Corporate Governance and Business Ethics

Order Description

This is a topic on corporate governance and business ethics.

The aim of this coursework is to test your understanding of the application of corporate governance and ethical issues and application to business situation and your ability to select relevant information and present arguments in clear and logical manner. It also aims to test your ability to relate a case scenario to appropriate regulatory requirements and make an initial evaluation and provide recommendations.
Read the provided case study below carefully. Then consider the questions provided at the end of the article when preparing for your presentation and writing your report. You are required to discuss the main reasons behind the failures of RBS and to explain to what extent the practices that were followed (governance and ethical) were responsible for these failures. Finally, you need to explain how this failure could be avoided.
In presenting and writing this report you can use information and references (preferably academic ones with implications for corporate governance and business ethics) that are relevant to the case study (RBS). The assessment of the coursework will depend on to what extent you’ll manage to integrate the corporate governance and ethical principles and practices into your analysis for the case study (RBS).

Royal Bank of Scotland (RBS)

The Royal Bank of Scotland was an ancient institution with roots in the 18th century. Under the recent leadership of Chief Executive Sir Fred Goodwin, the company pursued a growth and acquisition strategy. The board, chaired by Sir Tom McKillop, accepted their Chief Executive’s growth strategy, which included the acquisition of National Westminster Bank in 2000, when Sir Fred axed some 18,000 jobs, earning himself the in-house title of ‘Fred the Shred’. But subsequent investments in American sub-prime loans and the acquisition of Dutch Bank ABN Amro for £10 billion in 2007, proved disastrous. Although, it should be said that the acquisition of ABN Amro had a bright side: the group included Hoare Govett: one of the City of London’s most successful brokers

In 2007, the market valued the bank at some £75 billion (£6.02 a share). But by early 2009, the value had fallen to less than £5 billion (10p a share), even though it had received at least £37 billion from the British government in October 2008. Subsequently, the government provided more funds to keep the bank afloat, taking its equity stake to 58%. The government also agreed to guarantee some £325 billion of RBS’s toxic loans in a government-backed insurance scheme. In February 2009, RBS reported a loss of £24 billion – a record for the UK.

Sir Fred Goodwin, 50, was described by friends as modest man, without airs and graces, and a strong sense of responsibility. He was a close ally of British Prime Minister Gordon Brown. But another perspective suggested extravagance, mentioning the Falcon 900 executive jet, with a car park space close by to save him walking far, and office wallpaper at £1000 a roll. Matthew Oakeshott, a member of the UK Treasury Select Committee, which grilled Sir Fred, said that the profligacy reminded him of Enron and that the waste and greed “would shame a medieval monarch”. “The auditors and non-executive directors,” he added, “were well-fed lapdogs round the throne” . Sir Fred resigned in November 2008, and was replaced by Stephen Hester.

But anger at Sir Fred’s retirement package, which included a pension equivalent to £703,000 a year for life, raised huge public ire with cries of “reward for failure”, “the British tax-payer pays him £15,000 a week, whilst shareholders lose their savings and employees their livelihood”, continued to reverberate. As a Times leader wrote: “It is a public scandal that, while his business decisions have incurred immense social costs, his compensation packages confer huge personal benefits.”

Another key player in the RBS saga was Lord Myners, the government Minister responsible for orchestrating the RBS rescue. Myners, who had significant experience in finance and had written a report on corporate governance, was a key figure in prime-minister Gordon Brown’s economic revival team. But his agreement to Sir Fred’s bonus led to calls for his resignation. He was also criticized by a UK Treasury Select Committee for failing to check the extent of Sir Fred’s pension rights, apparently leaving the details to the RBS chairman and remuneration committee. It was subsequently claimed that he had misled MPs about Sir Fred’s pension. Further criticism of Myners followed his promotion of a government plan to wage war on tax avoidance through overseas tax havens, when it was disclosed that until 2007, Myners had been chairman of Aspen Insurance Holdings, a company operating out of the Bermuda tax haven.

The collapse of RBS proved a catastrophe for the bank’s former chief executive, chairman, and directors, particularly the independent outside directors. Class actions were launched by disgruntled pension funds, private investors, and various shareholder representative bodies, including the pension funds of local councils in the UK and state public employee pension funds in the United States. Actions were brought in US courts, which are typically cheaper and more flexible than UK procedures, and avoid the danger of being awarded the other parties’ costs. These actions sought compensation for the losses alleged to have resulted from the actions of RBS, Sir Fred, and other directors who falsely assured investors about the bank’s financial health. In addition to civil claims for damages, investigations by the financial regulators could lead to criminal charges

The RBS case highlighted the roles of the chairman of the board and independent non-executive directors in monitoring, and if necessary challenging, executive management. After all, the non-executives were well-respected businessmen including Peter Sutherland (the Chairman of BP and Goldman Sachs) and Sir Steve Robson (a former Treasury top civil servant). It has been suggested that Sir Fred wielded considerable power over the board. Some suggest that there may have been an element of complacency; others allege that some outside directors might have been intimidated by threats to their re-appointment if they failed to concur with management.

The role of the UK financial regulatory system also came under the spotlight in the RBS case. Prior to the financial reforms introduced by Tony Blair’s new-labour government, and led by Gordon Brown who was then Chancellor of the Exchequer, the Bank of England supervised and regulated British banks. This role was passed to the newly created Financial Services Authority, who seemed unable to withstand industry pressures. For example, some RBS institutional investors wanted to vote Sir Fred out, but found that directors’ re-appointments were staggered and his renewal was not due for some years. So they proposed a shareholder motion that all directors should stand for re-election at the same time. This proposal was blocked by the Financial Services Authority. The Treasury Select Committee commented that the FSA was “responsible for supervising ten big banks and allowing five of them to collapse.”

