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A brief review of the role of shareholder wealth maximisation and other factors contributing to the global nancial crisis
Noel Yahanpath and Tintu Joseph
Eastern Institute of Technology, Napier, New Zealand
Abstract
Purpose In the aftermath of the global nancial crisis (GFC) governments lost condence in market fundamentalism and realised the inadequacies of regulatory measures. The purpose of this paper is to outline the proximate causes of the nancial crisis of 2007-2009 and to investigate the role of the shareholder wealth maximization (SWM) objective in the GFC. Design/methodology/approach The methodological procedure used in this paper is based on the historical case-study approach. Case reviews of individuals and world-level role models of the nancial crisis have been cited in this paper. From this aggregated material, the paper examines the side effects of the SWM objective in order to develop the argument that the SWM objective played a role in the present crisis. Findings The case studies revealed that unethical behaviour, agency issues, CEO compensation, creative accounting and risk shifting are some of the side effects of SWM. These cases indicate that the assumptions on which SWM are based are questionable. Further, it can be argued that the root cause of the GFC is excessive greed and the single-minded pursuit of SWM. Originality/value Though many studies have attempted to identify the proximate causes of the GFC, this paper is novel in highlighting the impact of the SWM objective function. Keywords Shareholder analysis, Wealth, Globalization, Recession, Strategic objectives Paper type Literature review

Qualitative Research in Financial Markets Vol. 3 No. 1, 2011 pp. 64-77 q Emerald Group Publishing Limited 1755-4179 DOI 10.1108/17554171111124621

1. Introduction The global nancial crisis (GFC), which had been threatening for some time, began to display its effects in the middle of 2007 and into 2008. Around the world, stock markets have fallen, large nancial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to develop with rescue packages to bail out their nancial systems. It is argued here that the problems could have been avoided if ideologues supporting the current economics models were not so vocal, inuential and inconsiderate of others viewpoints and concerns. What is more, it was never suspected, at micro level, that the corporate objective of shareholder wealth maximisation (SWM) had a major role in the crisis. The nancial sector, in spite of arguably being underestimated by some experts, remains one of the pillars of the contemporary process of production and consumption; this is why all developed economies have developed a strong nancial industry. The current nancial crisis brings to light nancial hypertrophy theory which argues that the origin of the current economic problems is that contemporary economies have excessively developed the nancial eld, neglecting the primary production process (Rafaschieri and Rafaschieri, 2009).

The deregulation of the capital and securities market in Europe and the USA in the late 1980s, which changed the nature of the production process, as well as the internationalisation of nancial transactions, is welcome results of economic globalisation. Many analysts consider the emergence of a trans-national nancial system as the most fundamental and dening feature of our time. Increased mobility among different segments of the nancial industry with fewer restrictions and a global view of investment opportunities were the attractions of the liberalisation of nancial trading. Advancements in the eld of data processing and information technology gave added momentum to the growth in tradeable nancial value. Aided by new communication technologies, global entities and speculators earned spectacular incomes by taking advantage of weak nancial and banking regulations in the economies of developing countries. The Central Bank of the USA, led by Federal Reserve Chairman Alan Greenspan, kept interest rates very low for a long time to blunt the recession of the early 2000s. The resulting under-investment and over-consumption by investors and consumers, respectively, prompted the development of a housing bubble that ultimately burst, precipitating the nancial crisis. This crisis, together with sudden and necessary de-leveraging and cutbacks by consumers, businesses and banks, led to the recession. Austrian Economists argue further that, while they probably affected the nature and severity of the crisis, factors such as a lack of regulation, the Community Reinvestment Act and activities of entities such as Fannie Mae and Freddie Mac are insufcient in themselves to explain the severity of the crash (Lawrence and David, 2009). In addition to macro-level issues, we discuss micro-economic factors in Section 3. Even though there is a well-developed body of knowledge in both areas, to our knowledge no attempt has been made to examine the role of the SWM corporate objective function in the crisis; in this paper, we have therefore revisited the issue, citing more recent case studies to argue that there are some fatal aws in the assumptions on which the pursuit of SWM is based. The remainder of this paper is organised as follows. The methodology is presented in Section 2. In Section 3, we briey discuss ve factors that contributed to the present crisis, in order to develop the argument that the SWM corporate objective function had a role in the GFC. Section 4 presents case studies to illustrate the side effects of SWM. Section 5 provides a discussion of the case studies, before Section 6 summarises and concludes. The main conclusion drawn from the study is that almost all of the root cause of the nancial crisis was the pursuit of SWM. 2. Methodology The methodological procedure used in this paper constitutes historical case studies and appropriate literature to examine the role of the corporate SWM objective function in the nancial crisis. Yin (2004) suggested using multiple sources of evidence as the way to ensure construct validity, while Levy (1988) shows that multiple case studies follow replication logic. Similarly, Stake (1995) argues that information generated by case studies would often resonate experientially with a broad cross-section of readers, thereby facilitating a greater understanding of the phenomenon. From this aggregated material the argument that SWM pursuit contributed to the crisis is developed.

