Good Honest Dollar $$

In today’s global banking environment, the adoption of effective corporate governance practices is essential in order to maintain the trust and confidence of the global investment community, and executives who fail to live up to required standards should not be allowed to continue in their positions.

Nevertheless, as a small shareholder in Australia’s largest bank, the Commonwealth Bank of Australia, I do not support calls for heads to roll (this time) in spite of a recent debacle involving a botched capital raising initiative.

Instead, the fiasco (see below) should be considered a ‘strike one,’ against senior management, who should be put on notice that marching orders will be given in the event of any recurrence of this type of drama.

 
The fiasco
The fiasco in question centers around a share placement scheme which took place on December 16 as part of a capital raising initiative.

The placement, which was geared toward large institutional investors who were offered the opportunity to purchase shares in the bank at a discounted price, took place during a two hour time period that afternoon.

That same evening, just one hour after closure of the placement, the bank announced a profit warning due to an upward revision in the estimates relating to the provision for bad and doubtful debts, which were now expected to cost the bank between $400-800 million Australian dollars (USD $2.72-5.44 million) more than previously anticipated in the current financial year.

Apparently, the bank had intended the revised estimates to be disclosed during the share placement process, but Merrill Lynch, who conducted the placement on the bank’s behalf, neglected to make such a disclosure.

Accordingly, participating institutions had no information with respect to these estimates when making decisions regarding their level of participation.

 
Understandable anger
Unsurprisingly, institutional investors were livid. Their fury is well justified, and calls for the dismissal of the bank’s Chief Executive Officer and Chief Financial Officer are more than understandable, though I do not agree with such calls at this point.

CBA had a duty of care to ensure that investors who participated in the placement were properly informed about any information which was material with respect to their investment decisions.

This included the revised estimates, and failure to ensure that participating investors were informed about these estimates raises serious questions about the bank’s corporate governance practices.

 
A feeble response
Equally unacceptable was the response of the bank, which blamed Merrill Lynch (who conducted the placement on the bank’s behalf) for the fiasco and claimed that in any event, the revised estimates were immaterial with respect to the placement.

These lame excuses are preposterous. However negligent Merrill may have been, the underlying responsibility to ensure that investors were properly informed rested with CBA, and no amount of misconduct from Merrill absolves the bank of this responsibility.

As for the claim about the revised estimates being immaterial, this sounds ludicrous given that the following day saw analysts slash earnings forecast and the share price plummet by twelve per cent.

Management should stop making feeble excuses and acknowledge responsibility for this farcical situation.

 
The case for heads to roll
I have no doubt that neither Ralph Norris (CEO) or David Craig (CFO) intentionally left investors uniformed, and I do not question the integrity of either.

Nevertheless, there is a reasonable case for dismissal of both.

A key priority for the bank going forward will be to work toward regaining the confidence and trust of the global investment community, and this process may well be hindered so long as those responsible for the fiasco remain in senior positions.

Moreover, the cloud now hanging over the head of both is almost certain to provide an unwanted distraction from key priority management issues. Such a distraction is likely to hinder their ability to function effectively in their roles.

Both of these reasons provide a reasonable justification for a fresh start going forward, with new management whose reputation is unaffected by the recent fiasco.

 
The most important consideration
However, notwithstanding the seriousness of the fiasco, I do not believe that these events in themselves provide sufficient justification for heads to roll on an automatic basis.

Instead, the board must make an assessment as to whether or not they retain confidence in the leadership team in light of the fiasco, with dismissals only being necessary if the board feels that it has lost confidence in the ability of management to deliver acceptable results going forward.

To be sure, the importance of perceptions within the global investment community cannot be overstated, and these add considerable weight to the case for heads to roll.

But even more important is the degree of confidence which the board retains in management to deliver results going forward, and this should be the primary consideration in determining whether or not dismissals are necessary in light of the current fiasco.

 
Strike one
That said, the fiasco was a serious affair, and at very least, senior management should be put on notice that severe consequences will result if other such debacles reoccur.

Strike one – three strikes and Mr. Norris and Mr. Craig should be sent on their way.

Contrary to the opinions expressed from certain quarters within the business world, the U.S. government is right on the money in seeking to place limits upon executive compensation in firms who receive government assistance as part any bailout of financial institutions.

American taxpayers should not have to subsidize mass exit packages for executives whose firms have failed to deliver acceptable results.

An in-depth examination of specific proposals is beyond the scope of this discussion. However, I do wish to comment today on the general issue of whether the American Congress should seek to intervene in relation to executive compensation at firms which participate in any taxpayer-funded bailout.

  
Generally, the government should stay out of it …
In general, governments should not intervene in the process of determining appropriate compensation arrangements for executives in private sector firms.

The process of determining fair and appropriate structures for executive remuneration is extremely complex, and a high degree of flexibility is required for corporate boards, acting on behalf of shareholders, and the executives concerned to negotiate compensation packages which are appropriate in the context of the individual firm concerned.