RBS Remuneration Committee report 2009
The 2009 RBS Remuneration Committee report, which included Sir Fred’s £700,000 a year pension, was rejected by 90% of shareholders voting at the AGM. Questions about the remuneration of Stephen Hester, the chief executive who had replaced Sir Fred, also emerged. PIRC, an institutional shareholder lobby group, called for the remuneration committee report to be rejected, alleging excessive pay awards and insufficient disclosure of the related performance targets. Standard Life, a major institutional investor, complained about rewards that relied solely on share price movements.

Hester was paid a salary of around £12 million, plus a bonus tied to a rolling three-year incentive plan over 2010 – 2012, based on share price performance. In the light of public criticism, Hester waived his right to £16 million bonus for 2009. In April 2010, RBS chairman, Sir Philip Hampton, admitted to shareholders that the bonus scheme had priced the share options too low. In future the company would consult with leading investors and UK Financial Investments, the organization formed to oversee the UK Government’s stake in RBS.

The Financial Services Authority (FSA)
The FSA was set up by the UK’s labour government under Prime Minister Gordon Brown and Chancellor of the Exchequer Ed Balls. The Bank of England was stripped of its previous powers to regulate the financial sector. The regulator, with offices in Canary Wharf (nicknamed ‘Wall Street on Thames) was separated from the day-to-day operations in the City money markets. The government’s intention was to regulate the financial sector ‘with a light touch’, in the belief that the classical ‘boom and bust’ economic cycles had been overcome. It proved to be a disastrous policy.

Following the collapse and government bail-out of RBS, the FSA launched an inquiry. Its report went unpublished for two years. Sir Fred’s lawyers sought changes and in the final report Sir Fred was mentioned only twelve times. He, along with the chairman Sir Tom McKillop, and other board members escaped censure or any punishment.

Under pressure from the media, the House of Commons Treasury Select Committee, and the newly-elected coalition government the report was finally released in 2011. It laid bare a raft of management shortcomings, including excessive risk taking and disastrous unrecognized bad-debts. Sir Fred’s domineering management style had apparently been recognized as a risk much earlier. Incompetent due diligence in the take-over of Dutch bank ABN Amro led the FSA chairman, Lord Turner, to write in the foreword to the report: “the RBS board had done due diligence amounting to two lever-arch files and a CD on the £49 billion deal that made the British banking system’s legs buckle.” .

The former Prime Minister Tony Blair and Ed Balls were lambasted in the report for urging the regulator, then the Bank of England, to leave RBS and other banks alone Regulatory failings, the result of the government’s ‘light touch’, were also apparent.
The FSA, which employed several thousand people, admitted that the number of staff responsible for RBS was ‘severely deficient.’ At one time only one person was responsible for overseeing RBS, now one of the world’s largest banks, and Barclay’s investment company.

The next steps
Commenting on the losses incurred by shareholders in RBS, and the need for a government bailout, Lord Oakeshott, a leading spokesman for the coalition government, said: “the Royal Bank of Scotland was a monster – too big to control, too big to fail, driven by greed, and ruled by a tyrant. The head of the UK Serious Fraud Office, Richard Alderman, said: “if you are running a bank and you run it recklessly and you run out of money and you can’t pay your depositors or have to be bailed out by the taxpayers, I reckon that’s reckless and the company and the individuals should end up in jail. You can’t do that at the moment. But I think it’s what the public wants to see.” He added that people such as Goodwin and Adam Applegarth of the collapsed Northern Rock bank (see case in this collection) had to be given a real incentive to make sure they didn’t turn a blind eye.

Knighted in 2004 for services to banking, eight years later in 2012, his knighthood was rescinded and Sir Fred Goodwin became plain Mr. Goodwin again. In January 2012, Sir Fred Goodwin was also told that he was to be barred from holding any senior position in banking in future.

In 2013, the FSA is to be split into two new regulatory authorities, despite some legislative delays. The Financial Conduct Authority (FCA) will be a government agency to regulate financial services firms that provide services to consumers, both retail and wholesale, to maintain the integrity of the U.K.’s financial markets. The Prudential Regulatory Authority (PRA), to be put back inside the Bank of England, will contribute to the stability of the UK financial system, both banking and insurance. According to the Bank of England’s web-site it will have a single objective – to promote the safety and soundness of regulated firms – and will meet this objective primarily by seeking to minimise any adverse effects of firm failure on the UK financial system. (http://www.bankofengland.co.uk/publications/Documents/other/financialstability/uk_reg_framework/pra_approach.pdf )

Please also refer to Chapter – 1 and 6 in Crane and Matten

Discussion questions

1- Provide a profile for RBS and highlight the key financial, regulatory and governance facts. (20%)

2- What are the underlying corporate governance and ethical issues that contributed to the collapse of RBS?
(40%)
3- How could RBS avoid this failure reflecting on the best practices?
(40%)

To answer the above questions you may need to touch on the following points:

• If you had been advising the British government, instead of Lord Myners, what actions would you have proposed?

• What do you think is the most appropriate relationship between the Chairman of the board and the company’s chief executive?

• If a financial regulator is to do a competent job it needs to be staffed by people with extensive experience in that industry. But then they are likely to identify with the industry, accepting its norms and culture. How can a regulator avoid becoming ‘captured’ by its industry?

• What is your opinion of Sir Fred’s annual pension and Stephen Hester’s remuneration package?

• Do you think the new regulatory structure with the FCA and the PRA will work any better than the FSA?