Behavioural Risks in Corporate Governance

Regulatory Intervention as a Risk Management Mechanism

Ngozi Vivian Okoye

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781317701408
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Wirtschaftssethik

Recent cases of corporate failures, including the fixing of LIBOR rates and money laundering issues in the banking industry, highlight how behavioural issues on the part of company directors are significant contributory factors in corporate governance and the success or failure of companies. This book examines how personality and behavioural issues have contributed to major corporate failures, and how this risk may be managed.

The book examines behavioural risks in corporate governance, and evaluates the extent to which risk management mechanisms have acknowledged various aspects of behaviour. Drawing from cases in the UK, the US and Australia and research in psychology and the behavioural sciences, Ngozi Vivian Okoye argues that current corporate governance mechanisms lack provision for identifying and managing personality risks, and suggests how constituent elements of behaviour should be engaged with when developing preventive mechanisms for corporate failures. Okoye presents a conceptual framework for identifying and managing personality risks, and explores how personality risk may be built into corporate governance regulation.

The book will be of great use and interest to researchers and practitioners in business and company law, corporate governance, and critical management studies.

1 Introduction

1.1 Background and overview

Corporate governance as a concept has become increasingly prominent due to the occurrence of high-profile corporate failures.¹ Some of these failures resulted in negative consequences such as capital and job losses which affected the economic and social welfare of society.² It became important, therefore, to increase the focus on corporate governance because it is recognised as a mechanism which contributes to the prevention of corporate failures.³ From the era of the major corporate failures in the United Kingdom (UK) around the early 1990s to the corporate scandals in the United States (US) a decade later, efforts have been made by governments and business communities to improve corporate governance mechanisms in order to help prevent corporate failures.⁴ Reforms have taken the shape of promulgating principles of best practice in the UK and statutory intervention in the US.⁵ In the UK in particular, committees have been set up to examine corporate governance issues and develop mechanisms geared towards increasing the effectiveness of corporate governance.⁶ An examination of high-profile corporate failures which have occurred in the last two decades illustrates that inappropriate behaviour by company directors contributed to some of these failures.⁷ Companies are essentially managed by corporate officers, company directors being the principal officers provided for under the law.⁸ Therefore, management functions in companies are usually undertaken or authorised by company directors and managing companies effectively in order to prevent corporate failures is their responsibility.

Corporate failures can occur for a number of reasons,⁹ but of particular concern in this book are those failures in which a contributory component is the inappropriate behaviour of company directors. Despite the numerous corporate governance reforms that have taken place, corporate failures attributable to behavioural issues are still occurring. In the reports that followed investigations after the 2008/2009 financial crisis, it was clearly identified that the behaviour of company directors is a problem in corporate governance.¹⁰ These reports acknowledged, as had been evident in some of the corporate failures of previous years, that behavioural issues associated with company directors were a major contributory element in some recent corporate failures and the resulting financial crisis.¹¹ Behavioural issues can, therefore, be viewed as risks to the corporate governance process, and these risks are significant because they have the potential to result in corporate failures.¹² Questions then arise as to whether existing corporate governance mechanisms have taken cognisance of the significance of behavioural risks; whether there are processes in place to manage such risks, and how effective these mechanisms are in relation to these risks. In answering these questions, it becomes pertinent to investigate what contributes to the creation and continued existence of behavioural risks, as that would be the starting point in managing such risks. An analysis of literature indicates that two components, personality and situations, are vital elements in relation to behaviour.¹³ Therefore, if a corporate governance system does not include mechanisms which identify these components of behavioural risks, and there are no processes in place to sufficiently manage the risks which accrue from each of the components and which in turn make up the totality of what behavioural risks entail, then a gap exists in relation to those unmanaged risks and the system is flawed to that extent.

