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Corporate Governance, Risk Management, and the Financial Crisis: An Information Processing View

Authors


Fordham University, 1790 Broadway, Suite 1147, New York, NY 10019, USA. Tel: +1-718-817-5101; Fax: +1-718-817-5544; E-mail: pirson@fordham.edu

ABSTRACT

Manuscript Type: Perspective

Research Question/Issue: What were the reasons for poor risk management on the board level before and during the financial crisis? Were there systemic information processing problems that an alternative board design could alleviate?

Research Findings/Insights: Using an information processing perspective, we identify two reasons for boards failing to manage risk well during the financial crisis: (1) board members did not have access to relevant information on the risks management incurred because they had no control over information supply; and (2) board members were unable to process the available risk-related information, and lacked incentives or power to influence managerial decision making. Based on insights from cybernetics and decision making theory, we suggest increasing board level information processing and decision making capabilities by including multiple boards for different stakeholders to create a division of power and labor. We label this alternative structure network governance and posit that it allows superior risk management.

Theoretical/Academic Implications: The paper illustrates that the unitary board structure's systemic shortcomings increase the likelihood of poor risk management at the board level. The solutions proposed are an important theoretical advancement of the discussion on ongoing board failure in increasingly complex business environments.

Practitioner/Policy Implications: This paper is one of few providing actual recommendations based on a systemic insight. Enlightened shareholders and/or managers could introduce network governance by amending corporate constitutions. Regulators should require firms considered too big to fail to adopt network governance or pay the cost for regulators establishing a risk-monitoring unit in each firm.

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