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The role of corporate governance in the 2008 Financial Crisis

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Corporate governance links to the financial crisis

An EU-funded project based on earlier research on corporate governance and its regulatory implications studied the potential role of corporate governance in the financial crisis. It focused on whether the crisis could have been avoided or mitigated by appropriate incentives and monitoring mechanisms.

Industrial Technologies

The project CG&FC (The role of corporate governance in the 2008 financial crisis) selected three study areas. These covered the association between managerial risk-taking incentives and excessive risk-taking, the effect of corporate risk oversight on firm value, and the role of proxy advisory firms in the corporate governance process. Research underlined the important economic consequences of top executive compensation. The project developed a new measure of the risk-taking incentives introduced by managerial equity holdings. The study showed that risk-taking incentives can lead to undesirable behaviour, from both shareholder and societal perspectives. The findings offered evidence that equity portfolios provide managers with incentives to misreport. Furthermore, there was evidence for a link between externalities and the level of risk-taking incentives in the banking sector and that risk-taking incentives of bank managers played an important role in the financial crisis. The research also pointed to the importance of accounting for a firm's monitoring environment when evaluating the risk-taking incentives provided by a compensation contract. Another line of investigation showed that corporate governance follows economic principles and is consistent with the maximisation of shareholder value, as they benefit from stock option repricings around the financial crisis. However, the benefits of such changes were found to be lower among firms following the restrictive policies of proxy advisors. The consequences of corporate governance regulation, introduced as a result of the financial crisis during the post-crisis period, were also examined. The research underlined possible impacts of risk exposure on director turnover after the financial crisis. Similarly, post-crisis emphasis on risk management could come at the cost of lost director talent. Overall, project results point to compensation practices and other governance mechanisms shaping managerial behaviour. The research highlighted the importance of awareness of the trade-offs and spillovers of corporate governance regulation. Project results contribute to the ongoing debate on corporate governance in the field of academia and among market participants. More precisely, the research contributes to a better understanding of the economic consequences of corporate governance regulation on different issues and its potential role in the financial crisis.

Keywords

Corporate governance, financial crisis, incentives, monitoring mechanisms, CG&FC

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