The purposes of this book are, first, to ascertain whether and how behavioural issues contribute risks to the effective operation of corporate governance processes and how these risks are identified and managed. In so doing, the book seeks to identify the elements which constitute behaviour, as those would be essential in the determination of whether behavioural risks are being managed effectively. Personality and situations are identified as the major elements of behaviour and the book then particularly investigates and focuses on personality as a significant contributory element to behaviour, and seeks to ascertain whether personality risks are effectively managed in corporate governance. Upon the examination of risk management mechanisms in corporate governance, it is found that personality risks are not identified and managed. This situation is argued to contribute to the insufficient and ineffective management of behavioural risks in corporate governance. Arguments are presented regarding the need to manage personality risks, highlighting the existence and negative implications of these risks as evidenced by the corporate failures which have occurred as a result of behavioural issues.

Second, this book aims to determine what should be achieved as regards the effective management of personality risks and makes suggestions in a conceptual framework of approaches which can be adopted towards attaining this goal. Considering corporate and regulatory theories, and taking cognisance of the role of the State in the management of public listed companies, arguments are made for the adoption of a regulatory model to be utilised in the management of personality risks and in turn behavioural risks associated with company directors. There are also suggestions for provisions to be included in this model. This book contributes to the literature by addressing the issue of personality risks in corporate governance, highlighting the significance of personality risks and the linkage between personality and behaviour as far as corporate governance risks are concerned, illustrating that corporate governance mechanisms have largely ignored the personality aspect of behavioural risks, presenting a conceptual framework for personality risk management, arguing for statutory intervention in the management of behavioural risks, and developing a regulatory model for that purpose. All of the above contributions are aimed at improving the effectiveness of corporate governance by increasing knowledge and offering solutions which could influence policy in an area which might otherwise remain ignored despite its significance, and ultimately contribute towards a reduction in corporate failures attributable to behavioural issues.

The main proposition which this book seeks to address is ascertaining whether behavioural issues are risk contributors to the corporate governance process, and if behavioural risks and personality risks in particular are routinely identified and managed effectively by existing corporate governance mechanisms, and, if not, to ascertain an effective means of doing so, particularly in relation to company directors. In order to address the main proposition, the following sub-questions are considered and addressed:

• Are corporate failures attributable to the behaviour of company directors?

• Does the behaviour of company directors constitute risk in the corporate governance process?

• What constitutes behavioural risk?

• Is behavioural risk properly identified considering all it entails?

• Is behavioural risk effectively managed in corporate governance?

• Is personality a significant aspect of behaviour and what is the linkage?

• What constitutes personality and personality risk?

• Is personality risk effectively managed in corporate governance?

• Why is it important to manage personality risk?

• How can personality risk be managed effectively?

• Which approaches/mechanisms would meet the criteria for effectiveness?

• Why is a regulatory framework a good option for managing personality risks associated with company directors and how would it work?

The recurrence of corporate failures apparently attributable to behavioural issues is such that there should be concerted efforts towards understanding the reasons for these failures, as this is a foundational step in the quest to find a meaningful solution to the problems associated with those issues. The enhancement of knowledge regarding personality risks and its impact on behavioural risks would contribute to an in-depth awareness of the problems which can arise in cases where personality risks are unmanaged. This knowledge also aids the development of effective risk management mechanisms in that regard. Considering the processes which are involved in risk management, developing a conceptual framework for personality risk management would afford detailed insight into the issues involved in the process and from which beneficial knowledge can be drawn in relation to developing effective risk management models. Flowing from an understanding of the underlying issues in relation to personality risks and behavioural risks, and taking cognisance of relevant factors, developing a personality risk management model for company directors is one means of contributing to the efforts being made to help in the prevention of corporate failures. These efforts are particularly justified considering the negative consequences of corporate failures such as economic and social losses, loss of lives and property, financial crisis, credit crunch and recession.¹⁴

