Catastrophic Errors caused by Corporate Governance Failings

Andrew Haldane, Executive Director of Financial Stability at the Bank of England was recently interviewed by William Davies, Demos Associate and Research Fellow at Said Business School.  They discussed the causes of the financial crisis, trends in economic thinking, the financial system and policy responses.  Haldane talks about the mathematisation of the discipline of economics and is critical of the assumptions upon which many models are based, saying that many “made no intellectual sense.”

The part of the interview which I found most interesting was Haldane’s identification of corporate governance failings as a critical reason for what he calls “catastrophic errors” in decision making.  Haldane says that these problems are particularly acute in banking and financial institutions: 

this has led to a corporate governance structure in which those owning maybe 5% of the balance sheet – i.e. the shareholders – have the primary, some would say the exclusive, power in controlling the fortunes of the firm.  There is no say from the debt-holders or depositors or workers or any sense of the wider public good which we know to be important in banking and finance.  We also know that those firms are working on time horizons which in some cases are really quite short.  So to think that his will necessarily lead to the best outcome, even for the longer-term value of the firm, is questionable given the governance model.

He asks how corporate governance structures evolved into those which we see today: 

at each stage it was a sensible reason.  But it led to a corporate governance structure that looks pretty peculiar, given where we started off 150 years ago.  So what I mentioned about structures and incentives – an important thing about that is who runs the firm and how they run the firm.  I think that corporate governance in the way I’ve defined it is super important – more important than regulation in getting us into a better place.

So we have it from a director of our central bank: the reform of corporate governance is critical to the financial stability of our economic system, more important than regulation.