Rebuilding Trust in the Financial System

By Olu Akanmu

“…Markets rely on rules and laws, but those rules and laws in turn depend on truth and trust. Conceal the truth or erode trust and the game becomes so unreliable that no one will want to play. The market will empty and share prices will collapse, as ordinary people find other places to put their money-into their houses, maybe, or under their beds…”
-Charles Handy

The financial service industry needs to rebuild trust. Without trust, the industry cannot stand. When a Goldman Sachs would sell financial derivatives products to its clients, and create a counter product to bet against them on the basis that they would fail and made billions of dollars, on the basis of its successful bet, something has fundamentally gone wrong with banking. The engagement of the US Congress with Goldman Sachs executives was very revealing. The Goldman executives tried to show that they did not break the law, that what they did was legally permissible. It does not matter. It is unethical. Goldman Sachs clients who bought the financial derivatives products that it sold trusted it. Goldman, by betting against its own product did not believe in what it sold. By making billions of dollars on its successful bet that the product it sold would fail, it betrayed trust. At home in Nigeria, we are also dealing with trust issues. The audited reports of many of our financial services institutions have had to be reviewed with the effect of a night and day difference in the reported health of those institutions between 2008 and 2009. Yet, the public took its investments decisions on these institutions based on their previously reported financial health. Many have lost money. Many were ordinary retail investors participating in the stock market for the first time. These are our own “Main Street” people. Their investments, sometimes life savings have been eroded. They remember the banker or the stock broker who visited them in their offices and homes and sold the bank’s shares to them. He had the figures and the facts, well presented. He is a banker, their brother, their sister or even their church member. Why should they not trust him? They are disappointed. They have turned away from the market and lost confidence in it. It is however not about banking alone. If the same auditors work for the banks and other non-financial service companies , we should reasonably expect that there would be issues in the audited financials of the manufacturing and other sectors, if they are subjected to same rigorous test. The issues of the financial service industry might therefore be a reflection of a more general pervasive but not yet very visible problem of big business. Yet, it is critical that our financial services industry regain public trust. Their financial intermediation role in the market is critical to the efficient allocation of capital to where it would be best utilized, a critical function for economic growth. Organizations and individuals are the players in the financial markets. To trust the market, we must trust the organizations that play in it. It is in the self-interest of these organizations to get the public to trust them again, so that they can play their role and fulfill their reason for being. What therefore, do business organizations and financial market players need to do, to get the public to trust them again?

First, we need a new regime of transparency in business organizations. Transparency is a critical foundation of trust. Companies must commit to transparency with its external publics especially its shareholders. To do this however, the companies would first need to be transparent to themselves. According to Warren Bennis and James O’Toole, Professors of Leadership and Business Ethic s “..No organization can be honest with the public if it is not honest with itself..”. Internal transparency is therefore a prerequisite for external transparency. Information that is true on the business and its performance must flow more freely among managers and employees of companies. Free information flow pre-supposes that the processes that generate the information themselves are transparent. Access and control of information tend to be seen wrongly as a privilege of power. And sometimes, the restriction of information flow is excused on the basis of protecting critical information from leaking to competitors. This concern however has to be balanced with the imperative of organizational transparency ensuring that employees as critical internal stakeholders know the business, its financial performance and can question their leaders with candor on the performance issues of the company. This will engender trust between the organization, its leaders and its staff. And if the leaders of a company can be transparent to its staff by information and by internal process, they will have little problem in being transparent to its shareholders and the general public as they would have first built a culture of transparency internally. Of course, we do recognize that leadership commitment alone is not sufficient to make internal transparency happen. The governance structure of the organization is critical, a functioning board, that enforces by policy and by its policy audit processes, transparent processes and information flow as part of larger commitment to external transparency to the shareholders and the larger public. In addition, we will like to recommend the evolution of a new set of players in the financial markets which we call Transparency Auditing and Rating Organizations (TAROs). Just as countries are rated on the basis of their Transparency and social governance by organizations like the Transparency International, companies could be rated by the TAROs on the basis of their internal transparency and corporate governance. The TAROs will fuse the model of the Credit Risk Rating agencies like Standard and Poor, with country transparency audit model of the Transparency International. We expect that good companies will submit themselves for Transparency audit and bad companies will not. We expect that the market will factor this formal independent transparency audit into the risk rating of the company and the determination of the cost of capital to the company. Essentially, transparent companies will be rewarded by lower cost of capital and better share prices.