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3. Factors that contributed to the GFC The world economy has overcome various phases of recession and nancial bubble before. However, the burst of the bubble this time had a severe impact because it was more than a simple nancial bubble, but involved a credit-fuelled real asset bubble as well. The liberal nancial policy has also contributed much to the crisis; in an interview with Finsia, Stephen Roach, Chairman of Morgan Stanley Asia, expressed the view that had the banks maintained a tighter nancial policy, a GFC would not have been possible, although growth would have been hampered. Politicians also focus on economic growth irrespective of the consequences; while trying to stimulate growth, government and other policy makers have to consider the cause-and-effect relationship (Stiglitz, 2010). Although too late, one aftermath of the crisis was that governments lost condence in market fundamentalism and realised the inadequacies of regulatory measures. In addition to the above broader issues, we argue that ve specic factors that contributed to the crisis and these are now set out. 3.1 Over-leveraging, credit default swaps and collateralized debt obligation When a company is nancially geared, the variation in the level of earnings due to changes in trading conditions generates more than proportionate variation in earnings attributable to shareholders. Hence, such companies are regarded as relatively risky (Pike and Neale, 2006). Whilst acknowledgement of nancial risk is long-standing in mainstream nance literature, it is argued here that it represents one of the reasons for the recent sub-prime crisis. In terms of the causes of the sub-prime crisis, which paved the way for the broader global nancial collapse, the following can be seen as the most important: . The tendency for low income (or sub-prime) US households to borrow excessively from banks and nance companies to buy their homes and then default on their debt obligations. . The sheer size of the sub-prime housing loan market about US$1.4 trillion. The growth in the market partly reected the US Governments attempts, since the 1990s, to extend home ownership, which in turn placed pressure on mortgage lenders to increase loans to low- and moderate-income individuals and households (Hull, 2009). . Wall Street nancial engineers packaged these loans as highly complicated nancial instruments called collateralized debt obligation (CDO). As is now well known, The US and European markets invested heavily in these products. As defaults on US home loans rose, the nancial instruments that were based on these loans lost value and CDO prices started plummeting. The falling prices in turn dented banks investment portfolios and the losses destroyed banks capital. Defaults on mortgage loans were the trigger for the nancial crisis sweeping the world. As the housing loan crisis intensied, banks grew increasingly suspicious about each others solvency and the ability to honour commitments. The interbank market shrank and disrupted the ow of funds, which culminated in the problems in the global banking system. 3.2 Models and quantitative nance CDOs and credit default swaps (CDSs) were constructed by using complex models based on restrictive assumptions. The house price defaults were estimated using prices of CDSs rather than through more rigorous and complicated methods. The market was

persuaded that the business cycle had changed, and a period of moderation was expected. The anticipated end to excessive volatility in economic output and ination was based on trends observed in the previous 20 years. When this prediction proved to be untrue (with disastrous results), the realization came too late for many (Barrett, 2009). The players in the nancial market (both new entrants and the more nancially literate) failed to understand the nancial products, such as CDOs. Asymmetric information compounded the misjudgment. A factor that unquestionably amplied the magnitude of the crisiss impact was the widespread miscalculation by banks and investors of the level of risk inherent in the unregulated CDO and CDS markets (Crisishelper, 2009). Accordingly, banks and investors systematised the risk by taking advantage of low interest rates to borrow large sums of money that they could pay back only if the housing market continued to increase in value. The Austrian School of Economics suggests that the crisis is an excellent example of the Austrian Business Cycle Theory, in which credit created through the policies of central banking give rise to an articial boom, which is inevitably followed by a bust. This theory argues that the monetary policy of central banks creates excessive quantities of cheap credit by setting interest rates below where they would be set by a free market. This easy availability of credit inspires a bundle of malinvestments, particularly on long-term projects, such as housing and capital assets, and also spurs a consumption boom as incentives to save are diminished; an unsustainable boom thus occurs (Antony and Gregory, 2001). 