Introduction
Lehman Brothers (LEH) was a multinational monetary utility organization (Mawutor,2014). The company was the fourth substantial investment bank in the USA, doing business in investment banking, equity, and fixed-income sales and trading. The company also had research, investment administration, private equity, and private banking operations (Fleming & Sarkar, 2014). Lehman operated for approximately 158 years since its establishment in 1850. In 2008, the company filed for bankruptcy, which was the beginning of its collapse (Wiggins et al., 2014). The company filed for Chapter 11 bankruptcy safeguarding due to an enormous exit by most of its customers, drastic losses in its stock, and the devaluation of assets by credit rating organizations. All these were mainly influenced by Lehman’s engagement in the subprime mortgage crisis and the exposure to liquid assets (Chadha, 2016). The company’s bankruptcy is substantial in USA history. It equally played a role in the global financial crisis witnessed in the late 2000s, with its peak being in 2008 (Bredart, 2014). Its stock price plummeted by approximately 70% 0f its value in early September alone. By mid-September 2008, it had lost $4 billion attempting to dispose of its shares in one of its subsidiaries (Mawutor, 2014). To explain the various causes of the collapse of the business, numerous economic analysts have established a series of academic and significant arguments aimed at identifying the actual causes of the destruction. Some other analysts have carried out a series of investigations mainly to account for the company’s failure. Much of the blame has been on the administration’s failure, led by the chief executive officer (CEO) Dick Flud. The company’s administration failed to observe corporate governance principles effectively. To add up to the body of apprehension, the results in this paper reveal the diversity of aspects starting from dubious accounting practices, unethical administration practices, over outlay in perilous unsecured outlays, and laxity on the part regulators. The paper also reveals that external auditors also played a significant part in the collapse by not identifying the financial statement malpractices by the Lehman administrators. Importantly, policy formulators like the Security and Exchange Commission (SEC) should initiate stringent policies to address Lehman’s failure to prevent future occurrences. This report intends to investigate and review the activities and transactions that led to the loss of the Lehman Brothers. The paper will address how failure in the business’s corporate governance led to its collapse. Mainly, the discussion will focus on board, executive compensation, financial reporting, and shareholders’ rights elements of corporate governance and how they led to ye collapse of Lehman Brothers.
Board
The board of directors of Lehman’s Brothers was composed of ten independent members (Maria & Singh, 2021). The directors and the council formed four committees. The committees incorporated audit, nominating corporate governance, finance and risk, and the compensation and benefits committee (Chadha, 2016). Following the necessities of the United States Securities and Exchange Commission, one of the audit committee members was a financial expert. The company’s board has been substantially blamed for the company’s failure (Kumar & Baag, n.d). The committee always had poor oversights and strategies that could not help the company when it started facing financial issues that made it bankrupt in 2008. Notably, the board had high leverage high-peril-taking enterprise blueprint supported by minimal equity (Adu-Gyamfi, 2015). For instance, the company took its leverage ratio up to approximately 30 times its equity. The board also initiated the company into a culture of aggressive growth blueprint that mainly paid attention to complex and multiplex monetary and fiscal products like subprime, derivatives, and commercial real estate vends. However, the board failed to carry out the deleveraging blueprint in 2007 when the real estate vends slowed down (Luo, 2021).
The Lehman’s board of directors’ responsibilities were the oversight of an advisory to the organization (Lumar & Baag, n.d). They led the company to take excessive debts and did not create a diversified product portfolio. The board of directors did not also monitor its blueprint and peril administration more carefully (Adu-Gyamfi, 2015). Notably, all of the major causes of Lehman’s failures are traced back to the dysfunction of the board of directors and the agency issue. The agency problem always arises when an agent, a company director, does not act in the best interest of a principal, the shareholder (Karim, 2021). Wiggins et al. (2014) say that when the principal chooses to work through their people, and its appeal relies on others, this is always subject to an agency issue.
