Wednesday, July 11, 2012

The LIBOR Crisis and Corporate Governance

Whenever a corporate crisis erupts (a phenomenon all so common these days), questions quickly emerge regarding the role of governance (or failure thereof) at the companies involved. On a similar note, questions are being raised regarding the failure of board oversight, risk management systems and internal controls at banks such as Barclays that failed to curb manipulation in “fixing” the LIBOR rates. As this report by Reuters notes:
The lack of specific internal controls, particularly in reviewing email communications, was one of the failures cited by a Commodity Futures Trading Commission regulatory order implementing its share of the Barclays settlement. The CFTC said Barclays lacked daily supervision and periodic reviews that could have detected the interest rate manipulation. The order also accused the bank’s senior management of encouraging executives to submit lower rates than the bank was actually paying.
From a corporate governance perspective, this is a manifestation of the classic agency problem between managers and shareholders. While managers are incentivized through executive compensation (a large part of which is variable in nature), it is the shareholders who suffer in such episodes. Even in the Barclays settlement where the company agreed to pay hundreds of millions of dollars in fine, not only does that cause a dent in books of the company, but the resultant fall in stock price also further erodes shareholder value.
While some of the key managers were forced to vacate their positions with the company, negotiations were underway on the severance packages to be paid to them even though there were strong objections to payment of such significant sums of money. However, it has been reported that the former CEO of Barclays has forfeited his bonus but retained a year’s salary.
The repercussions of the LIBOR saga could be several, for both Barclays as well as the other banks involved. The immediate fallout could be lawsuits against the banks and their directors. The long-term implications could be reforms in governance norms that could become tighter, particularly with reference to executive pay. The UK has already initiated steps to insist on a binding shareholder vote for executive pay, as we have previously discussed, and such moves could receive further impetus in the light of the new developments. These are again classic instances of lawmaking in the wake of a crisis, which some commentators warn may be counterproductive and therefore ought to be avoided.


Badrinath Srinivasan said...

most of the international contracts which provide for interest rate link it to LIBOR. Now that LIBOR has been discredited (to an extent) it is interesting to see if a new index would become the next LIBOR.

V. Umakanth said...

@Badrinath. Thanks. In addition to the loss of credibility, the banks involved seem to be facing dire financial consequences as well ( As for a possible alternative index, it would depend on the manner in which the rate is determined by that system, and whether some of the deficiencies found in the LIBOR system can be purged.

DigitalAsian said...

With any new rate the problems will still exist unless the rate can be set independently of the banks.

V. Umakanth said...

The Economist has a discussion about the use of auction theory as an alternative to set the LIBOR.

Anonymous said...

The finding says, "The lack of specific internal controls, particularly in reviewing email communications, was one of the failures..............", shows importance of reading emails carefully.