3.3 Securitisation and misjudgment of risk The securitisation of assets in the years prior to the crisis represented an attempt at managing risk; while this could be argued as being a prudent course of action, the specic nancial instruments used contributed to the severity of the crash. Investors considered derivatives, nancial futures, CDSs and related instruments as a means of insuring against risk and, as they initially made more money by taking more risks, it reinforced their view that they had got it right. Therefore, banks and hedge funds became over-condent and over-reliant on nancial instruments for managing risk, wrongly thinking that they had spread their risks effectively whereas in fact when things went wrong, the effect was disastrous. Derivatives did not trigger the current nancial meltdown, but they did exacerbate it once the subprime mortgage market collapsed, because of the inter-linkages amongst investments. The nance industry ourished as investors began examining how best to insure against risk. When considering how to price this insurance, economists came up with the option of a derivative that gives someone the right to buy something in the future at a price agreed in the present. Mathematical and economic experts believed they had devised a formula for how to price such an option; the Black-Scholes model. This was a hit; once options could be priced, they became easier to trade and a whole new area of risk management was born. Combined with rapid developments in information technology, the derivatives market exploded, making buying and selling of risk on the open market possible in ways never seen before. As people became successful quickly they used derivatives, not to reduce their risk, but to take on more risk to make more money (Stiglitz, 2010). Greed started to compound and companies began venturing into areas that were not necessarily part of their core business.

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The integrity of credit rating agencies is also under the spotlight, as it is partly responsible for the present crisis. Boyle (2009) argues that the issuer-pays model of ratings agencies encouraged the generous evaluation of subprime-linked securities and encouraged lenders to turn a blind eye to borrowers shortcomings. While credit rating organisations have served investors and the market well for nearly a century, ratings on US housing-related structured securities in recent years have, regrettably, generally failed to perform as well as intended (S&P, 2009). In this context, Hull and White (2009) examined whether assigned ratings were reasonable and found that AAA ratings for the senior tranches of asset-backed securities (ABSs) were not unreasonable; however, they concluded that the AAA ratings awarded to senior tranches of mezzanine ABS CDOs are much less easy to defend. 3.4 Inadequate governance and regulations A system of corporate governance requires that a board of directors be accountable to regulators, while allowing the board to create wealth for the shareholders of the company. While recognising these twin objectives of a system of good corporate governance, rms might usefully direct their attention towards issues of control and accountability. It has been found that a far greater understanding of the links between governance mechanisms and their effects on accountability and enterprise is required, in order to ensure that measures to increase accountability do not have unforeseen effects on the enterprise activities of the corporation (Short et al., 2009). WorldCom is a good example of inadequate corporate governance leading to an unexpected collapse. By 2001, WorldComs growth had started to decline, revenue began to decrease, debts rose and, along with continued over-capacity, these changes forced the company into severe decline (Boyd, 2003). The stock value slipped from a double-digit gure to US$0.50. Trading in WorldCom was stopped and, in June 2002, company ofcials confessed that the rm had inated its prot by improperly accounting for more than US$3.9 billion[1]. A detailed investigation further revealed that: accounting entries were made without documentation (as directed by the senior management of the company), prot was reported in times of losses, executives led statements to the SEC that treated current expenses as capital and manipulation of specic reserves were detected from the books of WorldCom. Financial experts have pointed out that WorldComs accounting practices, particularly those relating to the acquired businesses, made it impossible for investors to gauge the performance of the company (Zekany et al., 2004). Revisions of nancial statements were thus the norm in WorldCom. While protability was overstated, investors were misled by the opaque nature of its regular operating performance. 3.5 Fair value and accounting standards International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles dene the fair value of nancial instruments in a three-level framework:, i.e. the observable market price of the instrument, or the observable market price of a similar item or the result of a nancial valuation model. The IASCs framework for the preparation and presentation of nancial statements views fair value as reecting relevance, reliability, understandability and comparability (Chisnall, 2001). The ongoing nancial crisis has caused much nger pointing at fair value accounting for nancial instruments, as set out in IFRS and US GAPP, particularly IAS 39.