Secondly, to rebuild public trust in business, we need an overhaul of our auditing standards and corporate financial reporting. This is obvious. The Nigeria Accounting Standards Board and the Institute of Chartered Accountants of Nigeria (ICAN) have a responsibility to make this happen. In their seminal work on the subject of Corporate Financial Reporting and Public Trust, Samuel DiPiazza, Global CEO, of PricewaterhouseCoopers and Robert Eccles said as follows “..Information is the lifeblood of the capital markets. Investors risk their hard earned capital in the markets in great measure based on the information they receive from their target companies…When information comes from companies, investors need confidence that it is complete, accurate and trustworthy..Investors understand that in free capital market, the opportunity for gain comes with the possibility of loss. But investors have the right to expect that the benefit or consequences will result from the decisions they make, not from flawed information….”. Financial reporting and auditing can no longer be done with a subtle hint of Caveat Emptor. To the extent that the lay public, our Main Street, is participating more actively in financial markets as it gets more deepened, they need to trust financial reports, and they need to get it increasingly in the formats that make meaning to them. If the auditing and accounting profession will keep public trust and fulfill its social purpose of an independent attester of the financial health of public companies, it must increasingly think and act this way. It is apparent that given the wide disparities in the financials reports of banks between 2008 and 2009 and similar events in Cadbury some few years ago, that our national auditing standards may not be sufficient to un-earth and report the true financial health of our corporations. We also need specific industry standards that allow transparent and objective comparison of companies on their performance ensuring that measurements are standardized among players in the same sectors. For example, who is the second largest telecom company in Nigeria? It depends on who you ask, on what you measure and how you measure it. If the second and third telecos in Nigeria were to come to the market, unless such industry standards are defined, it will be difficult to compare them objectively for investment decisions. The issues apply to other industry sectors as well. Good transparent companies would however go beyond industry standards disclosure requirements. Good companies will un-opaquely disclose their strategic plans, corporate governance, risk management practices, shareholding structures and compensation policies. They will show why they are the best parent of the businesses they manage and if they are not, what they are doing to ensuring so. These three practices, adoption of higher auditing standards than we have today, industry specific standards in financial reporting and company specific disclosures on policies, plan, shareholding structures and business practices, will improve the integrity of financial reporting and engender better public trust in our corporations. This will also correct information asymmetry in the financial market s ensuring that information flow more freely among market players, making the market more efficient in its role of allocating capital and resources to where it would get the best returns.

Thirdly, the larger Nigerian society and investment community must change its lottery (kalokalo) paradigm of the investment market. While there will always be short term arbitrage opportunities in markets due to information asymmetries that some investors could exploit for short-term gains that are akin to playing lotteries, the larger society cannot be investing with a kalokalo paradigm that excludes business and market fundamentals. That is a key lesson of our financial markets in the last five years. Unreasonable kalokalo expectation returns of investors from companies tend to compel the managers of those companies to look for kalokalo profit that has little bearing with their business fundamentals. And when they do not meet the unreasonable profit which they have promised the market, they tend to look for short-cuts to cover the gap. If they succeed the first time, the kalokalo investor expectation gets even stronger fueling a stronger kalokalo profit promise and even more dangerous short-cutting by company managers. Intuitively, we (investors and company managers) recognized that we should not trust each other, but everyone tried to be smart in the market- game in their little space, as if they could cocooned out the larger market fundamentals from their space. Eventually, the complex interactions of our several games created a market-burst that blew in everyone’s face. To correct this and rebuild trust between investors and company managers, three set of players in the corporate reporting supply chain will need to play some critical roles. As discussed earlier, independent auditors need to raise their standards to report what is truly reflective of the financial health of corporations. Secondly, the third party Analyst community will need to be more rigorous and more clearly separate itself from the stock brokers to ensure independence and objectivity. The third party analyst community in Nigeria, seem not to have an independent defined structure outside the stock broking professional community. They need to raise their standards, self- regulate themselves and take public accountability for the integrity of the advice they give the investment community. Our third party analyst tend to use valuation models that relate stock values only to their peers in the same or similar sector within the Nigeria market. If a peer stock is therefore overvalued due to poor market information, market manipulation or distorted information by company public relations, the valuation model overvalues the stock and issue a strong unreasonable buy advice to the investing public. Such models as we typically use, do not recognize the increasing stronger integration of our market with global financial markets as short-term capital flows moves freely in and out of the Nigeria market. Our analyst community must do more to access international data and use models that value stocks relative to their peers in similar sectors and similar country and risk markets. That is the difference in the quality of market analysis by a J.P. Morgan on the Nigeria stock market and that which you get from your local stock broker. Then we will need to raise the standard of financial journalism and investment information distribution. Efficient market hypothesis is based on the assumption that investors are rational and that information is available for buyers and sellers to price assets objectively and optimally. When there are information asymmetries, when information are not widely available or they are distorted by public relations activity of companies, the market cannot be efficient; assets will be priced wrongly and everyone will loose. Financial journalism therefore has a social and historic role to play in the efficient functioning of our markets and the rebuilding of public trust.

