An insignificant truth

Normally, the annual World Economic Forum (WEF) in Davos, Switzerland is a lush affair. This year, however, irony proved the underlying theme. With global markets collapsing, stripping billions from pension funds and placing tens of millions of people out of work, the tone of the world’s most powerful businessmen was a lot more austere. This was clearly demonstrated in the opening speech when Russian Prime Minister Vladimir Putin called for stronger international regulation while keeping a ‘concentration of surplus assets’ out of state hands.

To heighten the irony, at a gathering little followed in the corporate governance world, powerful forces were discussing the future of global corporate regulation.

‘Any group where CEOs fly on company jets to hobnob with other CEOs and celebrities would not be considered a wise use of shareholder assets,’ says Charles Elson, chair of the John Weinberg Center for Corporate Governance at the University of Delaware’s Lerner College of Business & Economics. ‘It’s an economic conference. The fact that I couldn’t tell you what happened there should tell you something.’

And that is true. Traditionally, Davos has not focused on corporate governance. In fact, the assembly did not heavily stress the topic. ‘It was acceptable but hardly specific,’ says Thomas Wajnert, a member of the boards of Reynolds American, NYFIX and UDR, and former chairman and CEO of AT&T Capital Corporation. ‘Asking about corporate governance, I didn’t see anything coming out of it. Whether our values will be forced to change remains to be seen.’

‘Governance is still somewhat arcane as a topic,’ says Hank Boerner, CEO of the Governance & Accountability Institute. ‘It’s not really a topic for the Davos glitterati. But if you look at the duty of care to the board, their responsibility to the real owners, you could say it is the number one thing that should be top of their minds.’

Speaking of change
Still, discussion happens, and that influences how countries approach regulation which, in turn, affects business. When times are tough, you never know what influence will be brought back home. And when major business and government leaders start discussing the place of values in business, you have to wonder how long corporate governance will stand in the wings. And given the global economic meltdown, the perception of corporations and the number of heads of state in attendance, the chance that discussions will have an impact on future policy-making seems high.

For example, the final communiqué was explicitly targeted at the April G20 summit. ‘The message is: You must continue to develop a swift, coordinated response to the most serious crisis since the 1930s,’ Boerner says. ‘How do we look at the existing international corporate governance structures and improve them?’

Some of the ranking attendees did make some suggestions. German Chancellor Andrea Merkel, for example, envisioned a global economic council modeled after the United Nations. Imagine calls for an additional global layer of corporation regulations, and suddenly a small ski resort in Switzerland seems to take on significantly more importance.

Of the many panels and formal discussions that took place at the WEF, few were specifically about governance. Some were, however, and for those who were too busy to keep track, we’ve provided a review of some of the more importance governance-related discussions.

What happened to the global economy?
For this brainstorming session focusing on economic failures, a group of WEP participants were divided among 20 tables, each with a discussion leader. The tables considered a series of questions and then wrote answers that were later entered into a database. The following are the questions and the answers that were most frequently cited:

What are the policy assumptions that created the most damage to the global economy? Answers: markets can self-regulate; availability to cheap money financing; economic literacy; good times last forever; putting regulation over ethics; high leverage is good; and China can save the rest of the world.

Which regulatory failures proved to deliver the largest systemic shocks? Answers: lack of international regulatory framework; non-regulation of leverage; inability to assess risks property; securitization of assets not adequately regulated; and misplaced trust and confidence in the credit
rating agencies.

What were genuine market failures? Answers: misquotation of risk valuation; misalignment of incentives and performance; governance failure; improper assessment and pricing of tail risk; failure of interbank lending; excessively complex financial instruments; and disregarding risk.

One overriding conclusion that was made clear during the many discussions that evolved during this session is that the world is moving toward more oversight and government regulation of markets.

The values behind market capitalism
Another governance-focused panel moderated by Maria Ramos, CEO of Transnet, included Tony Blair, former British Prime Minister, Stephen Green, chairman of HSBC, Indra Nooyi, chairman/CEO of PepsiCo, Shimon Peres, President of Israel, James Schiro, group executive and chairman, Zurich Financial Services, and Jim Wallis, editor-in-chief/CEO of Sojourners magazine.

Discussions began with a quote from Robert Reich’s  book Supercapitalism, which suggest that the difficulties the world faces are not caused by extraordinary individuals, good or bad, but by systemic problems. The values of capitalism can only be discussed in the context of humanity’s values and whether the world has the right institutions and right rules in place, with sufficient respect to adhere to those rules. Blair said the world needs to revive a concept of free enterprise ‘that is about enlightened self-interest and a stakeholder concept’ and in the new, globally integrated economy, the world needs ‘a globalization based on values, otherwise it will not be effective.’

Green focused on the more narrow issue of what happens inside financial institutions. He said that the problems are partly structural but also ‘about the values that had developed in the markets in recent years.’ He went on to explain that it is as if the financial sector has moved away from the underlying issues of right and wrong, to a theory that it is enough if something is legal and there is a contract for a transaction, so there is no need to think of anything else. But rules alone will not guarantee good behavior, nor will it guarantee the maintenance of values ‘essential to sustainable, flourishing capital markets.’

Shoring up the model
Nooyi stated that Main Street companies have been ‘tainted by the issues that have been created by the other Street.’ The worst thing would be to question the notion of capitalism. It works as long as the process of an economy generating a surplus is moderated by three elements: competition; personal morality and ethics; and regulation. When competition is tempered by ‘lack of transparency or obfuscation of facts,’ the result is greed. There is a fine line between fraud and poor judgment, but when personal morality and ethics fall apart, capitalism comes into question. The issue is how people comply with laws, not the laws themselves. Regulation can bring all this into balance. But when innovation gets ahead of regulation, there is a problem. And when regulators are not given the resources to keep up with innovation, the third check and balance is missing. Now is not the time to over-regulate, but rather to challenge corporations to examine their personal morality and ethics, and to perform with a sense of purpose, not just to satisfy short-term shareholder interests.

