Management and the financial crisis

The financial crisis of 2008-9 has revealed that our broad model of corporate governance is broken, independent of the shortcomings in the regulatory system. Managers and boards of directors in scores of systemically important firms failed to protect employees, customers, or shareholders, and placed the global financial system at risk. I assert that the root cause of the crisis can be found in five related systems: incentives; risk management and control; accounting; human capital; and culture. The worst firms had lethal combinations of strong incentives, weak control and risk management, flawed internal and external accounting, low skill and/or low integrity people, and corrosive cultures. Piecemeal attempts to fix elements of corporate governance will fail. The problem, to illustrate, is not just the structure of compensation. Nor will increasing required capital prevent problems at companies with strong incentives and weak controls. I believe that we may need a new kind of external agency for systemically risky firms that would take a holistic look at the five systems to identify weaknesses, make recommendations to managers and boards, and set regulatory policies, including assessing charges for insuring against losses. Without such a comprehensive assessment and improvement plan, boards cannot do their jobs, and the system will remain as subject to calamitous events as it was before the crisis.