Governments are in no position to intervene in this process. Indeed, any significant level of government intervention would most likely entail unintended consequences, and could, in many cases, be detrimental to the objective of achieving reasonable and fair compensation arrangements. This is particularly the case particularly if the intervention resulted in an overly prescriptive, one size fits all approach.

Moreover, any intervention should be limited strictly to firms participating in the bailout. Under no circumstances should it apply to any other firms. Nor should it be used as part of any wider plan to increase the level of government intervention in relation to the broader issue of executive compensation structures.

  
… but not when taxpayer money is involved
But things are different where taxpayer money is involved.

Governments, as custodians of taxpayer funds, are obligated to ensure that such funds are allocated in an appropriate manner. Support for the financial system may or may not be an appropriate use for taxpayer funds, but the payment of grossly excessive compensation packages is not.

Wall Street should accept this. Taxpayer bailouts should, and do, involve consequences. One such consequence is a significant increase in the importance of the general public as a key stakeholder, and this necessitates a much greater degree of public scrutiny and accountability. This includes the area of executive compensation, which must not exceed levels which are considered to be fair and appropriate from a public viewpoint.

Firms cannot expect taxpayer help without accepting the associated consequences.

To be fair, I have no doubt that each of the individual executives concerned devoted considerable effort toward their employment responsibilities. But compensation should be proportional to outcomes, and given the extent to which negative outcomes have had an adverse impact on American taxpayers, limits on compensation are more than fair.

  
In short
In cases where firms receive taxpayer assistance as part of any Wall Street bailouts, sensible government intervention to prevent excessive remuneration is justified.

American taxpayers should not fund mass exit packages at firms which have failed to deliver acceptable financial outcomes.

Despite being convicted last year on charges of embezzlement and raising a slush fund to bribe government officials, Hyundai chairman Chung Moon Ko will not serve any prison time.

Mr. Chung’s initial punishment was a three year suspended sentence. But even that was overturned in August when he, along with approximately 340,000 other South Koreans who had been convicted of criminal offences, received a presidential pardon from South Korean president Lee Myung Bak.

This pardon should not have been granted – at least not for business people.

Under the terms of the pardon, which was granted last month on the day marking freedom from Japanese colonialism, the affected individuals will be cleared of their relevant crimes, and will suffer no further punishment in respect of those crimes.

The majority of the crimes involved relatively minor offences, such as traffic related offences. According to my understanding, the pardon for these people was intended principally as a symbolic gesture of national forgiveness.

I see no problem with this – there is too little forgiveness in the world as it is.

But the pardon also covered 74 influential business people, convicted of serious offences such as fraud, bribery, assault and kidnapping (refer article). Along with Mr. Chung, these people included Kim Seung Youn, a tycoon who boasted about how he and his bodyguards physically assaulted staff at a bar after his son was injured in a scuffle. Also pardoned was Chey Tae-won of SK Group, a telecommunications, oil refining and construction conglomerate, convicted in 2003 of illegal share swaps designed to maintain family control of the group.

 
Flawed economics
According to media reports, the inclusion of these men was not merely a symbolic gesture of forgiveness. Instead, it was bought about by a different, and highly flawed, rationale – economic grounds.

From the viewpoint of the government, these people are leaders and entrepreneurs, and their imprisonment was a hindrance to the economy.

I cannot agree. Aside from being unjust, the idea that those who have been convicted of criminal offenses are needed to stimulate the economy simply defies all forms of logic.

On the contrary, the pardon will have a detrimental effect on Korea’s economy, primarily by reinforcing the country’s poor reputation in terms of corporate governance.

 
Reinforcing poor corporate governance
For many years, South Korea has suffered from a poor reputation in relation to corporate governance, which has inhibited the country’s ability to attract investment.

The Korean economy is dominated by chaebols – large corporate conglomerates who wield a considerable degree of political and economic influence. Although shares of many of these entities are listed on the local stock exchange, they are typically controlled by wealthy and well connected families, the behavior of many of which often reflects a negligible degree of corporate accountability and scant regard for issues such as legal compliance, corporate governance or minority shareholder rights. Cases involving practices such as bribery of government officials or stock manipulation are not uncommon.

Why are these practices so common? One reason is that they get away with it. The government has in the past shown a considerable degree of reluctance to hold key business people to account, fearing that heavy handed action would be detrimental to the economy.

But instead, allowing poor governance practices to go unchecked has in itself had a detrimental economic impact. It has created an environment which is not conducive to attracting investment, causing some foreign companies to think twice about job creating investment projects in Korea. It has also inhibited competition in industries where the chaebol are operative, largely to the detriment of consumers.

Dramatic improvements in corporate governance practices are crucial if Korea is to reach its full economic potential, let alone achieve its stated goal of becoming a financial hub within North East Asia.

But corporate governance will not improve as long as criminal behavior goes unpunished.