Peres expressed his belief that economies are a matter of concepts. He discussed how communism, in some cases, sought to substitute freedom for equality, but exaggerated the idea so much that in practice succeeded in removing both. Taking off from that view, he said that Henry Ford did better than Vladimir Lenin, by making customers out of workers. Social democracy is a wonderful idea, he continued, but it implies giving as much as possible, as quickly as possible, to people who are doing as little as possible. Looking at the different schools of thought, he considered that what might be necessary is to think more deeply, beyond the focus on how to distribute wealth to how to create it. That will depend more on ideas than just capital.

Schiro dismissed the approach of questioning when the current crisis will end. Instead, he asked how the crisis will change the way we think, the way we make decisions, habits of the heart and the ways in which we do business. ‘This is a structural crisis, but it’s also a spiritual crisis,’ he said. ‘It calls for social regulation … but also a new kind of, perhaps, self-regulation. We have trusted the invisible hand so much that we have forgotten to bring virtue to bear on our decisions, so the invisible hand has let go of some important things, like the common good.’

Wallis felt the debate shouldn’t be over values at all, but over delivering on the promises made by the values. The issue is having disappointed people and losing trust, credibility and reputation. ‘I don’t think you can look and say it’s the business community, it’s government, it’s the NGOs. We all have to say we apologize. … We do need critically at this point of time government intervention to stabilize the situation. The danger that we have at the end of the day is that we get to the point of not knowing how to extricate ourselves from so much regulation and government institutions.’

Reviving economic growth
Another panel included Gordon Brown, Prime Minister of Britain, Felipe Calderon, President of Mexico, Han Seung-Soo, Prime Minister of South Korea, Kgalema Motlanthe, President of South Africa, and Fareed Zakaria, editor of Newsweek International.

Zakaria asked if the crisis was at least ‘at the end of the beginning.’ Brown believed it depends on the level of international cooperation, because, he said, ‘there is no one country that can solve this crisis on its own.’ The problem has become even worse because of the way it has been dealt with over the last few months. ‘This is a crisis not just of credit, but of trust in our financial institutions,’ he added. Stopping banks from collapsing was only the first stage. The second stage is monetary stimulus. The current stage we’re in is a resumption of lending, and we’re taking note of the fact that the old methods do not necessarily work. ‘We’ve got to rebuild the financial system,’ continued Brown. ‘We cannot reward or condone irresponsible risk-taking and excessive risk-taking, which has been what has happened in the past. The values that underlie our markets are important as well.’

Been there, done that
Zakaria asked what lessons the world could learn from Mexico’s crisis in the early 1990s. Calderon answered that firstly, it is important to bring ‘a sense of urgency to clean the banking system.’ The second thing that needs to be attended to are the bad bank assets, he added, admitting that required the ‘right incentives in order to recover in time the real values.’ Thirdly, he concluded, risk and accountability must be allocated carefully among stockholders, bankers, creditors and governments. In addition, counter-cyclical fiscal and monetary policies, like public spending, need to be generated.

Addressing another tumultuous scenario, Zakaria noted the irony in the US response to the Asian financial crisis in the late 1990s when American policy makers advised countries not to prop up bad banks, to keep interest rates high and not to spend a lot of money. Western nations have now done just the opposite. Han said that South Korea took ‘medicine [that] was very bitter’ to restructure the financial sector, adding that whatever actions a country takes must be ‘fast, decisive and sufficient.’ The country created a national bad bank to hold the toxic assets. The process, though, in the long run, strengthened the country’s financial system. Zakaria asked if western countries should avoid the attempt at a ‘painless recovery,’ to which Han responded that he believed that there is always pain because the funds to restructure come out of people’s pockets in the form of higher taxes.

Brown said that the UK recognizes that it will have to spend more over the next couple of years in areas where markets don’t bounce back immediately, but at the same time has set out a path to fiscal sustainability relying on taxes and spending. In his view, some demands by the International Monetary Fund (IMF) during the Asian crisis were wrong. Conditions are significantly different today, he explained, because at the time of the Asian crisis there was a global economic expansion, not the current contraction. More international cooperation is necessary, he stressed, otherwise there is the risk of a ‘de-globalization’ of the economy, which is why the G20 will play an important part in the attempt to recover global markets.

Calderon agreed with Brown’s assessment, and added that the US became an epicenter of the crisis because of a consistent lack of leadership. He also said that it’s not just the banks, but multinational institutions such as the World Bank and IMF that need recapitalization.

Some attendees expressed hope, however. Motlanthe, for one, said that Barack Obama is a ‘breath of fresh air’ in terms of making positive attempts to fix the crisis.

In conclusion, Zakaria questioned if it were possible to have global governance without super-national bodies resented by the people. Brown responded by saying that people understand that the global nature of current economic and financial problems extends beyond the scope of national regulatory bodies. ‘It cannot work when you have cross-border activities and nobody quite knows what’s happening. I think people are realizing that the international cooperation that we’re talking about is essential.’ The problem, he continued, is that institutions were ‘built in the 1940s for sheltered economies, for limited competition, for national, not global, flows of capital.’ In summary, he said that the single most important change would be to create a system that can take action earlier to prevent collapse and get lending moving again, but that it is too late for such a system to help now.

Without action, though, protectionist tendencies might come into play.