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Corporate Governance in the Documentary “Inside Job” Report (Assessment)

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Updated: Jun 11th, 2020

Introduction

The understanding of firms as simply entities that should work towards the maximization of shareholder value ends up creating misconceptions about the contractual obligations of firms (Klein, Mahoney, McGahan, & Pitelis, 2012). The stakeholder theory arose as a replacement to the shareholder theory to recognize the importance of all stakeholders in a firm’s affairs. A complete focus on shareholders’ interests ends up creating an obscured distribution mechanism. It also takes away value creation opportunities in strategy management (OECD Observer, 2015). The realities of the shortcomings of corporate governance ideology were visible in the documentary “Inside Job”.

This paper’s discussion will show that the extension of the chain of credit from buyers to investors ensured that lenders did not worry much about homebuyer ability to pay because they knew they could sell the debt to investment banks. This allowed them to introduce more loans to the market and offer riskier options. At the same time, academics played a part in fooling the market about the health of investments and institutions that were responsible for the crisis.

Theoretical Perspectives of Corporate Governance and Stakeholder’s Interest

The influence of corporate governance across the world is unmistakably large in size, capability and influence. Companies can influence governments and social landscapes but this has not always been for the benefit of shareholders. As a result, there is widespread loss of trust and market value of corporate governance (Awotundun, Kehinde, & Somoye, 2011). Corporate governance entails all the process that a firm uses to manage its operations. Consequently, corporate governance helps in assigning roles to different stakeholders. It also defines the roles of the management, the board and shareholders in the organization (Awotundun, Kehinde, & Somoye, 2011).

Corporate governance stipulates that those who run the firm should treat every shareholder with fairness. At all times, there should be active cooperation between stakeholders and management (Kaufmann, 2009). The prevailing practice in corporate governance derives its guidelines from the shareholders theory and the principle-agent theory. Managers in a company work on behalf of company owners to meet the demands of shareholders and achieve the objective of the company.

In such an arrangement, management staff will focus more on safeguarding the interest of shareholders because shareholders directly feel any loss in the company. Other stakeholders may incur losses, but their economic threshold will not match that incurred by shareholders. This way of thinking has dominated corporate governance and it continues to influence policies of many companies in regards to dealing with stakeholder interests.

The problem with the above way of thinking is that it only observes the organization from an economic point of view (Palmquist, 2013). Even then, it does not capture the economic interests of all stakeholders. For example, consumers have an interest in a firm embracing ethical competition practices to improve the overall market condition and keep them away from purchase-related losses that can occur due to misinformation and fraud. In the meantime, a number of non-economics related professions continue to observe corporate governance and its relation to society’s well-being. The idea behind stakeholder theories is that when firms are interacting with buyers, the two parties get involved in co-specialized investments. It is important to encourage and protect the investment as they put relational-specific capital at stake (Klein, Mahoney, McGahan, & Pitelis, 2012).

The Inside Job and its Role in Revealing Causes and Impacts of the Global Financial Crisis

The Inside Job is an elaborate documentary that brings out the entire narrative of the financial crisis in simple form for lay understanding. At the same time, it packs insights on current practices in corporate governance that go against public expectation and harbor corruption of academic and regulatory staffs. From, its name, the documentary insinuates that there were people who knew the trouble they were stirring and still kept on with their unethical deeds. The question asked is whether university professors were aware of the ongoing crisis. This comes after the fact that many economists who were faculty members of several reputable universities around the world were also board members of companies implicated in the documentary (Inside Job, n.d.).

The documentary highlights the case of Iceland. According to Gylfi Zoega, a Professor of Economics at University of Iceland, the country had a complete infrastructure of a modern society, with good education and clean air. The disastrous effects of poor corporate governance were to the environment and then to the economy. They began with the entry of multinational corporations into Iceland’s economy. Iceland put its three largest banks in the hands of private investors when the crisis began.

Iceland was a pure experiment of financial deregulation that eventually collapsed. The three banks borrowed funds equal to ten times the economy of the country and this led to too much cash in the economy and unprecedented consumption through debt. Additionally, an audit report by KPMG did not establish any malpractices in the Iceland banks. Unemployment in Iceland skyrocketed following the downfall of the banks after the crisis. At the time, a third of the country’s financial regulators had shifted and was working for banks to help them deter any regulatory scrutiny in their business.

