Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis – Edited by Hawley, James P., S. J. Kamath and A. T. Williams

• Published date: 01 September 2011
• DOI: http://doi.org/10.1111/j.1467-8683.2011.00877.x
• Date: 01 September 2011
• Author: Kenneth A. Merchant

Book Review

Hawley, James P., S. J. Kamath and A. T. Williams (eds.) Corporate Governance Failures: The

Role of Institutional Investors in the Global Financial Crisis. University of Pennsylvania Press,

Philadelphia, PA, 2011, ISBN 978-0812243147.

The core of this book is focused on relationships between

financial risk and corporate governance. The goalwas to

explore the roles of large, supposedly sophisticated institu-

tional investors in the recent global financial crisis. Institu-

tional investors, which include pension funds, mutualfunds,

endowments, and, in some countries, banks, have broadly

diversified investments across various classes of equity and,

increasingly, other asset classes. Theirsize and, hence, impor-

tance has grown significantly in the last 40 years.

The book contains 11 chapters. Nine of the chapters are

revisions of presentationsmade at a conference sponsored by

Saint Mary’s College of California. A tenth chapter wassolic-

ited from a conference participant. The eleventh chapter, an

introduction by the book’s editors, provides a summary of

the major topics and themes discussed both at the conference

and in the chapters in the book. The authors are mostly

academics, in the fields of business, finance,and law, but they

also include investment professionals, attorneys, and a pro-

fessional financial writer. The purview of the book is almost

exclusivelyAnglo-American. All but one of the chapters were

written by authors located in the United States, the United

Kingdom, or Australia. The exception, a chapter written by

three authors located in the Netherlands, focused on the

boom and then bust in the US real estate market.

Collectively, the chapters provide persuasive arguments,

supported by examples and in some cases empirical analyses,

showing that in their pursuit of “alpha,” almost all of these

institutional investors made significant errors both of com-

mission and omission. They became exposed to extremely

complex financial instruments (e.g., credit default swaps)

often coupled with leverage to magnify returns. In so doing

they contributed to the growth of these risky markets and the

potential for failures at the portfolio, firm, sector (especially

financial sector), and systemic levels and contributed to the

global financial crisis. The firms’ managers did not under-

stand the risks that they were taking; they did not have

effective risk monitoring systems in place; and their corpo-

rate governance practices failed them. Each of the chapters

also provides ideas for preventing, or at least mitigating,

these problems in the future.

This is not a book that one would typically pick up and

read from front to back. It is not like a well-organized book

written by a single author. There is no guarantee that all the

relevant issues are discussed; differing points of view are

expressed, and there is no resolution; and there are some

redundancies. The ordering of the chapters is somewhat

arbitrary.

The chapters in this book focus on different aspects of the

financial crisis. For example, several chapters focus on fail-

ures of modern portfolio theory models. One focuses on

executive remuneration and “say on pay.” One focuses on

the crises in real estate markets. Two focus on aspects of

socially responsible investing. Most readers will have more

interest in some chapters than others.

As I read through the chapters, I had two main overall

reactions. One was regarding the complexity of the issues

and, hence, the breadth of topics discussed. The scope of the

book – focused on the roles of institutional investors in the

recent global financial crisis – was seemingly suitably

narrow. To discuss this topic adequately, however, the

authors needed to discuss many diverse topics, including

the applicability and limitations of quantitative models in

finance, many aspects of corporate governance, the potential

for effective laws and regulations, the propergoals and roles

of institutional investors, and the meaning of the term “fidu-

ciary obligation.”

My second overall reaction was regarding how much

there is yet to be learned about many critically important

topics. The authors of the chapters, each an expert, raised as

many questions as they answered. Here are some examples:

•Finance models. Can we rely on modern portfolio theory

(MPT) and its assumption of the efficient market hypoth-

esis? Are models built on analyses of the past useful in

making judgments about the future? Does MPT cease to

provide adequate representations of risk in stressed

markets or in times of “bubbles”? Does it start to fail as

more and more investors come to rely on it? In particular,

did the rise in index investing magnify the problems by

increasing the proportion of speculators in the market?

These are critically important questions because if these

models fail to measure risk, it becomes extremely difficult

to manage risk other than by using significant subjective

judgments, and it becomes largely impossible to judge the

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Corporate Governance: An International Review, 2011, 19(5): 502–503

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00877.x