Lehman Brothers

and

Corporate Governance failure

By : Syed

Sagheer Abbas

Azhar

Akhter

Contents• Introduction.

• Brief history of Lehman Brothers.

• The Board Structure on Lehman Brother.

• Causes of Lehman Brothers failure.

o Corporate Governance Failure.

o Technical Causes of Lehman Brothers failure.

o Other Causes.

• Conclusion.

IntroductionOn September 15, 2008, Lehman Brothers Holdings Inc filed for bankruptcy. It filed for protection under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. It filed with $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide.

In this presentation we will focus in the corporate governance failure.

Why did Lehman Fail?

On 15 September 2008, Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection. Its bankruptcy filing listed debts of $613bn, and named banks from Tokyo, Hong Kong, New York, Singapore, Taipei and elsewhere as unsecured creditors owed hundreds of millions of dollars.

There are many causes of Lehman Brothers failure, we could divide them to tree categories as follow:

Causes of lehman Brothers failure

Corporate governance

failures

Technical causes

Others

Lehman Brothers had weak corporate governance arrangements which failed to safeguard against excessive risk taking are partly to blame for the economic crisis. Such failures remained hidden in a prosperous market but the downturn has revealed a number of flaws. The key areas of weakness that have been highlighted are:

• Corporate risk management;

• Board of directors;

• Remuneration scheme; and

• Nomination committees.

Corporate Governance Failure

Lehman Brothers had sex committee, one of them was a

Finance and Risk Committee, which consists of the

Firm’s Executive Committee, the CRO and the CFO,

should meet weekly to discuss all risk exposures,

position concentrations and risk taking activities, but it

only met twice in both 2006 and 2007.

Risk Management

LEHMAN BROTHERS, “Quantitative Risk Management Policy Manual”, September 2007, P. 3.

Sores:- Grant Kirkpatrick, “The Corporate Governance Lessons from the Financial Crisis”, UNCTAD, P. 68

Timothy Geithner (Secretary Of The Treasury),said in his

report, “Lehman’s plunge into high-risk businesses in the

years before its bankruptcy has become a familiar story. 

During this period of aggressive growth, Lehman developed

significant exposures to risky subprime lending,

commercial real estate, structured products, and high-risk

lending for leveraged buyouts.  Importantly, the Valukas

Report indicates that Lehman repeatedly breached its own

risk concentration limits in pursuit of higher earnings”.

Risk Management

Treasury Secretary Tim Geithner

NEW YORK (CNNMoney.com), Failings by Lehman

Brothers executives and its auditor led to the bank

collapse that unleashed the worst of the financial crisis.

According to a report by a court-appointed investigator,

“Lehman repeatedly exceeded its own internal risk limits

and controls," and a wide range of bad calls by its

management led to the bank's failure, says the report,

authored by examiner Anton Valukas.`

Risk Management

Lehman Brothers adopted a new strategy to overcome

their problems but this led to business risks because its

investments in long term assets like the commercial

real estate, private equity and leveraged loans had

more vague prospects and were less liquid than its

usual investments.

Risk Management

A study from researchers at Harvard University, 

“The Wages of Failure: Executive Compensation at Bear Stear

ns and Lehman 2000-2008,”

 shows that the top executive managers of Lehman Brothers

received about $1 billion respectively from cash bonuses and

equity sales between 2000 and 2008.

The Board at Lehman Brothers awarded total remuneration of

close to $500 million to Chairman Fuld, just four days before

its collapse and following an announcement that the firm lost

almost $4 billion in the third quarter, Fuld told the media that

"the Board's been wonderfully supportive."

Remuneration scheme

• Fuld (CEO) received nearly half a billion dollars in total compensation Between 1993 and 2007.

• In 2007, Fuld earned a total of $22 million, including:- a base salary of $750,000;- a cash bonus of $4.25 million; and- stock grants of $16 million.

• The staff received a disproportionately high percentage of their pay in Lehman stock and options. When the firm went public, employees owned 4 per cent of the firm, worth $60m. By 2006, they owned around 30 per cent, equivalent to $11billion, at least on paper.

Remuneration scheme

Four of the ten member board at Lehman

Brothers were over 75 years of age and

only one had current financial sector

knowledge.

Nomination

• One of the main failure cases in Lehman Brothers was the misbehavior of top

executives and the inaction of both the board and the auditing firm (Ernst & Young).

• There are many similarities between the collapses of Enron in 2001 and Lehman

Brothers in 2008, that they managed to reduce leverage on the right-hand side of the

balance sheet and, at the same time, reduce assets on the left-hand side. In Lehman

Brothers, Repo 105 transactions doubled between late 2006 and May 2008, were

known inside the corporation, exceeded the firm's self-imposed limits and typically

happened at the end of each quarter, when financial information had to be released.

Technical Causes of Lehman Brothers failure

• Lehman in the last year was unable to retain the

confidence of its lenders and clients, because it did not

have sufficient liquidity to meet its current obligations,

and on two consecutive quarters with huge reported

losses, $2.8 billion in second quarter 2008 and $3.9

billion in third quarter 2008, without news of any

definitive survival plan.

Technical Causes of Lehman Brothers failure

• The Wall Street equivalent of a coroner’s report, mention that Richard S. Fuld Jr, Lehman’s former chief executive, certified the misleading accounts, the report said.

• Mr. Valukas (one of the examiner) wrote in the report “Unbeknownst to the investing public, rating agencies, government regulators, and Lehman’s board of directors, Lehman reverse engineered the firm’s net leverage ratio for public consumption,”. The report states that Mr. Fuld was “at least grossly negligent”.

• Henry M. Paulson Jr., who was then the Treasury secretary, warned Mr. Fuld that Lehman might fail unless it stabilized its finances or found a buyer.`

Misleading

Henry M. Paulson Je.Shannon Stapleton/Reuters

Lehman Brothers filed for many reasons, corporate governance failures were the

most important, especially risk management.

Lehman Brothers failure and other failures that happened in the financial crisis will,

in turn, spawn a new wave of corporate governance reforms.

Conclusion