It’s all about governance in the end.
A career and a marriage ended in 25 seconds — that’s how long it took to force the resignation of Andy Byron, CEO of US data company Astronomer, valued at more than $1bn. Byron was captured on a big screen at a Coldplay concert in an intimate embrace with the company’s HR head, Kristin Cabot.
The directors, clearly mindful of their duty of care for the company’s reputation, placed Byron on leave and he soon tendered his resignation.
As the US business strategy and advisory service Growth Shuttle has commented, the Byron/Cabot brief encounter “serves as a powerful reminder of the delicate balance between personal conduct and professional responsibility. Their affectionate embrace … quickly escalated from a moment of joy to a significant headline, raising critical questions about corporate governance, ethical behaviour and the standards expected of leaders in the workplace.”
Parmi Natesan, CEO of the Institute of Directors in South Africa, has said: “It is for this reason that King 4 places so much emphasis on creating an ethical culture and mindset. When this mindset is present, individuals and companies will seek to act in the right way — even when nobody is looking — because they understand that to do so makes good business sense and reduces risk.”
Nothing can be taken for granted in governance.
For instance, how could a 160-year-old financial institution — the fourth-largest investment bank in the US, holding $639bn of assets and $613bn of liabilities, with a market value of about $45bn — collapse abruptly over a weekend?
That’s what happened to Lehman Brothers in 2008. The firm had been borrowing significant capital for many years to provide loans to those looking to buy real estate. It borrowed recklessly, and reached a point where its outstanding loans exceeded its available capital many times over. That meant it would be at risk of collapse if the housing market faced a downturn — which is exactly what happened. Lehman was the biggest casualty of what became known as the subprime mortgage crisis.
To disguise its risk from analysts and investors, the company had used repurchase agreements, “selling” its liabilities to banks in the Cayman Islands with a promise to buy them back at a later date. When the subprime crisis broke, Lehman could not repay its debt to those banks because clients were defaulting on their loans. Its exposure was so great that it could not borrow from the Federal Reserve Bank or renew its repurchase agreements.
Even the most rigorous governance policies … will be undermined if those running the company are prepared to behave illegally and unethically
More than 70% of the company’s value was destroyed in the first half of 2008, and Lehman was forced to file for bankruptcy later that year. As Yassine Bakkar of the UK-based think-tank Economics Observatory pointed out, the irony was that “just before filing for bankruptcy, Lehman was given investment-grade ratings by the big three independent ratings agencies. These ratings were reflected somehow in its share price and market capitalisation, which hit their highest levels ever in 2006.”
The reasons for the Lehman collapse are obvious: greed, reckless lending and deceit. The real question is why the executives were allowed to destroy the company. It came down to poor governance in several key areas, over a long time.
“In Lehman,” wrote Young Ah Kim in April 2016 in the Illinois Business Law Journal, “eight out of 10 directors met the independence standards of the New York Stock Exchange in 2006, but they lacked the financial expertise and failed to reliably monitor Lehman.”
The finance & risk committee at Lehman met just twice a year. Even if its members had known about the scale and nature of the repurchase transactions engineered by the firm’s executives, they either did not understand them, or failed to interrogate them in any useful detail. Or they simply turned a blind eye.
However, ignorance cannot be presented as mitigation. It is the duty of board members to take care to be informed, and to ask, in governance guru Mervyn King’s term, “the intellectually naive questions”.
“Lehman Brothers failed because the company was dominated by the CEO … Richard Fuld,” wrote advocate Chenoy Ceil. “Richard had full control over the company, and though several control mechanisms were put in place, the CEO never listened to his board of directors and followed the path to profit maximisation.”
According to Larry McDonald in his book A Colossal Failure of Common Sense, Fuld’s “smouldering envy” of Goldman Sachs and other Wall Street rivals led him to ignore warnings from Lehman executives. He would insist that the firm’s chief risk officer had to leave the boardroom during key discussions.
Jack Welch, CEO and chair of General Electric from 1981 to 2001, said: “Unfortunately, even boards with sound judgment didn’t stand much of a chance against the newfangled financial instruments that sparked the 2008 crisis.”
Even the most rigorous governance policies — with all the boxes ticked — will be undermined if those running the company are prepared to behave illegally and unethically. It is no excuse for a director to claim ignorance. They must constantly attempt to discover in detail what the company and its executives are doing.
It is interesting to speculate generally how executives and directors of businesses and state-owned companies (SOCs) in South Africa would behave if they knew they might at any time be caught out by the equivalent of the camera at the Coldplay concert — not only in their personal relationships, but in all their actions and statements.
And how different might certain South African companies and SOCs have looked today if there had been such scrutiny.
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