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A Discussion About The Failure Of Financial Engineering And Corporate Governance As A Cause Of The Global Financial Crisis

1494 words - 6 pages

In this paper, an analysis of how the failures in financial engineering and Corporate Governance have been closely related with the recent Global Financial Crisis is carried out.

The Real Estate Bubble in 2006 leaded to the Subprime Mortgage Crisis in 2007 which expanded from the United States to the whole world generating the biggest financial crisis since the Great Depression of the 1930s. There are multiple factors that originate a crisis like this, and will be explained and analysed later, but in order to understand the global economic situation it is necessary to understand how the changes in the Corporate Governance have been one of the reasons of this and how this changes have been ...view middle of the document...

The two biggest examples are the deregulation of the mortgages in the 80s and the end of the division between commercial banking and investment banking in the 90s. After this, the Corporate Governance of financial companies changed to adapt to the new markets that they were now able to cover.

Regarding the liberalization of the economy, once again the Corporate Governance of the companies needed to change in order to fit the variation in the policy concerning the reduction in the barriers to the free transit, which was inevitably implemented in order to allow the Financial Globalization, and can be sometimes considered as a source of instability.

Either way, both the reduction in the regulation of the banking system and the liberalization of the economy leaded to the Financialization of the Economy, understood as the process in which financial markets take a bigger relevance over the primary and secondary sectors of the economy. Once again, this has consequences in the Corporate Governance of the different companies because of three different factors:

With the decrease in the intensity of the regulations, now all the parts involved in the financial markets can move their assets from one place to another more easily.

After the clear limits between Investment Banking and Commercial Banking disappeared in the 80s, new sorts of institutions that manage different markets at the same time have appeared.

The collective investment schemes, through investment management groups, have increased their relevance in the executive boards of the companies they own.

These factors have been the natural consequence of the Financialization of the economy and have therefore resulted in a Change in the Corporate Governance of the Financial System.

There are five major changes in the Corporate Governance that can be highlighted as a result of the increased relevance of the financial markets in the global economy: an inadequate risk assessment, the new ways to economically motivate executives, the artificial increasing of the share value, the shareholder approach and the lack of long-term perspective.

Regarding the inadequate risk assessment, over the last decades it has become clear that the right risk management policies have been lacking in the main financial corporations. The increased risks that the different companies have taken have proved to be a result of the lack of the proper control tools and regulations, enabling a bigger uncertainty.

Regarding the new ways to motivate executives, the increased percentage of the salary coming from variable incentives and flexible benefits has created a situation in which the division between the leading managers and the executive board is sometimes difficult. Additionally, the benefits were based on the actual results of the company, but not so much in the risks that had been taken to guarantee those immediate results. Furthermore, their bonuses are usually related to the benefits and do not share the risks of the...


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