Xcellon Institute_School of Business

Case study analysis of Coping with Financial and Ethical Risks at American International Group (AIG)

PGP-GBM (2011-13)

Corporate Governance and Business Ethics

Submitted By: Manish Kumar Lodha M00103
1|Page

Submitted To: Prof. Vivek Raina

3-4 Question & Answer………………………………………………..Index:_________________________________________________________ Case summary……………………………………………………. 5-9 Conclusion……………………………………………………… 10-10 2|Page ..

The corporate culture at AIG had been involved in a high-stakes risk-taking scheme supported by managers and employees that appeared entirely focused on short-term financial rewards.5 billion. The perfect storm formed with the subprime mortgage crisis and a sudden sharp downturn in the value of residential real estate in 2008. Maurice “Hank” Greenberg had been open about his suspicions of the AIG Financial Products unit. guarantees. Nevertheless. Out of a firm of 116. and by 2009 this amount had fallen to a mere $3. the unit generated billions of dollars of profits for AIG. AIG Financial Products. AIG had a market value of close to $200 billion in 2007. it became one of the most controversial players in the 2008–2009 financial crises. was chiefly to blame.Case Summary When American International Group (AIG) collapsed in September 2008 and was subsequently saved by a government bailout. Since much of the speculation in the Financial Products unit was tied to derivatives. after Greenberg resigned as chief executive of AIG in 2005. who was summoned by former Treasury Secretary Hank Paulson. AIG had exposure to $64 billion in potential subprime mortgage losses. Current CEO Ed Liddy. and the more recent events that led to its demise. even small movements in the value of financial measurements could result in catastrophic losses In this case. one unit with around 500 employees. estimates that only twenty to thirty people were directly involved in bringing down the company The AIG Financial Products unit specialized in derivatives and other complex financial contracts that were tied to subprime mortgages or commodities. we trace the history of AIG as it evolved into one of the largest and most respected insurance companies in the world. However. the Financial Products unit became even more speculative in its activities Immediately before its collapse.000 employees. and financial injections prevented AIG from facing total bankruptcy in late 2008 3|Page . investments. during his long tenure as CEO of AIG. Only a government rescue of what has amounted to $180 billion in loans. While its dealings were risky.

however. the analysis looks at the role of the government and its decision to bail out AIG. taking 79. Then it reviews the events that occurred in 2008.Saving AIG was not meant as a reward.9 percent ownership in a company that grossly mishandled its responsibility to its stakeholders 4|Page . The government rescued the company not to keep it from bankruptcy. but to prevent the bankruptcies of many other global financial institutions that depended on AIG as counterparty on collateralized debt obligations. If AIG had been allowed to fail. including the philosophy of top management and the corporate culture that set the stage for AIG’s demise. Finally. including ethical issues related to transparency and failed internal controls. it is possible that the financial meltdown that occurred in 2008 –2009 would have been worse This case first examines the events leading up to the 2008 meltdown.

governed and controlled by Greenberg and other AIG executives. AIG admitted no wrongdoing. Sullivan has not been accused of any wrongdoing. Any hint of that and he.V. could be forced out. AIG has a highly unusual arrangement with three private entities. estimates that only twenty to thirty people were directly involved in bringing down the company Investigators believe that AIG may have goosed its financial performance with dubious transactions and improper accounting. who essentially hand-picked Sullivan as his replacement. The company also came under the glare of New York Attorney General Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos. if any. was chiefly to blame. An AIG spokesman says Sullivan has no comment on his future or the company's direction while AIG cooperates with investigators. he also serves as a director in C. in its downfall The corporate culture at AIG had been involved in a high-stakes risk-taking scheme supported by managers and employees that appeared entirely focused on short-term financial rewards. Current CEO Ed Liddy. Discuss the role that AIG’s corporate culture played.000 employees. one unit with around 500 employees. the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. who was summoned by former Treasury Secretary Hank Paulson. Each serves a different purpose and raises unique concerns A close confidante of Greenberg. AIG Financial Products. but regulators are looking for signs that he knew of or oversaw the dubious transactions. for deals it structured for outside clients that allegedly violated insurance accounting rules. which led to the ouster of Hank's son Jeffrey as CEO there. (MMC). Out of a firm of 116. although AIG admitted no wrongdoing. but two of its executives plead guilty and left the company.Question & Answer 1. Is Greenberg out of the picture? 5|Page . Starr and SICO. Last fall. too.

Last fall. after Greenberg resigned as chief executive of AIG in 2005. He used mechanisms now being revealed as deceptive and improper. The problem: AIG never assumed any of the risk associated with insurance underwriting. Maurice “Hank” Greenberg had been open about his suspicions of the AIG Financial Products unit. Ethical issues related to transparency and failed internal controls Nevertheless. but two of its executives plead guilty and left the company. which led to the ouster of Hank's son Jeffrey as CEO there. The company also came under the glare of New York Attorney General Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos. during his long tenure as CEO of AIG. But the complex $99 billion insurance and financial empire he leaves behind remains mired in turmoil. although AIG admitted no wrongdoing. On Mar.2. 28 announcement that Chairman Maurice R. says a source in Spitzer's office. 30. (AIG) may have breathed a sigh of relief at the Mar. 6|Page . Discuss the ethical conduct of AIG executives. However. Investigators believe that AIG may have goosed its financial performance with dubious transactions and improper accounting. AIG admitted no wrongdoing. the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. the company acknowledged that "the transaction documentation was improper" and should never have been classified as insurance premiums. the Financial Products unit became even more speculative in its activities Investors in embattled American International Group Inc. Greenberg strived for a steadily rising stock price. (MMC). for deals it structured for outside clients that allegedly violated insurance accounting rules. and how a stronger ethics program might help the company to strengthen the ethics of its corporate culture. "Hank" Greenberg would step aside two weeks after being pressured to give up the chief executive's role.

