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What Boards Have Learned From the Financial Crisis

There is no one lesson  that has been learned from the financial crisis. Instead, the crisis has reiterated long-standing principles for boards and financial companies:  the importance for boards in exercising prudence and judgement, the  importance of diversification, the fleeting nature of liquidity, the importance of understanding the complex risks and products of modern global finance, and the risks associated with concentration.

But beyond reinforcing these principles, the financial crisis elevated certain concerns for boards to new levels of prominence: the forms and capacity of internal risk management, the issue of remuneration and executive compensation including its relationship to different types of risk, and the diversification of boards including how capable boards are in dealing with highly technical issues of global finance.

With these issues in focus, there is good reason -for boards and shareholders alike- to be concerned that risk management has become more of a “box-ticking exercise” than a sophisticated management strategy where managers and boards exercise their judgement through meaningful dialogue and discussion about complicated macro- and micro-economic risks. If boards learn something from the financial crisis it should be that risk management requires more resources and sophistication than a procedural and pro forma “box-ticking” exercise.

Boards should also be concerned about how remuneration policies- at least at some firms- may be out of line with shareholder interests. While some directors believe that the issue of executive compensation is a red herring which does not create risks for financial firms, others rightly express concerns that excessive and non-transparent compensation policies can create both systemic risks for the financial system as well as reputational risks for  firms. In attempt to improve compensation policies, boards should acknowledge and consider some of the “new” approaches or policies that some financial firms are using: holdback, vesting and other incentives.

Another potential lesson for boards is the importance of building diversified boards while maintaining the technical skills and capacity to oversee complex financial management issues. If managed and adopted skillfully, board diversification is an important strategy in creating more effective and informed boards. In addition to board diversification, boards should also be aware of and consider other means of institutional improvement including: promoting independent directors, limiting or eliminating “insiders”, ensuring that boards have more opportunities for and expectations of engaging with employees and shareholders, the use of board representatives within the company, and increased remuneration for directors so that there are incentives to spend more time on board responsibilities.

Despite the dramatic nature of the recent global financial crisis, there is also reasons to be concerned that very little had really changed in the way boards operate, including financial firms. The danger for these firms- and for the economy as a whole- is that the opportunity for reform and improvement will evaporates without any meaningful changes having been implemented. And, in order to target the most meaningful changes and reforms that are needed, we require a much better understanding of the things that went wrong during the financial crisis. Rather than moving toward “knee-jerk” reactions proposed by either firms or regulators, everyone should take the time and allocate the resources to better understand the problems and the types of firm-level and policy reforms that will be helpful in either preventing or mitigating future crises. Perhaps the biggest concern for us all is that the time, resources and level of introspection necessary for meaningful organizational and regulatory reform have faded away as impossibilities in the modern architecture of global finance and the cynical underworld of realpolitik.

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