Prominent nancial leaders singled out fair value and the related wide use of mark-to-market accounting as major factors in the crisis. In this context, fair value accounting has prompted two specic criticisms: illiquidity and pro-cyclicality. The illiquidity criticism focuses on complex products resulting from the securitisation of assets, such as mortgage loans, which are at the core of the current nancial crisis. The illiquidity criticism notes that the market conditions for many complex nancial instruments are characterized by an imbalance between supply and demand, which means that market prices are rendered abnormal by the evaporation of liquidity and, as such, may bear no relation to the underlying value dened as the potential to generate future cash ows. The pro-cyclicality criticism is broader in scope; according to it, the very idea that observable market prices provide the best possible indication of value is awed because it boosts the apparent robustness of banks balance sheets at the top of the cycle and reduces it by the same measure at the bottom (Veron, 2008). The factors outlined above are of course only a few of the numerous contributors to the GFC. In particular, we argue that the excessive greed, allied to the dominance of the SWM had a signicant impact on the crisis. The next section explores this issue by reviewing relevant extant case studies and prior studies. 4. Side effects of the corporate objective function of SWM Corporate nances greatest strength and its greatest weakness are its single-minded focus on value maximisation (Damodaran, 1999). Every rm tries to achieve this corporate objective through careful planning and the implementation of investment, nancial and dividend decisions. Had all boards of directors being successful in their assigned role of protecting all stakeholders of the rm, rather than just shareholders, then we believe that the GFC would have been avoided. Most business concern is focused on prot maximisation. However, prot maximisation fails for a number of well-known reasons; it ignores: (1) the timing of returns; (2) the cash ows available to shareholders; and (3) risk. Without explicitly considering these factors, higher earnings alone do not necessarily translate into higher share prices (Gitman et al., 2008, p. 13). 4.1 Conict between shareholders and bondholders The most common ways that managers take action to achieve SWM at the cost of bondholders are: investing in risky projects, paying more dividends and increasing nancial leverage. If the executives are also shareholders then there may be a further tendency for them to want to maximise shareholder wealth, which could be detrimental to the bondholders (Ertugrul and Hegde, 2007). In the recent past, there have been ample cases of related party transactions, insider trading and other attempts to expropriate funds for the benet of shareholders. For example, the US Securities and Exchange Commission (2010) allege that Goldman Sachs failed to disclose to investors vital information about CDOs, with Paulson & Co., having an economic incentive to select residential mortgage-backed securities. Capital and Merchant, a New Zealand nance company, disclosed $10 million of related party loans on the balance sheet but further investigation by the receivers uncovered $80 million of related party loans that were not

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disclosed and unrecoverable. St Laurence Limited suffered a similar fate with its abundance of related party loans, including substantial transactions between itself and Dorchester Finance Limited. Shareholders carry more risk than bondholders because they are entitled to the prots remaining only after all other stakeholders and creditors are paid. If nothing is left, they do not receive any return as they are the residual claimants of a companys prots. If a company generates large prots, shareholders enjoy the highest returns. Meanwhile, lenders keep receiving the same interest payment year in and year out, regardless of the level of company prots. By contrast, owners keep whatever prots are left over and therefore can receive a greater return on their capital. Shareholders lose value before bankruptcy; bondholders hurt much more in bankruptcy than shareholders (Ross et al., 1996). This statement is especially true in current market conditions. While the traditional goal of the rm is MSW, this should occur while being able to meet its nancial commitments, including repayments to bondholders; such an approach provides the best results for both shareholders and bondholders. More recently, the steep drop in the value of Citibanks bonds indicates fears that the US Government will take over the institution and compel bondholders to take big losses. The Managing Director of Institutional Risk Analytics, Christopher Whalen, argues that: Its a done deal that Citibank shareholders