rather than as a one-shot effort when it appears to be needed. Ethics programs convey corporate values. have large personal stakes. is a group of agencies that develops business and issues specialized policies for AIG. Starr & Co. who oversees a stake in AIG worth more than $300 million: "I don't think you can have a publicly traded company that allows board members to own a private entity that does business with the publicly traded company. C.AIG has a highly unusual arrangement with three private entities. A charitable entity which Greenberg also chairs and which has a 2% share in AIG. Moore. Ethics programs: 7|Page .V. A stronger ethics program might help the company to strengthen the ethics of its corporate culture. depending on the organization. Each serves a different purpose and raises unique concerns. They provide guidance in ethical dilemmas. The arrangement also creates endless possibilities for conflicts of interest. Futter joined AIG 's board. governed and controlled by Greenberg and other AIG executives. Benefits of Managing Ethics as a Program There are numerous benefits in formally managing ethics as a program.5 million to the American Museum of Natural History shortly after museum President Ellen V. often using codes and policies to guide decisions and behavior. and decide who gets paid what. Regulators believe SICO hides executive pay and takes away powers that should rightly lie with the compensation committee of the board. It's owned and operated by AIG executives.. and can include extensive training and evaluating. Greenberg and other AIG directors sit on the board. It has come under fire for doling out money for political causes and for giving $36. Says North Carolina State Treasurer Richard H. on the other hand.

and the necessity of spending amounts of huge taxpayer dollars in a bailout. Holding AIG’s positions constant. clearing would have not substantially affected the allocation of losses among its trading parties. What could AIG have done differently to prevent its failure and subsequent bailout? Treasury Secretary Tim Geithner recommended the mandatory formation of a clearinghouse as a means for preventing future financial crises.         Establish organizational roles to manage ethics Schedule ongoing assessment of ethics requirements Establish required operating values and behaviors Align organizational behaviors with operating values Develop awareness and sensitivity to ethical issues Integrate ethical guidelines to decision making Structure mechanisms to resolving ethical dilemmas Facilitate ongoing evaluation and updates to the program Help convince employees that attention to ethics is not just a knee-jerk reaction done to get out of trouble or improve public image 3. they would have required them with a clearinghouse If anything. is based on an incomplete understanding of how clearing actually works. a subset of AIG’s counterparties) 8|Page . the losses from an AIG default would have been concentrated at fewer banks (the members of the clearinghouse. and if these losses required a bailout without a clearinghouse. A more complete analysis demonstrates that it is unlikely that clearing would have made a blow up less likely. and it would almost certainly have made things worse by concentrating the risk on fewer systemically important banks. This view that clearing could have prevented the AIG problem.

would clearing have had a material effect on the financial crisis During the financial crisis.have required a government bailout of these firms Only if clearing had led AIG to scale back its trading. these counterparties would have incurred larger losses on these positions. and if this in turn had led to a substantial decline in the amount of subprime lending. That assistance was a critical part of a broad-based effort to break the back of an historic financial panic and prevent a second Great Depression. That is because not only was the objective of stopping a financial panic accomplished. given its estimation of how profitable they were Even if AIG had reduced its positions. losses that would have likely . Treasury's offering this week of $20. it is very plausible that these costs would not have been so large to have induced AIG to reduce substantially its positions. since its counterparties were trading to hedge their exposures to structured products.7 billion in AIG common stock is an important milestone. Federal banking regulators bear significant responsibility for not recognizing the risk of allowing regulated banks to buy large amounts of credit protection from AIG 9|Page . the Treasury Department and the Federal Reserve committed a combined total of $182 billion to stabilize AIG. and if such a scaling back of AIG’s trading had led to a substantial reduction in the issuance and holding of the securities that AIG’s counterparties were hedging through the insurer. but the expected proceeds of this offering will mean that the overall $182 billion commitment made to stabilize AIG is fully recovered.Although clearing would have presumably raised the costs that AIG incurred to hold positions (due to margining).

the systemic implications of AIG’s original plunge into CDOs. A systemic event would have occurred if AIG didn’t exist. the major banks and investment banks–the Citis.Conclusion In my view. not its cause. The cause was the real estate bubble and the huge pyramid of structured finance built on top of it. and required an even larger bailout. the Goldmans. AIG’s decisions were certainly a disaster for its shareholders. 10 | P a g e . and that crisis likely would have been more severe. AIG’s collapse was a symptom of the underlying systemic problem. Although AIG arguably contributed to the size of that pyramid. and the other firms that traded with AIG–would have suffered even worse losses. and the subsequent collapse of this strategy are vastly overstated. its shareholders absorbed a good deal of the blow resulting from its collapse. Without AIG.

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