Eight out of the ten directors of Lehman Brothers met the independence standards of the NYSE in 2006 (Fleming & Sarkar, 2014). Still, they did not have the economic prowess and thus failed to reliably monitor Lehman. For instance, the finance and peril committee had only two annual meetings while the compensation committee met more times, approximately eight, than the committee in charge of auditing (Mawutor, 2014). The audit committee had seven yearly conferences. Additionally, the company did not have any current CEOs of major public corporations, and former CEOs were well in retirement (Bredart, 2014). As such, the board did not comprehend the multiplexity and severity of the fiscal vends well enough to minimize and stop the challenges when the financial vends slowed down. The inability of the directors on the board to effectively deal with the economic issues that the company faced is an indication that they did not act in the best interest of the shareholders (Fleming and Sarkar, 2014). They equally did not exercise fully the duty that they owed to Lehman. They did not act in good faith in exercising their oversight responsibilities and duties only in the best interest of the Lehman shareholders (Chadha, 2016).
It is always challenging to raise doubts when an organization’s fiscal and monetary performance has been robust (Maria & Singh, 2021). Notably, this is always the case because it is reliable to analyze the executives’ capacities for running the enterprise, whose purpose is always to maximize the returns. Fuld, the CEO, embodied Lehman’s colossal success (Mawutor, 2014). During his tenure, the company’s revenues and profits augmented 600%, from $3 billion in 1994 to $ billion in 2006 (Bredart, 2014). Kumar & Baag (n.d) say that because of this augmentation and growth of the company’s revenue, a culture was created where the workers could not ask questions and raise concerns. The directors equally failed to challenge Fuld (Wiggins et al., 2014). Thus, the executives like Fuld became principals in the board of directors, and the board of directors became executives’ agents, not shareholders. Therefore, there was an agency issue between Lehman’s shareholders and directors due to this reversed association (Luo, 2021).
Executive Compensation
Executive compensation refers to the economic packages that are always explicitly created for the members of the executive administration teams (Luo, 2021). The main aim of executive compensation is always to motivate the teams to work in the best interest of the shareholders. Executive compensation is always composed of financial payments and other non-financial benefits that executives get from their employing firm for their services (Kumar & Baag, n.d). The amount is always designed to help retain the executives in the bad times due to the adverse vend and spectral factors. In most cases, the cost of executive pay should be limited to the extent that shareholder wealth is not affected (Maria & Sing, 2021). However, the wealth should be maximized. Sadly, this was not the case for Lehman Brothers. According to Mawutor (2014) ‘s report, the executives and directors at the company led by the CEO did not consider this factor. They only sought to have themselves maximumly benefit from the finances and funds at the organization without considering the business’s financial operations. The top executive teams at Lehman cashed out substantial amounts of performance-based compensation between 2000 to 2008 (Maria & Singh, 2021). The company executives cashed out significant amounts of bonus compensation that were not clawed back when the company collapsed. The executives also pocketed large quantities from the sale of shares (Fleming & Sarkar, 2014). The Lehman Brothers derived cash flows of approximately $1 billion from cash bonuses and equity sales in the eight years from 2000 to 2008.
Lehman Brothers derived cash flows of about $1.4 billion and $1 billion, respectively, from cash bonuses and equity sales from 2000 to 2008 (Adu-Gyamfi, 2015). In the eight years, the executives at Lehman Brothers received aggregate salaries of $18 million. However, the wages were independent of performance (Maria & Singh, 2021). They also got a considerable amount of performance-based cash bonuses during the same period. The executives received approximately $61 million in performance-based bonuses (Karim, 2021). The company offered its top executives substantial rewards following the bank’s high earnings and stock price increases. These doings by the executives led to a web of conflicts of interest (Luo, 2021). The pay to the directors was relatively excess. The company’s CEO was considered the highest-paid executive (Wiggins et al., 2014). According to research, Fuld had paid himself an aggregate of $300 million in pay bonuses in the eight years, making him among the USA’s highest-paid CEOs (Chadha, 2016). Despite the company’s challenges before its bankruptcy and collapse, the executives continued to increase their bonuses. The increase was one of the significant factors that further jeopardized the company’s operations (Mawutor, 2014). However, they used funds that they would otherwise use to pay for the numerous debts that the company had as their bonuses. Equally, as much as their salaries were based on the performance that they offered the company, they were relatively high (Wiggins et al., 2014). These were unethical actions by the executives, and thus, many experts blamed them for the company’s collapse.