would be wiped out completely in nationalization but bondholders could also be in for a real whacking (Elestein, p. 1). The Australian Shareholders Association (2005) states that the basic expectation of the shareholders is the generation of maximum cash ows and prot, while the bondholders expectation is always the committed cash ows. Bondholders reasonable expectations are held to be more limited than those of shareholders, and should be limited to terms of trust indenture and prospectus (Hewat and Richler, 2009). There are covenants which restrict actions that shift risk to bondholders, and also to compensate them with accelerated rates of interest, with every increase in the risk component. Even amidst these restrictive covenants, managers/agents nd ways to shift risk from shareholders to bondholders and thus increase the value of shares at the expense of bonds. Even though conict between shareholders and bondholders is one of the side effects of the pursuit SWM, it is less clear that this conict has contributed to the present crisis directly. However, as noted above, excessive greed has contributed directly or indirectly to the dysfunctional behaviour and institutional failures at the heart of the global crash. 4.2 Agency issue Damodaran (1999) explains that, in the real world, managers perform the decision-making function with four factors or linkages in mind: shareholders, bondholders, society and nancial markets. Competitive market conditions place signicant pressure on agents and managers who will be tempted to resort to unethical means to portray a positive picture. It is acknowledged that the wealth maximisation objective is not always compatible with a rms social obligations, and it usually involves an agency problem which arises when the managers fail to act in the best interests of the shareholders, preferring instead to benet themselves (Jensen and Meckling, 1976). Differences in the objectives of ownership and management lead to agency costs; if these are to be controlled, the shareholders must maintain a strict watch over the functioning of the company. The managers should be rewarded for acting in the interests

of the shareholders and the managers should maintain a balance between the interests of the shareholders and other stakeholders. In this context, the GFC highlighted the important inuence that incentive structures within nancial institutions and other businesses can have on risk-taking and nancial performance. In particular, it highlighted the dangers of badly designed remuneration incentive arrangements leading to excessive risk-taking, poor nancial performance and a bias towards short-term results at the expense of longer-term nancial soundness (Mortlock, 2009). 4.3 Executive compensation and inappropriate incentives It is well documented that executive compensation packages should be designed to align the interests of senior management with those of the shareholders and thereby reduce the dysfunctional behaviour of managers; this is typically done by rewarding executives for taking decisions and actions that increase shareholder wealth (Mortlock, 2009). Unfortunately, the shareholders (and directors) may have neither complete information about the actions of executives or the expertise to evaluate those actions, making it difcult to base compensation on actions alone. Instead, compensation in practice is often linked to measures that are positively correlated with managerial performance, for instance market share, share price or accounting prot. The World at Work (2007) Handbook discusses the various components of executive compensation packages, such as base salary, bonus, perquisites, stock options, stock grants, pensions and severance payments. These components have varying effects on executive motivation and risk, and also different costs for the corporation. Consequently, stock options became an ever greater part of executives compensation, increasing from 27 per cent in 1992 to 60 per cent in 2000 (Smith and Russell, 2003). The xing of base salaries for executives is often guided by the salaries paid to peers in the same industry. A xed salary will reduce the risk to the executives and guarantee a standard of living. On the other hand, it may not encourage them to improve their performance in order to maximise shareholder wealth. The use of golden handshake and golden parachute clauses in management contracts may also be driven by managers acting to further their own interests, rather than those of their shareholders. Matsumura and Shin (2005) characterized conicts of interest between shareholders and managers as usually arising in three broad areas. First, executives enjoy (as well as exploit) the perquisites provided to them. Second, executives are more risk averse in decision making and aim for better compensation as a trade-off. Lastly, executives are more interested in making decisions that have short-term impacts rather than taking a long-term perspective. By designing executive packages in a way that balances the interests of shareholders and executives, these conicts can be reduced. The packages should be so designed to motivate the executives, whilst at the same time allowing management to control the amount spent on compensation, based on the performance of the CEOs themselves. Mortlock (2009) notes that the major nancial and corporate sector distress seen in the USA and Europe in recent times is partly attributable to poorly designed remuneration incentive arrangements. 