Fourthly, we will need to reshape the values of managers of businesses in public corporations to which we have endowed a privileged trust, as customers, shareholders, government and the larger public. One of the most important lessons that managers need to re-learn is that an organization does not just exist to make profit for its shareholders alone. A good company is that which has a social purpose for which making profit is the by-product of fulfilling that larger social purpose. Therefore, a good company is not that which posts bumper profits that managers celebrate but harms the larger interest of other stakeholders such as customers, the government and general public welfare. A good company is that which is able to optimize the interest of all its stake-holding groups of customers, shareholders, the state and the larger public. It provides great products and services that improve the quality of life of Nigerians, return good profit to shareholders while contributing to national economic development. A good company will not significantly externalize the cost of its business. When a company makes huge profit by destroying the environment, and gets away with it, because social institutions are weak to make it pay for it, it is externalizing its cost and betraying public trust. As we have seen all across the world, when managers of financial institutions take excessive risks, which endanger the financial system and have to be bailed out by their governments and state resources, they are externalizing the cost of their firm’s profit. Society has however trusted too much. The fact is that firms will most always externalize their cost unless there are social institutions such as regulations and the tax system that prevents them from externalizing their cost or make them pay for it, when they do so. That is why we support the new policy being pushed by the US authorities and President Sarkozy of France that banks need to be taxed specially to build a pool of funds which shall fund the cost of future bail-out of the financial system when the need arises again.

The argument above however presupposes that if the interest of managers and the larger public interest are not fully aligned, that at least managers are true agents of their principal (their shareholders) and their interests are fully aligned. This is not always so. Our compensation policy especially the big annual profit bonuses, tend to reward managers excessively for the short term over the long term. This tend to create a classic moral-hazard problem where managers take investment decisions with excessive long term risk, which may not crystallize in the early years when they cash in on their short term profit and profit bonuses. When these risks eventually crystallize in the future, the managers have moved on, leaving the firm, its shareholders and future managers to manage the consequences of fallen profit and collapsed share prices. Essentially, our compensation policy, encourages a risk behavior that allows the transfer of the consequence of managerial risk decisions to someone else in the future. When the reward of a risk could be appropriated by the risk taker, and the consequence of the risk is for someone else, there is a tendency by the risk taker to take excessive and sometimes unreasonable risk. This is the moral hazard problem in risk management. It plays heavily in the nature of our managerial compensation where rewards are heavily weighed in favour of annual profit bonuses and virtually nothing in long term share prices of corporations. This will need to change to align managerial interest better with that of shareholders and strengthen public trust in corporations. Compensation of managers must carry a significant long term portion related to the future share prices and values of their firms, as a function of the long term impact of their managerial decisions.

As we have discussed earlier, a transparent organization and a culture of candour between the managers of a firm and its employee is critical to building organizations that will win public trust. When an organization is transparent with itself, it will have no problem being transparent with its publics. To build a culture of candour however, leaders and managers will have become more tolerant of dissent. This is a big challenge given big “Oga” nature of our organizations that has its roots in our typical African gerontocracy. A boss is like an elder in the family. He is male, older, therefore much wiser and always right. He, as an elder sits in managerial council of elders, with older and wiser people like him, where like the African secret cults of elders, they meet in secret, agree in secret and only communicate their decisions even without rationale, to ordinary young plebians (their staff) to implement. The young plebians must not question the decisions of the elders because they do not know what the elders know, or are not wise enough. The elders (the managers) can therefore do anything and get away with it. Once, in a while, there could be some young people sitting in the council of elders, because of their specials skill or valor. These young people acquire the character of the secret cult of the elders and behave like them. It is not therefore a question of age but of our typical African gerontocratic management culture. To build transparency, we must create new “open societies” in our organizations with a new type of elder who while being a leader, can be openly questioned by her followers, a leader who will tolerate dissent as a necessary ingredient of widening perspectives in solving organization problems. Essentially, we will need to have organizations where managers are more openly accountable for their decisions to their internal stakeholders. Related to the above, is that leaders must take responsibility for promoting strong ethical behavior in their organizations. As Peter Drucker said “..the spirit of an organization is created from the top”. Leaders are the biggest influence on their organizations. They create the spirit of the enterprise, its values and its behavior. What they do, or do not, is most critical in building organization culture. The character and behavior of managers in organizations are shaped by two things, what the leaders do or how they behave, and secondly by what the leaders reward or sanction. Leaders must act as important ethical role models for their organizations. They must reward not only result or performance but also the process and the behavior exhibited in delivering performance. Leaders have a responsibility to ensure that there are strong consequences for ethical infractions in their organizations. Unless, they do this, ethical behavior becomes a mere sermonizing that can be ignored or adopted only when convenient by managers.


