In July 2007, as once-giddy financial markets began sensing that something might be horribly wrong, the top executive of the then-largest financial-services firm in the United States justified his bank’s “party hearty” attitude toward risk. “When the music stops, in terms of liquidity, things will be complicated,” Citigroup’s Chairman and CEO Charles Prince told the Financial Times. “But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
This quote has become the emblematic aphorism of the economic crisis of 2008–09: a symbol of how some banking and financial-services executives justified their poor judgment and negligent (or even fraudulent) behavior. But it also reflects a more pernicious pathology — relevant to all the corporate crises we’ve seen recently in the oil, automobile, and financial-services industries, in which companies’ own missteps have been at least partially responsible for their woes. As one respected non-executive director of a rival top-tier U.S. money center bank noted in private conversation recently, “I still can’t believe Prince said that. If I had been one of his shareholders, I’d have been furious. Where was his board?”
Where was the board? Prince apparently believed that his boardroom overseers were comfortable with their bank dancing away on its shareholders’ behalf. And he had every reason to believe that, because his directors apparently never challenged the assumption.
This “Prince of the Citi” governance model is more a norm than an exception in business. For example, at most of the banks and financial-services companies that were severely affected by the downturn, their corporate boards had sat on the sidelines during the mid- to late 2000s, doing little or nothing demonstrably substantive to oversee or critique the risks that those companies took with financial instruments, leverage, and investments. Among bailed-out or failed companies in the U.S., from General Motors to Citigroup to AIG to Fannie Mae to Goldman Sachs, no boards or independent directors stand accused of illegally breaching their fiduciary charges. The same is true, at least so far, for BP, Toyota, and other companies whose operational missteps have led to massive litigation and losses. In all these cases, as far as the courts and regulators were concerned, the boards did their duty. They merely followed the law and the customs of the moment.
The passive board — which obeys the law but does not provide meaningful oversight — is a hindrance and handicap for any corporation. In accounting terms, its oversight is mere overhead. Even when boards are more active, their involvement tends to focus on pressuring CEOs for better financial performance; it’s not clear that they provide the needed function of overseeing risk and identifying questionable behavior. Conversely, the value of a well-managed board oversight role has never before been so apparent in facilitating a company’s own health and longevity.
If evidence is needed that boards aren’t playing enough of a risk management role, it can be found in an underappreciated analysis that was published just before the financial meltdown. “Shareholder Report on UBS’s Write-Downs” was an April 2008 report commissioned by the board of this top-tier Swiss bank to examine how it lost roughly US$40 billion in 2007. The assessments were damning; they charged senior UBS management with a “failure to demand holistic risk assessment,” a “failure to manage [its] agenda,” and a “lack of succession planning.” Additionally, the report excoriated the firm’s risk management controls and testing methodologies, asserting “complex and incomplete risk reporting,” “lack of substantive assessment,” “inadequate systems,” “lack of strategic coordination,” and “inability to accurately assess valuation risk on a timely basis.” As for the board, its processes also lacked accountability for evaluating the firm’s risk exposures, assessments, and management. In other words, according to the report, the UBS directors were as guilty as the management they ostensibly supervised of failing to confront risk.