This book focuses on behavioural risks as they relate to company directors. This is because company directors are the most identifiable set of corporate officers as their role is provided for under the law and the management of the company is particularly their responsibility.¹⁵ A company may elect not to have any other corporate officers other than directors, and the directors would end up as the only persons who are involved in the management of the company. There is, therefore, better clarity in focusing on company directors as the corporate officers primarily recognised by law under Article 3 of the Model Articles of Association provided for by section 20 of the UK Companies Act 2006. The book also restricts its analysis and solutions to public listed companies. This is because, as highlighted earlier, corporate governance became an issue predominantly as a result of failures in public listed companies, as these failures had negative impacts on society. Essentially, the quest to improve corporate governance originates from the desire to improve the management of companies on behalf of their shareholders and stakeholders who are usually absent from the management function. As much as privately held companies can benefit from corporate governance reforms which promote effective governance of companies generally, the focus of corporate governance mechanisms has largely been on public listed companies, one of the reasons being the separation of ownership from control.¹⁶ Corporate governance codes also usually operate under the auspices of stock exchanges, which supports the fact that code provisions are focused primarily on publicly traded companies.¹⁷ Therefore, the issues which necessitated the arguments and discussions in this book originate and relate to public listed companies, and so the solutions that are suggested here are also focused on such companies.

Again, the justification to develop mechanisms which would help prevent corporate failures is higher when the failures in question have adverse effects on society as a whole, which is usually the case when publicly traded companies fail. Some private companies no doubt impact on the wider society as well in terms of their activities, but nevertheless, their shares are not publicly traded and losses are usually restricted to the private owners save as it relates to the services which the company rendered to the public. Public listed companies offer their shares to the public, and so society has a broader interest in these companies as numerous people could invest in the companies and losses from their failures would affect more people. The focus on risk is as it relates to corporate governance. It is acknowledged that the term ‘risk’ might be interpreted in varying ways in different contexts, but the context in which it is utilised here is as detailed in Chapter 3, section 3.2. Essentially, risks have been viewed in corporate governance as events or issues which impact on the achievement of corporate objectives. It is in this context that personality risks and behavioural risks are understood and analysed. The jurisdiction of focus in this book is the UK and the emphasis is on UK corporate governance processes. In some cases, examples have been drawn from other jurisdictions with the aim of illustrating how widespread an issue is or to examine how an issue has been approached in another location.

The book is structured as follows:

Chapter 1 contains this introductory section, as well as the section which discusses the methodology adopted in the book.

Chapter 2 is a discussion of the relevant literature which forms the foundational and theoretical basis for the book. It contains analysis of literature relating to corporate theories, corporate governance, company directors, corporate failures, personality and behaviour, corporate risk management, and regulatory theories. This chapter highlights the relevant developments in those areas and provides an understanding of the issues raised in the book. It also provides an underlying basis for the arguments that emerge in the book and presents the perspectives from which solutions to the problems are drawn.

Chapter 3 examines the concept of risk and situates risk in the context of corporate governance. This chapter starts by presenting different definitions of risk and highlights the importance of risk management. It goes on to discuss how risk has been approached in corporate governance terms, beginning with the Turnbull Guidance which was issued by the Turnbull Committee after examining internal control and risk management practices in companies. The chapter also evaluates how personality risk and behavioural risk has been addressed by other corporate governance mechanisms such as the UK Corporate Governance Code, Company Law provisions, EU Regulations, and Financial Conduct Authority (FCA) Approved Persons Regime which is applicable to companies operating in the financial services sector. Based on these discussions, arguments are made that personality risk should constitute a distinct and significant risk category. The chapter then highlights the lacuna in the risk management process as it relates to corporate governance by illustrating that personality risk has not been explicitly identified or provided for under existing corporate governance mechanisms. It is also argued that behavioural risks have been managed mostly from a ‘situational’ perspective, as contrasted with a ‘person centred’ perspective, and that ignoring the personality aspect of behavioural risks contributes to overall ineffectiveness in the management of behavioural risks as well as all other corporate risks.

Chapter 4 discusses investigations into high-profile corporate failures and the investigative reports issued after such failures with the aim of highlighting that behavioural issues have been recognised as a significant problem in corporate governance. For a practical perspective, and to situate the problem in the context of real experiences, the chapter then discusses some examples of corporate failures, highlighting specific behavioural issues which were contributory elements to those failures and illustrating the effects of the failures. There are discussions on personality and behavioural issues, indicating the linkage between these...