4.4 Ethics and social responsibility While emphasising SWM, the principle of ethics and its impact on the value of the rm is disregarded in many instances. The importance of ethics in the corporate decision-making process becomes important in view of the sheer number of stakeholders involved.

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It should come as no surprise that the advocates of wealth maximisation uphold the principle of utilitarianism in essence, an ethical version of maximisation. Fundamentally, the professional viability of ethical principles themselves is at stake. By denition, ethics involve the consideration of right and wrong in decision making and policy formulation. At the same time, it should be clear that the nancial maximisation principle itself offers no real ethical guidance in a corporate governance context (Halbert and Ingulli, 2008). However, research conducted by Van de Velde et al. (2005) concluded that socially responsible companies out-performed non-socially responsible companies, although the difference was not signicant. Evidence of this sort suggests that being socially responsible is advantageous to investors wealth in the vast majority of cases. The economic welfare of shareholders is a matter of prime concern to every corporate entity. According to conventional economic reasoning, corporations have a specied set of responsibilities primarily to maximise shareholders wealth while functioning efciently under conditions of perfect competition. However, the situations of imperfect markets and information asymmetries have become extremely signicant in the present climate. Many academicians consider the rm as an input-output model by explicitly adding all interest groups employees, customers, dealers, the government and society at large. Therefore, it becomes imperative to identify and label the pertinent factors which contributed to the nancial crisis and to identify the role of the SWMs theme in this regard. 4.5 Efciency and fairness in nancial markets In order to achieve growth in the global economy, nancial markets should be efcient and fair. The concern with efciency and fairness has led to various schemes of nancial market regulation being suggested. Debate about efciency and fairness, and the roles of market forces and regulations, reveals a continuing attempt by society, through its legislative process, to nd the right balance of these elements. Informational efciency is achieved when all investors hold objective beliefs and information in common, so that competitive prices accurately reect that information. Shefrin and Statman (1993) held that in a fair market, all parties have equal access to information relevant to asset valuation, but are entitled to nothing more, as well as speaking of informational efciency as being achieved when all investors hold objective beliefs and information in common. Included in Shefrins description were seven classes of nancial market fairness: freedom from coercion, freedom from misrepresentation, equal information, equal processing power, freedom from impulse, efcient prices and equal bargaining power. As noted above, the cases of Enron and WorldCom provide evidence that unfair and inefcient information are strong enough to shake the whole nancial system. However, the manipulation of accounting gures has a long history in the developed world, and governments the world over have tried to introduce order and transparency to the functioning of companies and capital markets. When the company is indulging in any type of articial stock market manipulations it is often the small investor who is enticed into this speculative trading and eventually loses when the collapse begins. 4.6 Corporate greed and creative accounting Creative accounting is the manipulation of nancial numbers, usually within the letter of the law and accounting standards, although its use can be unethical and does not