Financial Reporting and Auditing
Financial reporting and auditing are essential aspects of any organization (Kumar & Baag, n.d). The two elements help in determining the financial position of an organization. Financial reporting indicates profits and losses, if any, in the operations of a business within a particular period (Mawutor, 2014). Through financial reporting, the company can put in place effective strategies to improve its operations and boost returns, thus guaranteeing the continuity of the business. However, for an organization to realize this, they need to have a financial and auditing committee with adequate monetary prowess (Fleming & Sankar, 2014). However, this was not the case for Lehman Brothers. The company’s executives in charge of the finance committee had limited expertise in financial reporting (Wiggins et al., 2014). As a result, the company received unqualified audit reports, which contributed to its collapse. Audit failures occurred because the directors in charge of the financial and risk management committee led to severe distortions in the financial reporting not indicated in the audit reports (Chadha, 2016). Thus, the auditors always made serious errors while conducting the audit.
Through its board of directors and executives, its management violated its corporate governance responsibility by conducting numerous unethical behaviors (Bredart, 2014). Notably, the financial and risk committee employed a repurchase deal to manipulate the organization’s financial statement. The company’s balance sheet in June 2008 was fabricated with window-dressing mechanisms, which are often known as Repos 105 (Mawutor, 2014). The outcome was the elimination of $50 billion in commitment from their financial statement. Despite the unethical employment of Repo 105 by Lehman, it is always legal for banks to take part in Repo 105 transactions. Significantly, banks have historically utilized repurchase to administrate their short-term cash liquidity (Adu-Gyamfi, 2015). It always incorporates the pledging of the government bonds or some short-term low peril equipment in return for the term funds. To support their unethical performances and operations, Lehman failed to utilize effective and appropriate accounting systems to report Repos 105 (Kumaar & Baag, n.d). The company did not disclose it to the government, investors, creditors, and its board of directors. It performed this act by getting a federal bond from another bank utilizing one of its unique units in the USA (Mawutor, 2014). Before the preidentified dates for settlement for the end of the quarter, Lehman’s particular unit then transferred these bonds to their affiliates in London. The London affiliates then moved the bonds to another bank for cash while pledging to purchase them at a relatively higher rate (Mawutor, 2014). Notably, this was supposed to be 105% of the price. The affiliates then transferred the cash they got to the Lehman Brothers in the US to pay off a substantial aggregate of liabilities (Kumar & Baag, n.d). Critically, this minimized the company’s weaknesses to indicate healthier quarterly reports and influencing corresponding rations, the confidence of the investor’s regulators, and the general public (Mawutor, 2014). Before the subsequent quarter, Lehman then borrowed extra at other lending institutions to purchase back the securities from their London affiliates at 105% of the original price. After the practice, the financial statement reverted to its original unhealthy state (Mawutor, 2014). Sadly, this made Lehman be in a worse-off situation since the company’s financial position looked good, effective, and healthy in the eyes of the regulators and the state. Such practices led to financial statement fraud, which is one significant factor in the company’s collapse (Maria & Singh, 2021). The company’s external auditors cannot be exonerated from such a heinous crime; this indicates that unethical behaviors and failure in its corporate governance led to its bankruptcy and loss (Mawutor, 2014).
