The Financial Crisis Inquiry Commission's report repeatedly identifies corporate governance failures as a causal factor in the crisis of 2007-2008. At page 19, for example, the report opines that:
We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.
It's probably the case that there were corporate governance breakdowns at some specific firms. Lehman and AIG spring to mind. On close examination, however, the evidence is hardly conclusive.
Yet, on close examination, the evidence turns up some very curious findings. First, the U.K.’s corporate governance regime is generally regarded as more shareholder empowering than is the U.S., which in the minds of many governance activists makes it superior. If governance failures were a key factor in the crisis, one thus would expect the U.K. to have been less susceptible than the U.S. Yet, the U.K. went through essentially the same financial crisis as the U.S. at about the same time. Accordingly, while governance practices “such as independent board chairs and ‘say on pay’ votes have been available to U.K. shareholders for years,” they apparently did “did little to prevent the crisis or mitigate its effects on the U.K. financial system.” Christopher M. Bruner, Corporate Governance in a Time of Crisis 25 (2010), http://ssrn.com/abstract=1617890.
Second, there is some evidence that corporate governance standards widely regarded as best practice were actually associated with poorer performance during the crisis. A study by USC business school professors Erkens, Hung, and Matos of 296 financial institutions in 30 countries found that board independence and high institutional investor ownership, which we’ll see in chapters that follow are usually assumed to be good practices, were associated with poor stock performance during the crisis. They further found that financial institutions with more independent boards were more likely to raise equity capital during the crisis, which ultimately resulted in a wealth transfer from shareholders to creditors. As for institutional ownership, higher levels thereof were associated with greater risk taking, which ultimately resulted in greater losses. David Erkens et al., Corporate Governance in the 2007-2008 Financial Crisis: Evidence from Financial Institutions Worldwide (Sept. 2010), http://ssrn.com/abstract=1397685.
A study by Beltratti and Stulz found no evidence that banks with higher scores on the Institutional Shareholder Services’ Corporate Governance Quotient performed better than lower-scoring firms. Beltratti and Stulz attributed the crisis to flawed bank capital structures, instead of corporate governance failures. Banks that relied on long-term sources of capital fared better than those that relied on short-term funding. Andrea Beltratti & Rene M. Stulz, Why did some banks perform better during the credit crisis? A Cross-Country Study of the Impact of Governance and Regulation (ECGI Finance Working Paper No. 254/2009), http://www.nber.org/papers/w15180.
We can draw a couple of important conclusions from this evidence. First, what constitutes good corporate governance depends on which constituency’s interests one is seeking to advance. Governance regimes that advantage shareholders may not be good for taxpayers. Yet, virtually all of the reforms mandated after the financial crises of the last decade were designed to empower shareholders. The risk thus is that the reforms may make the next crisis more likely and potentially more severe.
Second, one size does not fit all in corporate governance. The problems of Wall Street and Main Street are quite different and may require quite different solutions. Yet, the reforms of the last decade almost without exception are one size fits all mandates from which derogation by private ordering is not allowed.