Corporate Governance, Risk Management, and the Financial Crisis: An Information Processing View

• Author: Michael Pirson,Shann Turnbull
• Published date: 01 September 2011
• Date: 01 September 2011
• DOI: http://doi.org/10.1111/j.1467-8683.2011.00860.x

Corporate Governance, Risk Management,

and the Financial Crisis: An Information

Processing View

Michael Pirson* and Shann Turnbull

ABSTRACT

Manuscript Type: Perspective

Research Question/Issue: What were the reasons for poor risk management on the board level before and during the

f‌inancial crisis? Were there systemic information processing problems that an alternative board design could alleviate?

Research Findings/Insights: Using an information processing perspective, we identify two reasons for boards failing to

manage risk well during the f‌inancial crisis: (1) board members did not have access to relevant information on the risks

management incurred becausethey had no control over information supply; and (2) board members were unableto process

the available risk-related information, and lacked incentives or power to inf‌luence managerial decision making. Based on

insights from cybernetics and decision making theory, we suggest increasing board level information processing and

decision making capabilities by including multiple boards for different stakeholders to create a division of power and labor.

We label this alternative structure network governance and posit that it allows superior risk management.

Theoretical/Academic Implications: The paperillustrates that the unitary board structure’s systemic shortcomings increase

the likelihood of poor risk management atthe board level. The solutions proposed are an important theoretical advancement

of the discussion on ongoing board failure in increasingly complex business environments.

Practitioner/Policy Implications: This paper is one of few providing actual recommendations based on a systemic insight.

Enlightened shareholders and/or managers could introduce network governance by amending corporate constitutions.

Regulators should require f‌irms considered too big to fail to adopt network governance or pay the cost for regulators

establishing a risk-monitoring unit in each f‌irm.

Keywords: Corporate Governance, Board of Director Mechanisms, Governance Environments, Corporate Governance

Theories

INTRODUCTION

The greater the uncertainty of the task the greater the amount

of information that has to be processed between decision makers

during the execution of the task to achieve a certain level of

performance. (Galbraith, 1974: 28)

We are experiencing a global epidemic of institutional failure

that knows no bounds. We must seriously question the concepts

underlying the current structures of organization and whether

they are suitable to the management of accelerating societal and

environmental problems – and, even beyond that, we must

seriously consider whether they are the primary source of those

problems (Hock, 1999: 6).

The f‌inancial crisis of 2007/2008 has been attributed to

many causes (folly, fraud, greed, and incompetence)

rooted in actions by interdependent actors – from the state

level to the organizational level and down to the individual

level (Bernanke, 2009; Reinhart & Rogoff, 2009; Rosales,

2009; Spitzeck, Pirson, & Dierksmeier, 2011; Taibbi,2010). As

the crisis unfolded, American shareholders lost nearly 10.2

billion USD (Kalwarski, 2009) and 45 per cent of the world-

wide wealth was destroyed (Davies & Siew, 2009). Three of

the largest bankruptcies occurred within the time frame.

Observers have pointed out that corporate boards did a very

poor job of exercising their f‌iduciary duty to manage risk

(ACCA, 2008; FCIC, 2011, Kirkpatrick, 2009; S1074, 2009).

This paper is motivated by the boards’ failure to manage

risk prior to the f‌inancial crisis. Kaen (2002) suggests that

risk management is a central corporate governance task as it

sustains value creation (see also Froot, Scharfstein, & Stein,

*Address for correspondence: Fordham University, 1790 Broadway, Suite 1147,

New York, NY 10019, USA. Tel: +1-718-817-5101; Fax: +1-718-817-5544; E-mail:

pirson@fordham.edu

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Corporate Governance: An International Review, 2011, 19(5): 459–470

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00860.x