provide the true and fair view of a company that accounts are supposed to provide (Moneyterms, 2009). As detailed below, many of the recently failed companies used creative techniques to mislead current and potential investors. Whether through income smoothing, inating prots, manipulating assets and liabilities, derivatives and hybrid instruments or off balance sheet nancing, the nancial positions of many companies were distorted so that they were seen in a favourable light, thereby encouraging further investment and facilitating continued trading. In December 2001, Enron, one of the worlds largest electricity and natural gas traders, led for Chapter 11 bankruptcy protections. The CEO, Kenneth Lay, persuaded the employees of Enron to buy the companys stock. Just three weeks later Enron reported a heavy loss and drift in shareholders equity. Employees lost their retirement and other savings tied up in Enron shares, as well as their jobs. It was later discovered that Mr Lay had made US$205 million in stock option prots in the previous four years. Many banks were exposed to the rm, having loaned money and traded with it; for example, JP Morgan admitted to US$900 million of exposure and Citigroup to nearly US$800 million. Former high-ranking Merrill Lynch bankers were charged with fraud in connection with Enron transactions, while the auditors Arthur Anderson, who failed to audit the Enron books correctly, collapsed. Enrons collapse, in conjunction with the failure of several hitherto popular and famous corporations, severely shook investors condence, with many becoming cynical about the nancial data reported by corporations, even when audited by big rms. An examination of history reveals that a range of practices, unrelated to any major improvement in cash ows and/or prots, have been carried out with the intention of increasing wealth; for example: accounting manoeuvres with deceitful intention and accounting fraud (in the case of Xerox), improper accounting, deviation from accounting principles with deceitful intention, leveraging of shares to raise debt for expensive acquisitions (as in the case of WorldCom), stretching the limits of accounting by misusing its limitations, lack of transparency, intentional projection of a rosy picture of performance (in the cases of Enron and Arthur Anderson), massive fraud, accounting scandal (in the case of Peregrine Systems), aggressive acquisition strategies and accounting frauds (in the case of Tyco), diverting business cash into off-shore, family-owned entities, articial support given to the stock of the company (in the case of Polly Peck), deceitful intention of elite and experienced hands with sophisticated outlets (in the case of BCCI banks) and highly leveraged synthetic nancial instruments (in the case of Goldman Sachs). Common to all the cases mentioned above was managements single-minded focus on SWM. By attempting to grow the company at high speed and by using creative accounting techniques, managers had failed to foresee the detrimental affect these actions would have in the long term. In this regard, and building on the aggregated material outlined in Sections 3 and 4, the next section develops the argument that one of the causal inuences on the GFC was indeed a corporate objective function dominated by SWM. 5. Discussion Damodaran (1999) stated that the SWM objective is based on the following four assumptions. First, all costs created by a company in pursuing SWM can be traced and charged to the rm. Second, the interest of all lenders and bondholders will be protected. Third, the managers of the company disclose all relevant information about

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the companys future prospects to the nancial markets. Lastly, the managers set aside their personal objectives and focus on the corporate objective function. It is clear that, in light of the side effects of SWM as discussed in Section 4 particularly their impact during the crisis the validity of the above assumptions has become questionable. In this regard, Jenkins and Guerrera (2010) argue that the recent SEC attack on Goldman Sachs strikes at the heart of the business model, a model that, as Friedman (1970) states, views the social responsibility of business being to increase its prots. However, as an agent, a manager is bound to act to maximise the wealth of shareholders, rather than to follow an agenda of social responsibility, this is evident in the cases and other supporting literature cited in Section 4. As noted earlier in the paper, the origins of the credit crisis can be found in the US housing market; more specically, the root cause lies with the problem that, when considering new mortgage applications the question was not, Is this credit we want to assume? but was instead: Is this a mortgage we can make money on by selling it to someone else? (Hull, 2009). This reasoning clearly illustrates that the aws in the SWM approach, allied with greed of the mortgage brokers and mortgage lenders, motivated them to relax their lending standards (Stiglitz, 2010). The fraudulent behaviour of chief nancial ofcers was sometimes motivated by the SWM-based corporate objective function and it brought about a hasty government reaction. The Sarbanes-Oxley Act of 2002 (SOX) was enacted by the US congress on 30 July 2002; SOX reformed US accounting rules and put in place a new regulatory body which was independent of audit rms (Arrunada, 2004). This sweeping reform required that a company strengthen auditor independence, have its CEO sign off on nancial statements, obtain an opinion about its internal control systems and have its internal audit function examined by external auditors (Grumet, 2007). The introduction of SOX should reduce managerial propensity to use creative accounting techniques to entice investors in the difcult post-crisis years. From the case studies cited in this paper, it is clear that major issues like unethical behaviour, executive compensation, creative accounting and conicts of interest, pushed the big entities towards major difculties and, in many cases, collapse. Though a series of accounting regulations were designed and directed, many giant organisations found convenient loopholes to take advantage of or, if this was not possible, resorted to manipulative means, actions which ultimately contributed substantively to the nancial crisis. Hull (2009) argues that the inappropriateness of extant incentive schemes led to a short-term focus in the managerial decision making. Given this situation, in February 2009, US President Barack Obama introduced new restrictions on executive compensation for institutions that receive nancial assistance from the government, by limiting cash compensation to US$500,000; similarly, the USs Financial Stability Board released a set of principles aimed to ensuring effective governance of compensation and the effective alignment of compensation with prudent risk taking. These developments in turn suggest that the SWM objective is neither self-regulatory nor awless in nature. As we have discussed in this paper, the reasons for the burst of this nancial bubble are many. However, most of the factors are (directly or indirectly) linked to the pursuit of SWM. The above discussion has shown that each factor had in common the desire to increase the value of owners wealth. It appears reasonable to argue that, by forgetting the importance of ethics and deviating from accounting principles, the greed paid off.

6. Summary and conclusions Excessive greed, obsolete accounting standards, conict between accounting and consulting, rendering of non-audit services and retired auditors sitting on boards of companies were identied as vital issues contributing to nancial misbehaviour, which led in turn to the nancial crisis at the micro as well as the macro level. However, if the above anomalies, problems and incidents can be subjected to robust governance standards, it may help to minimise the gravity of the problem. In the opinion of Stephen Roach, we need a global systemic risk regulator as part of a broader move towards risk management. Risk shifting and dysfunctional behaviour are some of the side effects and aws in an SWM-based system that is not self-regulatory. Maino et al. (2010) argue that the philosophy of efcient and self-correcting markets and intermediaries in the global nancial system represents one of the main causes of the crisis; this logic underpins our view that the SWM objective had a major inuence on the crash. However, the degree of inuence depended partly on the government regulatory environment and economic system; thus the argument is not equally valid universally. The collapse of Arthur Andersen in the wake of accounting manipulations found in Enron, along with the events at WorldCom, Waste management, Sun Beam, etc. have caused investors to raise serious concerns about the reliability of modern auditing. However, the events at Enron and Andersen resulted in several positive outcomes; a number of corrective measures were initiated worldwide to counteract corporate fraud. Indeed, many corporate governance and accounting reforms were enacted in the USA in the wake of the collapse, followed by similar reforms worldwide. The Sarbanes-Oxley Act brought in stiff penalties for violation of US securities laws. Again, we argue that the root cause of this manipulative and dysfunctional behaviour was greed and the single-minded objective function of SWM. Because of a strong focus on prot maximisation or even SWM, the corporate decisions that led to the economic downturn were never balanced with any good citizen approach. But value maximisation alone is no longer sufcient in todays competitive global business environment; organisations need to focus on objectives that have long-term benets rather than short-term value. By taking stakeholders and society into consideration a rm will truly begin to create sustainable wealth; while the corporate objective function is dominated by SWM this cannot take place.
Note 1. The Department of Justice identied a further US$3 billion as improperly recorded.

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