Philip A. Armstrong
Head, Global Corporate Governance Forum (An IFC Initiative)

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The severity of the financial crisis has called into question many of the fundamentals upon which capital markets have evolved in the post-war era, including regulation to safeguard investors, capital adequacy requirements for financial institutions to survive difficulties, derivatives to hedge risks, governments to provide liquidity, and the role of boards as guardians of shareholders’ interests.

As the tide pulls out, one sees the many problems that a record bull market led people to ignore or fail to perceive, intoxicated by the irrational exuberance that everyone knew would inevitably end, and when it did, its results would be devastating on scale not seen since the Great Depression.

As governments, investors, and academics sift through the wreckage to understand what went wrong, how to stimulate the economy, and what reforms to put in place rapidly to prevent a reoccurrence, the issue of board directors and whether their interests were aligned precisely with those of shareholders is appropriately gaining much attention.

The question is whether the questions being raised about board directors on many fronts. Are they too often too cozy with the chairman and CEO, sharing board roles with each others’ companies, etc.? Why did boards’ independent audit practices fail to raise red flags about poor risk management that contributed to speed at which the credit crisis spread? Have boards for too long viewed shareholders as a nuisance and put up too many barriers to ensure their input into decision-making, resulting in an insular arrogance that caused groupthink to prevail at board meetings and ostracized those with divergent opinions? Are the excessive compensation levels seemingly rubber stamped part of the malaise of boards, a malaise that led to other decisions fostering the financial and structural problems we see today?

Boards are justifiably under bitter attack from shareholders who survival financially depends increasingly on investments in securities. They need to look long and hard at how they work, the transparency of their actions, and the extent to which their financial statements accurately, clearly, and faithfully tell investors about the company’s strengths and weaknesses and future prospects. They need to find more ways to listen to shareholders, not out of a sense of noblesse oblige, but out of duty and respect for the fact that shareholders are “owners” of the company and their thoughts should be given sufficient consideration. And, boards will need to make progress in adopting policies and practices that protect the environment and help benefit communities, seeing those considerations as key to the company’s sustainability rather than public relations ploys to hold back the critics. Under extreme pressure now to ensure that their company is financially sound to endure in these extreme times, the temptation to forego the costs of products, services, and programs to protect and improve the environment and ensure that the people they affect, including their employees, are fairly treated along the lines outlined in many “ESG” codes.

Ahead, directors have a tremendous opportunity while support and need are greatest to do something constructive, to lead the changes essential to survive the short-term challenges, but more importantly, lay the foundation and build for a future of greater prosperity and a higher quality of life for all human beings.