Corporate Governance Failure in The Lehman Brothers Case
Corporate Governance Failure in The Lehman Brothers Case
Corporate Governance Failure in The Lehman Brothers Case
Essay
Simona Tothova 2
Essay
informed basis, in best interest and fairly to the company and shareholders. They should apply high
ethical standards and should be able to exercise objective independent judgment on corporate affairs.
Moreover, they supposed to fulfill several functions including reviewing and guiding corporate strategy,
risk policy budgets and business plans. Board should also monitor the effectiveness and manage
potential conflicts of interest as well as oversee the process of disclosure.
Lehman Brothers Board of Directors was composed of ten members. The Chairman and CEO was Richard
S. Fuld, Jr. and included eight independent directors according to NYSE. However, behind all of that
there was a fact, that nine out of 10 directors were retired. Moreover, their average age were 68.4 years
(four of them were over 75 years), only two of them have direct experience in financial service industry
and only one of them had current financial sector knowledge. In addition, one was U.S. Navy officer,
another theatrical producer. Pointless is also the fact, that indeed board members should be
independent and suppose to take care of the corporation, they cannot do it very precisely. Especially
not, when they are for instance director of Weight Watchers International, as well as chairman of
Lehmans governance and nominating committee and a member of the compensation, finance and risk
committee at the same time (e.g. Marsha Johnsons Evans). At the end of this section, we also cannot
forget to mention, that Lehman Brothers board members were paid for their services extremely well,
since the range was from $325 000 to $397 000 plus very high every year bonuses. However, this hasnt
been enough to Mr. Fuld who rewarded his self with nearly half a billion dollars between 1993 and 2007.
Simona Tothova 3
Essay
aggressive growth strategy to overcome their problems. During this period they developed exposures to
risky subprime lending, structured products, commercial real estate and high-risk lending for leveraged
buyouts, but they have not considered enough that these loans were less liquid that its usual
investments and had more vague prospects. Further, according to the Valukas raport, they exceeded
internal risk limits and controls to pursuit higher earnings, what was the start of the end.
Valukas report (report composed by court-appointed investigator of bankruptcy of Lehman Brothers,
Anton Valukas) further stipulates that there is evidence that top officers of Lehman Brothers Company
(including the Chief Executive) violated their duties by exposing the company to potential liability by
filling misleading reports and financial statements. The specialty of Lehman Brothers misleading
transactions was Repo 105 through which company could remove billions of liabilities off the balance
sheet. The existence and misuse of the Repo 105 is very questionable and goes beyond corporate
governance, concerning from accounting to legal issues of its use. In following sections we will explore
Repo transactions, their advantages, disadvantages and ways of misuse.
Repo operations
Repo (sale and repossession) operations transform a financing transaction into an asset disposal. They
started to be used in the 20th century for legitimate purpose. They were used for money making by
lending, circulating and investing it. Usually financial institutions borrow funds using securities as
collateral. Imagine that financial institution has securities for $ 102, it will borrow $ 100 from another
institution presenting the securities as a guarantee for the short-term loan. The difference ($ 2) is a
haircut price for the liquidity and risk of the bond. In these operations collateral (treasuries) stays on
the borrowers books, cash increases the banks balance sheet (as if asset were duplicated) and liability
arises from the borrowed amount. At the maturity of the repo, the borrower gets the securities back if
he returns the cash plus interest.
Another use of repo is as an asset disposal. Financial institution first sells a security for a price and then
buys similar security and gets the returns on the cash invested during that period. However, this
transaction is little bit problematic since the security can be sold at a discounted price (if nobody wants
those assets or market is not liquid) and there is no guarantee that the security will be repurchased for
the favorable price. On the other hand, financial institution may, by this method, raise capital which can
be used to reduce its leverage.
Simona Tothova 4
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Simona Tothova 5
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Conclusion
The fact is that on September 15, 2008, Lehman Brothers filed for bankruptcy. And it wasnt the first big
international company (also not the last one) who ended under the Chapter 11. We can for example
point out the Enron bankruptcy from 2001, which is (maybe) accidently very similar to Lehman Brothers
case. But why we have the old pattern here again? My personal opinion is that the reason is in the weak
corporate governance arrangements in the company and in the fact that corporate governance
principles are not under the root of law. In the Lehman Brothers weak corporate governance
arrangements allowed officers to find the way how to accumulate unearned profit and specifically
increase their personal wealth.
In my opinion, there is no problem in the context of OECD principles since they arch over all problems
discussed in this work. OECD principles specifically say that the corporate governance framework should
ensure:
1. The strategic guidance of the company, the effective monitoring of management by the board,
and the boards accountability to the company and the shareholders
2. That timely and accurate disclosure is made on all material matters regarding the corporation,
including the financial situation, performance, ownership, and governance of the company
3. That an annual audit is conducted by an independent, competent and qualified auditor in order
to provide an external and objective assurance to the board and shareholders that the financial
statements fairly represent the financial position and performance of the company in all material
respects.
As you can see above, if all of these points were fulfilled as is stated in the principles, the Lehman
Brothers company would probably not have to be under the Chapter 11. However, there are several
problems. First of all, Lehman Brothers had very weak corporate governance arrangements and officers
were not forced to fulfill the principles. Good instance is a situation in their board of directors. Secondly,
the most important issue is why companies should abide the OECD principles, if there are no
consequences of breaking them. I think that until the corporate governance framework will not be under
the law, these cases will arise. Moreover, problems are also in the matter, that there are crucial
differences between the law systems. As we could see, Lehman Brothers could not use Repo 105 in the
U.S., but they were allowed to do it in UK and manipulate their financial situation.
Simona Tothova 6
Essay
From nature, people are very inventive and they always look for means how to increase their personal
wealth. There will always be a group of people which goes beyond the principles as far as the law
permits and who will look for the opportunities to overpass the law. To conclude, I would see the key
issue in setting the system in the way, in which it will minimize opportunities of these speculators and
therefore minimize the failures of corporate governance.
References
1. http://www.oecd.org/dataoecd/32/18/31557724.pdf
2. http://ftalphaville.ft.com/blog/2010/03/12/173241/repo-105/
3. http://www.oecd.org/dataoecd/32/1/42229620.pdf
4. http://www.jenner.com/lehman/docs/debtors/LBEX-DOCID%20384020.pdf
5. http://www.imd.org/research/challenges/TC039-10.cfm
6. http://rmi.nus.edu.sg/aboutus/enewsletterrmi/issue3/MarketReviewRepo105(edited).html
7. http://globalinvestmentwatch.com/americas-most-wanted-the-lehman-brothers-board-ofdirectors/
8. http://beginnersinvest.about.com/cs/a/aa2203a.htm
9. http://www.fide.org.my/publications/articles/0013_OECD.pdf
10. http://www.slideshare.net/adnanqatinah1/lehman-brothers-case-study2
11. http://www.lehman.com/
12. http://jenner.com/lehman/