Crisis Talk - The World Bank Group

Supplementing the Leverage Ratio with a Gender Ratio

The idea of a leverage ratio as a useful prudential tool has by now entered the mainstream. (See, for example, this week's Economist: "There is now impressive momentum behind the idea of a leverage ratio, a measure that puts a fixed ceiling on the total amount of assets that a bank can hold relative to its capital.") One less conventional idea could be a gender ratio. In a piece on VoxEU, Anne Sibert argues that the financial crisis was testosterone-fueled:

UK Labour cabinet member Hazel Blears suggests a second reason, commenting that, “Maybe if we had some more women in the boardrooms, we [might] not have seen as much risk-taking behaviour” (Sullivan and Jordan 2009). Indeed, the financial services industry – one in which lap dancing is apparently considered appropriate corporate entertainment (UK Equality and Human Rights Commission) – is overwhelmingly male dominated. Women hold only 17% of the corporate directorships and 2.5% of the CEO positions in the finance and insurance industries in the US (Sullivan and Jordan 2009). In Iceland – home to a particularly spectacular collapse – it is said that there was just one senior woman banker, and that she quit in 2006 (Lewis 2009). If men are especially prone to being insufficiently risk averse and overly confident, then this male dominance may have contributed to the financial crisis.

Investor Protections and Economic Growth

A close look at equity prices around the world reveals how much they have been affected by the current financial crunch as well as by credit and market risks. Fluctuations in growth and exchange rate expectations have only enhanced their influence. Financial integration has scaled up the correlation between advanced, emerging, and (to a measurable extent) developing economies’ equity markets over the last dozen weeks, so that equity prices have been moving more closely together. However, financial integration has not been accompanied by a harmonization of investor protections and corporate governance principles.

As the policy response to the economic crisis moves from short-term solutions – corporate bailouts and economic stimulus – to longer-terms fixes like financial market regulatory reform, it becomes increasingly important that policy-makers move beyond finger-pointing. Countries with stronger investor protections tend to grow faster than those with poor protections. A recent paper, using objective measures of investor protections in 170 countries, establishes that the level of investor protection matters for cross-country differences in GDP growth. An improvement in investor protection leads to better risk sharing, which implies a larger demand for capital. This “demand” effect indicates a positive association between investor protection and growth.

Too Specific to Fail

The FPD Forum opened this morning with a not-so-cheerfully titled plenary The End of the World As We Know It?. The panelists were Daron Acemoglu of MIT, Alan Rosling of Tata Sons, Tim Harford of the Financial Times, and Michael Klein of FPD/World Bank. Perhaps my favorite line from the plenary: Too specific to fail. Acemoglu was discussing the bailout of banks in the U.S., and pointed out that the moral hazard problem isn't so much an issue of "too big to fail" as "too specific." The human capital and knowledge contained in investment banks is highly specific, and it's exactly during a crisis that it's needed. The upshot? It's very difficult to punish the managers of these banks for taking excessive risks in the good times when they're needed to help halt a systemic crisis during the bad times.  

Corporate and Government Transparency: Hong Kong (China)'s Experience

In January, Hong Kong (China) extended disclosure requirements for corporate executives. “Braving the financial storm with good governance” is the proud title of the January issue of Hong Kong (China)’s Independent Commission against Corruption Newsletter. In addition to remuneration disclosure, new rules made it mandatory for directors of listed companies to disclose all their current and past (during the past three years) directorships. Stricter disciplinary and possibly criminal sanctions for providing false information were introduced.

Hong Kong (China) also does well on disclosure by politicians - extensive financial and business interests’ declarations by its legislators are available online.

Hong Kong (China) owes its successful transformation from highly corrupt in the 70s to today being one of the most corruption-free societies to the activities of its anti-corruption watchdog. The Independent Commission against Corruption (ICAC) is mandated to deal with both public and private sector corruption. On the one hand, ICAC is empowered to conduct investigations up to searching and arresting suspects; on the other, it carries out a lot of advisory and guidance activities.

A robust system of checks and balances to ensure there will be no abuse is a major element in the success story of Hong Kong (China)’s ICAC. Crisis-stimulated empowerment of watchdog agencies should include building in stronger checks and balances. The checks and balances might include reporting to the executive, control by the legislature, prosecution separated from investigative powers, procedural guarantees by independent judiciary, media scrutiny and an open complaints channel.

No Trust Left

While most economists are busy discussing the origins of the current crisis, a few are looking ahead. One nice think-piece is by Daron Acemoglu, of MIT, which draws three lessons. I like the third lesson the most:

The third notion that has also been destroyed by recent events is at first less obvious. It is also one that I strongly believed in. Our logic and models suggested that even if we could not trust individuals, particularly when information was imperfect and regulation lacklustre, we could trust the long-lived large firms - companies such as the Enron's, the Bear Stearn's, the Merrill Lynch's, and the Lehman Brothers's of this world - to monitor themselves and their own because they had accumulated sufficient reputation capital. Our faith in long-lived large organisations was shaken but still standing after the accounting scandals in Enron and other giants of the early 2000s. It may now have suffered the death blow.

If right, Acemoglu is onto something big. Trust is essential to business activity, and losing it may result in bigger cataclysms down the road. For those interested in how trust develops, read Trust in Large Organizations, by my co-authors Andrei Shleifer, Rafael La Porta and Florencio Lopez-de-Silanes.

Moving Quickly on Corporate Governance

Editor's Note: Loty Salazar provides knowledge management and communications support to IFC's corporate governance program. She previously worked with the World Bank's East Asia and Pacific region as a Communications and Information Officer. Welcome!

As the economic crisis of the century takes hold across the globe, companies in emerging markets face tough circumstances. While it may not at first seem like a “front of mind” issue, improving corporate governance will be vital to making the most of the situation. Effective decision-making processes, transparency, robust risk management, optimum internal controls and reliable regular reporting – these are what a company needs to attract and sustain the confidence of shareholders, lenders, investors and stakeholders, attributes that help improve performance and access to cheaper capital.