Shareholders Rights
There was also a failure in the observance of shareholders’ rights by the organization (Mawutor, 2014). The company did not observe corporate governance principles regarding the shareholder’s rights. The organization failed to believe in and follow the fundamental rights of the shareholders (Kumar & Baag, n.d). Lehman brothers denied the shareholders the liberty to express their fundamental rights. The CEO helping it augment its profits warranted the executives and employees’ fear of asking questions and raising their concerns, just as previously stated (Luo, 2021). The CEO was at the center of formulating all resolutions without fully incorporating the shareholders. The shareholders did not fully participate in the matters of the organization (Karim, 2021). By Flud, together with other executives in the organization, not fully involving the stakeholders in the operations and activities of the organization, they failed to recognize their legal, moral, and civic obligations, which should be fulfilled according to the principle of corporate governance. As earlier indicated, the executives, particularly those in the finance and risk management department, conducted fraud in the organization’s financial statement (Chadha, 2016); this was meant to suggest that the organization was in a good and healthy position, which was not the case in an absolute sense. Notably, this was one instance of denying the shareholders their right to know the actual situation and operations of the firm (Bradart, 2014). They had a right to comprehend all these since they had invested in the company. When Dick Fuld was voted in as a CEO in 2005, he had 87% of the investors’ support (Luo, 2021). However, after some time, mainly when the company was declared bankrupt and on the verge of collapsing, people started raising concerns about how many shareholders and investors reelected him into the position. People also questioned whether the shareholders effectively executed their voting rights (Karim, 2021). Also, the idea of Flud being at the heart of all business decisions minimized the effort of the stakeholders to make significant changes in the organization that would at least guarantee that the organization did not collapse. However, after learning of its state, the shareholders were no longer in a position to revive the company (Muwator, 2014). They instead had to exit, incurring lots of losses.
Conclusion
The Lehman Brothers was a banking institution thriving for decades since its establishment. However, due to management ad unethical corporate governance, the company collapsed in 2008 after being declared bankrupt. Its collapse led to a considerable financial crisis in the USA and even around the globe. Notably, many people have blamed the failure and bankruptcy of the company on improper corporate management by its directors and executives. Majorly, Dick Fuld, the CEO, took considerable blame because he saw the company in a terrible state. The board of directors led the company into taking excessive debts without effective measures on how they were going to settle the debts. Equally, the panel comprised directors in the finance and risk management committee who did not have adequate prowess and expertise in monetary matters. The committee members failed to find effective measures to advise the CEO and other directors on the practical steps to properly manage the company’s finances. Also, the executives had substantial amounts of bonuses basing their reason that the company had been making profits. The money that would otherwise have been used to repay the debts and cater to other business operations was used to pay bonuses to the executives. Between 2000 to 2008, Fuld earned a substantial amount of compensation and even performance-based income, making him among the highest-paid CEOs in the USA. Although the executives had performance-based payments, they were way too high. They acted in such a manner that indicated that they did not have the effective performance and operation of the business at heart. Employees and other directors feared raising their concerns and asking questions about the business process because Fuld had seen the company making substantial profits. Thus, the employees and the directors feared challenging him.
Notably, after the collapse of the business, Fuld was ranked among the worst-performing CEOs and has highly been blamed for the company’s failure. The company did not also meet the legal rights of the shareholders. Having the financial and risk management committee commit fraud on the financial statement was a denial of the rights of the shareholders to comprehend the economic and general performance and position of the business. The committee sought to show that the company was good and had healthy operations and performance, which was not the case. Generally, Lehman Brothers failed in its corporate governance. If the CEO, directors, and other executives had acted according to the principles of effective corporate governance, the company would not have collapsed. Also, if Fuld and other directors pocketed a reasonable number of bonuses and salaries, the business would have enough funds to cater to its operations and pay the numerous debts. The employees and shareholders would also have been allowed to air their concerns, challenge the administration, and propose effective changes, guaranteeing that the business operated effectively.
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