LEHMANS BROTHERS COLLAPSE AND CORPORATE GOVERNANCE LESSONS

LEHMANS BROTHERS COLLAPSE AND CORPORATE GOVERNANCE LESSONS

Introduction

Lehman Brothers was among America’s largest investment banks in 2008. The corporate entity was incorporated in 1850; hence had been in operation for 158 years and employed over 25000 employees (De Haas 2012, p. 234). A few years before its collapse, Lehman Brothers bought many lenders with largely unsustainable subprime mortgages. The bank also invested a lot in securitized mortgages despite the declining housing market (De Haas 2012, p. 235). Although the government could have saved it from collapse, it didn’t have enough collateral, and the treasury department lacked the authority to salvage it. The federal government attempted to facilitate purchase by private entities, but still, it was unable to guarantee its continued operation. This paper will provide an in-depth analysis of how flaws in corporate governance strategies lead to the collapse of this giant cooperation while smaller companies in the financial services sector survived the turbulent season

Flaws in stakeholder’s theory application

Adherence to sound corporate governance guidelines is a key ingredient of sustained growth and stability of any corporation. When the governance of Lehman Brothers was tested, two years before it collapsed by the declining housing market, the top management failed the test terribly. The housing market was on a drastic downward trend, which called for reduced investment in risky mortgages.  Instead, the management doubled its real estate investment and even financed risky mortgages from other financial institutions.  Lehman Brother’s corporate governance structures failed to safeguard against excessive risk-taking.  Further, they violated the stakeholder theory by taking actions likely to expose stakeholders to significant risk without their knowledge. (Hasnas 2013, p.49).

Flaws in Agency Theory of governance

Furthermore, principals’ interests conflicted with those of the agents as outlined in the agency theory of management.  Since the shareholders were unaware of the enormous risks undertaken by the agents, it was not feasible to align their interests with those of the agents.  The principals would not have opted to expose their investment to excessive risk. On the other hand, the management only focused on the profits that would be made if their risky initiatives succeeded.

Disregarding risk assessment reports

Besides, the company’s top management ignored risk assessment reports and took risks not commensurate with equity. Further, they undertook excessive product diversification without due diligence at a time the markets were turbulent.  The governance personnel also failed to reserve sufficient equity to cushion the company from the risks taken during the period of sharp market decline. It was why government efforts to salvage it from collapse failed.

Employee motivation

Another factor that may have led to Lehman Brothers is the fact that its employees had a tiny portion of the shareholding hence could not guarantee to act in the best interest of the company (Hasnas 2013, p.48). Motivating workers required them to have some sense of ownership of the company. This could have been achieved by allowing them to own a considerable proportion of shares in the company.

Conclusion

Therefore, the collapse serves as a source of insight on how corporate governance can avoid financial crises by using sound management strategies. Had the management of Lehman Brothers observed the management guidelines suggested here, it is likely that the corporation could have survived the turbulence that caused its collapse.