Prof. Dr. Dr. Dr. h.c. Christian Kirchner Humboldt University Berlin Corporate Governance, Business Ethics, and Financial Markets Stability

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Prof. Dr. Dr. Dr. h.c. Christian
KirchnerHumboldt University BerlinCorporate
Governance, Business Ethics, and Financial
Markets Stability

• Paper to be presented at the conference
• Corporate Governance Sound Practices A Case for
  Financial Markets Stability
• Kuwait City, 2 Feb. 2013

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1. Introduction (1)

• ? Good Corporate Governance an essential
  prerequisite for well-functioning financial
  markets (and thus for financial markets
  stability)
• ? But how to define good Corporate Governance?

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1. Introduction (2)

• ? Bad Corporate Governance one of the causes
  of the international financial markets crisis in
  the past few years
• How to define bad Corporate Governance?
• ? Searching for good Corporate Governance
• ? Conventional approach focus on legal rules
• ? Public ordering / private ordering
• ? Normative criteria
• ? Introduction of business ethics

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1. Introduction (3)

• Organisation of the paper
• ? History of the international financial markets
  crisis
• ? Role of bad governance structures
• ? Methodological fundament
• ? Introduction of institutions
• - formal institutions
• - informal institutions
• ? Formal and informal institutions necessary,
  but not
• sufficient prerequisites for good Corporate
• Governance
• ? Role of business ethics

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Short History of the internationalfinancial
markets crisis

• Minimum capital requirements for banks combined
  with dysfunctional - financial reporting
  standards (fair value- problem)
• Governance problems
• ? shareholders goals moral hazard problems
• ? overcoming managements risk averseness
• ? perverse compensation incentives
• International financial markets crisis as a
  product of banking regulation, financial
  reporting standards and governance problems

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3. Methodological Fundament (1)

• Institutional Economics (Coase, Williamson etc.)
• Shifting the focus from the game (markets) to the
  rules of the game (framework)
• Rules of the games formal or informal rules
  together with their enforcement mechanism (
  institutions)
• Examples for formal institutions legal rules
• Distinction between public ordering (by the
  legislator) and private ordering (by private
  actors)

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3. Methodological Fundament (2)

• Assumptions of institutional economics
• Existence of transaction costs
• Incomplete information
• Bounded rationality
• Opportunism (ex ante / ex post)
• Moral hazard as a product of opportunism and
  dysfunctional institutions

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Formal institutions (public ordering)

• Better regulation Basel III plus national
  regulation
• corporate governance issues
• Basel II/III sound corporate governance
• financial reporting standards consolidation of
  special
• investment vehicles (SIV) collusion of
  management
• and auditors
• Legal rules on management compensation (e.g.
  Germany)

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Formal institutions (private ordering)

• Corporate Governance Codes not suitable for
  financial institutions
• Covenants to protect creditors interests not
  applicable for hybrid financial instruments

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5. Informal institutions

• Sound business practices
• Eroded by competitive pressure / problem of
  business ethics / how to behave morally under
  conditions in which actors, who do not act
  morally, have a competitive advantage?

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6. Dilemma of formal and informal institutions

• Legal interpretation problems (discretion)
• Incentives to extending the rules by means of
  interpretation (ex post-opportunism)
• Intervention of regulatory authorities within the
  rule of law (judicial review)

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7. Introduction of reputation mechanism

• Building reputation by
• Market places (e.g. Kuwait)
• Private market players (financial institutions)
• Asymmetry between building and destroying
  reputation
• Open problem 1 finite or infinite game?
• Open problem 2 exploitation of moral behaviour

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8. Trust building

• Trust building an investment process
• Methodology
• Starting point definition of ethical goals
• How to act under given restraints?
• Dilemma structure losses if defection occurs
• Reciprocal investment into joint welfare gains
• Credible commitments of market participants
• Combination of private credible commitments
  and market regulation
• Capital market access requirements
• Transparency and compliance

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9. Example management compensation

• The Wittenberg Center for Global Ehtics (WCGE)
  process
• Starting point How to cope with loss of trust in
  financial institutions in Germany
• Credible commitments ethical foundations of
  management compensation
• The process Dialogue managed by the WCGE
• Expected outcome credible commitment of German
  financial institutions (in the fields of
  management compensation)

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10. Interface between regulation, corporate
governance and business ethics

• Starting point Regulation (public ordering)
• Complemented by private ordering (corporate
  governance codes for financial institutions)
• Informal rules only functioning together with
  private credible commitment

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Practical consequences(lessons learnt)

• Interplay between
• Public ordering
• Private ordering
• Private credible commitments
• Central Issues
• Minimum capital requirements (hybrid capital)
• Corporate Governance management compensation