crash and continue to grow. The fact that economies even after receiving signals early on did not react to it and continued in the same manner shows negligence of corporate governance and over reliance on the bull market. The fact that economies were not ready for such a crisis shows their over reliance on the bull market and lack of practices to deal with a situation if a crisis happened. This shows lack of corporate governance to deal with matters (Fairfax, 2010). 3.4. Shortcoming on the management side Poor risk management is seen by the lack of policies at the organisational which was seen as a violence of corporate governance norm which led towards the crisis. The “shortcoming from the board and the internal management especially in the banking sector” (Kirkpatrick, 2009) highlights improper management policies and poor risk management. This shows the negligence on the part of the management to have a policy in store which could help to fight the worsening situation (Ryuhei, 2009). 3.5. Lack of backup plan The management did not have a backup plan to deal with the rising risk associated with investment and polices to combat those shows lack of management practices to deal with the situation in hand (Ryuhei, 2009). This was seen as a big factor which led to the downfall of many stock markets and economy as a whole. The lack of corporate governance practices to ensure that accountability is fixed led towards the collapse of the economies (Fairfax, 2010). This is a situation which highlights lack of risk management policies. It is evident as credit agencies were not hold accountable for providing wrong rating to different instruments. 3.6. Remuneration system which had inherent risk The remuneration paid to the executives was not based on performance. A problem seen was that “employees and executives were compensated while the organisation had not earned the profit” (Moxey & Priddy, 2008). This harmed the organisation as profits has not been realised and compensating the executives burdened the organisation. The market fell and organisation were not able to generate the same. This made organisation fail and made the effects of crisis look more devastating (Moxey & Priddy, 2008). 3.7. Lack of transparency The lack of transparency and not adhering to the corporate governance norm affected the organisation they were unable to mould the profits and this resulted in losses leading to a crisis (Judd, 2010). Also the fact that there was no mechanism to have a linkage between compensation and performance which made organization bears the brunt as they over compensated the employees (Moxey & Priddy, 2008). The organization based on the fact that economies were performing well had assumed the trend to continue which resulted in over estimating the employee payment leading towards a crisis. This was an act where corporate governance was not given weight age to which resulted in the crisis and failure of economies. The remuneration system also has a mechanism where bonuses were given in addition to the compensation package which affected the economies and was seen as a lack of corporate governance. A finding in European bank shows that the total salary was divided as 24% fixed salary, 36% cash bonuses and 40% incentives (Kirkpatrick, 2009). These incentives had no linkage with performance which affected the organization. They had to part more money to the employees then they actually deserved. This created a situation where corporate governance was neglected and only employees were considered as important (Kirkpatrick, 2009). 3.8. Lack of shareholding pattern Lack of shareholding pattern which is a perquisite for corporate governance was lacking in many organizations. The shareholding pattern of CEO’s was large compared to non-executive directors because there was no framework to decide the shareholding pattern. These had affected the distribution of remuneration as they started receiving more remuneration they should which led economies to bear the brunt during the crisis (McGrath, 2010). 3.9. Lack of disclosures Poor corporate governance on the disclosure aspect also led towards a crisis which grew as firms at the individual levels and big accounting firms failed to disclose their transactions (Mitton, 2001). The firms followed a principle where the risks were focused on few financial instruments rather than being diversified. This created a situation where risk multiplied manifold. Since, firms did not disclose their actual working and performance the effect of this was failures of institutions. This spread to other institutions and slowly the entire economy saw lack of corporate governance. This can be seen from the example of Enron which did not disclose all its transaction to the shareholders in the financial statement. Later when it was founded it resulted in the loss of public confidence (Austin, 2008). 3.10. Inefficient accounting policies The inefficient implementation of the accounting principles further gave organizations the freedom to use ways and measures to work in a manner which they felt suitable further led towards lack of governance and the crisis. This is a condition where organizations lack disclosure in their accounting methods. For example it is seen that certain quarters raised voice regarding the use of fair value accounting. Using the fair value accounting would have helped to ensure that the correct value of the assets would have been disclosed which would have reduced the effect of the crisis (Poskitt, 2005). This would have helped the investors and helped them to ensure proper mechanism to check risk. 3.11.Improper evaluation of assets Improper use of IAS 16 which with matters relating to the “treatment of assets, especially plant and equipment and property” (Deloitte, 2010) further made organisation not adheres to the accounting norms. It tries to explain how the non-current assets value will be found, situations when the assets need to be treated as long term, the treatment relating to deficiencies and surplus and impairment. This thus helps to “ascertain the correct value of the assets that will help the user of the financial statement gauge the correct value of the enterprises” (Deloitte, 2010). Lack of organisation effort on this part led towards poor implementation of the accounting policies. This also became a reason for the global crisis. 3.12. Lack of risk policies The risk management policies were lacking at each level. The banking, financial intuitions and other agencies over relied on the rating of the credit agencies which were flawed. This resulted in over estimating the actual conditions (Moxey & Priddy, 2008). Also the lack of instruments and the inefficiency of the instruments on the part of the different intuitions further aggravated the problem. The other problem seen was lack of transparency leading to poor corporate governance led to this problem. The agencies and institutions were not looking forward to tools and risk policies which could safeguard them even after the crisis broke out resulted in creating further problems (Moxey & Priddy, 2008). 3.13. Misguided information from the rating agencies The information provided by the credit agencies had a huge role to shape the global crisis. Credit agencies misused the power they had. Their role was to ensure that they provide correct information relating to the verification, and evaluation of the different instruments. (Austin, 2008) Instead, the agencies were taken aback as they provided incorrect information related to the investment avenues. This made different investors lose money and effected the entire set up of an economy leading to a crisis. The over reliance on this credit agencies misguided the investors. For example, in the US every market fund has to obtain a credit rating for their product. The market was booming and the credit agencies instead of concentrating on the fundamentals rates each market fund high. This resulted in incorrect information which finally got translated into a crisis (Austin, 2008). The verification processes from the agencies were missing which further complicated the matter and resulted in a crisis which was difficult to avert. Thus the inability to deal with the governance led towards a crisis. 5. Conclusion Economies thus need to lay stress to corporate governance and ensure that they have a strategy and policy in place which helps to improve corporate governance. To ensure that such a crisis doesn’t happens again corporate governance is an important aspect. Along with it special attention need to paid to strategies and monitoring process in all areas so that the performance improves and this will help to improve the efficiency of operations. Thus, corporate governance has become a vital tool for business. All agencies and society is looking at the different aspect the business works upon to ensure that they look for the well being of most. With various scandal and downturn it has become essential that business units focus on corporate governance. 6. 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