We should not conclude the discussion on shaping the character and values of managers without discussing education of managers and the challenge of public trust. This subject has received wide attention and soul-searching among leading international business schools. There is an acceptance by the business schools that if the gentlemen who nearly brought down the financial system by some of the most irresponsible behavior were Harvard , Wharton and Stanford graduates, there is something fundamental that they did not learn in business schools. Watching some of the younger Goldman Sachs executives defend themselves in the US Congress recently, you can’t but notice that the attitude is “it is about me, if it is profitable and it is legal, it does not matter what happens after, I take my profit”. While ethics is thought in business schools, its method and its content will need to be reviewed and reformed. Writing on this subject in the Harvard Business Review, Joel Podolny, a former Professor at the Harvard Business School said as follows “ I am angry about the inattention to ethics and value based leadership in business schools. We didn’t need the current melt-down to tell us that; the Enron and the WorldCom scandals proved it more than seven years ago”. We need the same type of open and public soul searching by our business schools especially the Lagos Business School (LBS) that produces the cream of our managerial leadership. The problem in teaching ethics and developing a robust ethics curriculum and content for MBAs is that the subject of ethical inquiry is philosophical, a humanities discipline with strong roots in philosophy, history, literature, religion and psychology, and not a quantitative science that lends itself to mathematical and statistical models of such as calculus, regression models and chi squares, the tools of some of the most prestigious academic disciplines in business schools. Charles Handy, the father of British Management education and one the founders of the London Business School observed in his memoirs that MBAs should rather be called Master of Business Analysis because of the heavy bias of towards analysis rather than critical thinking and moral reasoning in business education. Both Handy and Podolny observed that the analysis in typical business school case studies do not prepare managers to make moral choices when faced with ethical dilemmas after graduation. Charles Handy tells the story of his attempt to introduce the study of the Greek literature classic, the Sophocles Antigone in the curriculum of the London Business School in its early years. Antigone had to choose between the order of her uncle Creon, the victorious ruler of Thebes who had killed her brother Polyneices in battle and ordered his body not to be buried in humiliation for crows and vultures to pick at, outside the city walls. Yet by her duty to her religion, Antigone knows that it is a sacrilege to the Gods to leave a man unburied. Souls of bodies that are not buried will be condemned to perpetual hell and will be forever chased by the Furies. Yet to bury her brother, will be to disobey the order of the king and duty to the state. The consequence of disobedience of the order of the King was execution. Antigone’s conscience and duty to her state were in conflict. Antigone chose her conscience, buried her brother and committed suicide. Charles Handy wanted to use this Sophocles tragedy to teach his business students in the 1960s, the subject of ethical conflict and moral reasoning. In his memoirs, he noted that he had to drop the course from the London Business School curriculum as the course was un-popular, resisted as not being critically relevant by the students and the companies who sponsored them. Several decades later in 2006, writing in his memoirs, he regretted not being stubborn enough and bowing to the will of the business school education market at that time. Enron and Worldcom scandals had showed that the absence of such subjects in business education curriculum has produced generations of managers, loyal only to their bonuses with very little social conscience.

It is time to rebuild the broken wall of trust between business and society. The cracks are big and like a piece of broken china, they will be difficult to repair. Yet we must not despair. This broken china of public trust must be fixed because there are no options. The trust that the society gives business is the privileged charter on which business exits and does its business. If there is a one sentence summary of the lessons of the past three years for our big business, it is that the pursuit of profit cannot be a substitute for morality and social conscience. Business must no longer act as if profit and morality are mutually exclusive. Business and its civil organizations must adopt a new focused agenda of rebuilding public trust. There has been very little to suggest that this subject is receiving the right level of attention among the civil organizations of business and its professional associations. After the initial brouhaha of last year, our professional and business civil organizations are back to business as usual, with the annual traditional change and display of medals on the necks their different Presidents. As we have seen in the United States, our business, its civil and professional associations need to engage the public openly on what they are doing to reform themselves given that the larger society is the critical stakeholder in this dialogue of trust. Our business professional associations have traditionally acted like trade unions set up largely to protect their trade and the interest of their members. It is time now for them to act more altruistically in the in the interest of the larger society and fix this broken china of public trust. And as business does this, our larger society must reform itself. Our business are largely a reflection of who we are and the values that we celebrate. We must re-commit to stronger ethical values and public morality. We must commit to the values of a more open society and strengthen the civil and democratic institutions that enable such open and transparent society to thrive. It is an historic task for our generation that we must not fail.

Olu Akanmu
June 2010