There is a correlation between successful companies and good governance. However, shareholders are focused on less successful companies' governance. Once a company is beyond a respectable degree of success and it has reasonably traditional governance mechanisms, there is not a problem to be solved.
The problem arises when there is a failure, as with the banking industry in the global financial crisis. It was to do with the importation of America's aggressive bonus culture, incentive compensation sales systems in retail banking, PPI mis-selling and so forth. There was either a lack of supervision by management in terms of the degree of risk that the company ran, whether that was an overextension of the balance sheet and its inability to fund it, and/or the level of risk implicit in its activities. There must have been a lack of board oversight of the overall process.
I went into RBS as part of the rescue and found two things had happened that caused the problem there. One was that the investment bank went out of control, which was not reigned in by the chief executive or the board. Two, the acquisition of ABN AMRO at the top of the cycle compounded each other's effect. So, instead of the company having a serious problem, it had a terminal problem. If the oversight forces had been more effective, then other decisions would have been made. Individual directors should stand up and be counted and the board should heavily scrutinise the behaviour of management and their results.
If you are in a very successful country, a company is likely to get carried by the current. Therefore part of a company's success is being in the right place at the right time and swimming downstream. In some ways that context can be helpful, but it could be unhelpful.
I have been in business for 46 years, and in that time I have never ever seen a proposal, whether it is a loan or an investment, where the cashflows do not go up. I have never seen a business plan that builds in a downturn of the economic cycle. Management is therefore inherently optimistic – there needs to be a deposing force which says that the board should be sceptical, to offset this inherent force.
Businesses must give something up in good times for the preservation of value in difficult times. If they overextend themselves and take too much risk, the consequences in difficult times are more severe and this is deeply felt in banking. For example, if a bank gets into difficulties in a downturn, it takes seven to 10 years for it to normalise, and by normalise I mean earn its cost of equity. For example, seven years after the global financial crisis Barclays is trading at 0.6 times its book. And RBS is still partly owned by the government.
You can read the full interview with John McFarlane, Executive Chairman of Barclays, in the latest issue of Governance and Compliance or on the website.
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