This is yet another example of failed corporate governance that overly protects shareholders at the expense of other stakeholder’s interests (Singapore Management University, 2015). If a systematic investigation were to take place, then the culprits would be found. The “Inside Job” documentary explains that, 30 years ago, the person lending money expected payback in cash or through the banks with no intermediaries in the deal.

However, the new model creates additional levels to the home buying and overall real estate development. The securitization food chain included homebuyers, loaners, investment banks, investors. The original system was long and tedious because it involved paying home loans to the lenders. However, the new system entailed banks selling home loans to individuals, but the banks had to obtain the loans from the lenders. Therefore, in the new system when homebuyers pay their mortgages, their payments go to investors throughout the world.

The standards were weakening and regulators could see the facts. The question at the time was whether they could do anything. Another consideration at the time was on what actions to take to prevent a catastrophe that was about to happen. As Eric Halperin, Director, Center for Responsible Lending in Washington, DC explained, properties that were in foreclosure properties could be sold at a lower price than the market. Mortgage brokers, paid on commission, lured homeowners into borrowing even when they knew that the borrowers did not have sufficient capacity to pay. The mortgage brokers were responding to an incentive from predatory lenders whose only concern was selling more credit for short-term returns when they eventually sold the debt to investment banks (Young & Thyil, 2014).

Corruption of academics

The best remedy is to ensure that anyone in academics doing research or writing a report and having financial interests in any organization featured in the work should disclose the existing conflict of interest. A number of professionals received payment from the Iceland chamber of commerce to write favorable reports that would attract investments into Iceland. The reports glorified the economic situation of the country, despite its existing weaknesses and an untested model of financial liberalization. There is an interview with Glenn Hubbard, who was George Bush’s chief economic advisor (Inside Job, n.d.). He was also the dean of Columbia Business School.

Glenn promotes deregulation to protect private sector interests and sustain profitability of banks. In the interview seen in the documentary, Glenn appears as arrogant and unapologetic. Fredrick Mishkin, a former US central banker commits ethical mistakes of wiring a poorly researched article on Iceland and is adamant that he did not make a mistake (Inside Job, n.d.). He comes up with a flimsy excuse of a typo to explain changes in the title of the report from stability to instability when the crisis commenced.

It should have been the work of academics to point out the crisis and overbearing tactics of banks involved in credit default swaps (Daniel, 2008). The heads of the institutions had to meet performance targets and grow their company’s asset bases. However, academics could choose between selfish interest and public good. They only had monetary incentives to conduct or support biased research. The university professors were aware of the events that would lead to the crisis. They knew that the fundamentals of the system were not sufficient to prevent a catastrophe. They also knew that particular organizations were employing or paying them to keep the interests of shareholders checked and to divert their attention from economics fundamentals or the public good (Inside Job, n.d.).

Conclusion

The examples presented above show that economists have a financial conflict of interest. The case of Iceland showed that there was a lack of sufficient checks and balances. The report began with a mention of its support for a reevaluation of corporate governance because many companies are focusing too much on shareholders’ interest and forgetting market stability, business fundamentals and social sustainability of their business. The paper went on to discuss theoretical features of corporate governance and to discuss the financial crisis of 2008 – 2009 as presented in the documentary “Inside Job”. There is a discussion on the role of academics in stopping the crisis, and the argument here is that they failed to do their part and instead become corrupt by using their professional titles unethically.

References

Awotundun, D. A., Kehinde, J. S., & Somoye, R. (2011). Corporate governance and stakeholders interest: A case of nigerian banks. International Journal of Business and Management, 6(10), 102-112. Web.

Daniel, K. (2008). Capture and the financial crisis: An elephant forcing a rethink of corruption. Web.

Inside Job. (n.d.). Web.

Kaufmann, D. (2009). Corruption and the global financail crisis. Forbes. Web.

Klein, P. G., Mahoney, J. T., McGahan, A. M., & Pitelis, C. N. (2012). Who is in charge? A property rights perspective on stakeholder governance. Strategic Organization, 10(3), 304. Web.

OECD Observer. (2015). . Web.

Palmquist, M. (2013). . Web.

Singapore Management University. (2015). Bringing trasparency to financial reporting. Web.

Young, S., & Thyil, V. (2014). Corporate social responsibility and corporate governance: Role of context in international settings. Journal of Business Ethics, 122(1), 1-24. Web.

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IvyPanda. (2020) 'Corporate Governance in the Documentary "Inside Job"'. 11 June.

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