Analysis of CG Failures in RBS PLC

ANALYSIS OF THE CORPORATE GOVERNANCE FAILURES

IN ROYAL BANK OF SCOTLAND (RBS) PLC

Student Name: Ruth Maneesha Evanjalin Gomis

Student ID: 4659

Date: 16th March 2023

Module: Corporate Governance
Lecture Name: Mr. Dimuthu Heenpella
Code: ACC3017
Word Count: 3000 pg. 1
Analysis of CG Failures in RBS PLC

Acknowledgement

First and foremost, I want to give thanks and praise to God, the Almighty, for His gifts that
helped me finish my report analysis task.
I would like to convey my profound gratitude to Mr. Heenpella, my corporate governance
lecturer, for allowing me the chance to complete this report and for his helpful advice
throughout. I have been greatly inspired by his dynamism, vision, genuineness, and motivation.
Being able to work and study under his direction was a huge honor and privilege.
I am incredibly appreciative of my parents' love, prayers, concern, and sacrifices in order to
raise me and get me ready for the future. I'm grateful to my spouse and daughter for their
assistance in helping me finish this report job and for their love, patience, and prayers.
I want to express my gratitude to my friends and research associates for their unwavering
support during the preparation of this report.
Last but not least, I want to express my gratitude to everyone who helped me, directly or
indirectly, finish the report.

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Analysis of CG Failures in RBS PLC

Content
Contents
Acknowledgement..................................................................................................................................2
Content......................................................................................................................................................3
Abstract.....................................................................................................................................................4
List of Abbreviations.............................................................................................................................5
Introduction..............................................................................................................................................6
1.1 Overview of RBS..........................................................................................................................6
2.0 Corporate governance failures.....................................................................................................7
2.1 Section 3. Composition, Succession, and Evaluation;..............................................................7
2.1.1 Board Succession...................................................................................................................7
2.1.2 Board Composition.................................................................................................................8
2.1.3 Board Evaluation.....................................................................................................................9
2.0 Audit, Risk and Internal Control...................................................................................................9
2.2.1Audit committee............................................................................................................................9
2.2.2Internal and external Auditors...................................................................................................10
3.0 Remuneration.................................................................................................................................10
3.1 Remuneration Committee...........................................................................................................10
4.0 Stewardship code..........................................................................................................................11
5.0 Recommendations.........................................................................................................................12
6.0 Conclusion.......................................................................................................................................13
7.0 References.......................................................................................................................................14

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Analysis of CG Failures in RBS PLC

Abstract
The structure through which commercial corporations are led and managed is known as
corporate governance (OECD, 2016). Its notion raises a number of difficulties, including as
information disclosure to shareholders and board members, senior executive compensation,
and potential manager conflicts of interest (Deloitte, 2014). As a result, this report will examine
the RBS collapse with a focus on the bank's beginnings up until the financial crises and a
discussion of the specific corporate governance failures of RBS with regard to Composition,
Succession, and Evaluation, Audit, Risk, and Internal Control and Remuneration the Code of
Corporate Governance. Moreover, a critical evaluation of how the 2020 Stewardship Code's
implementation would have avoided the corporate governance shortcomings of RBS detailed in
this paper. This paper also includes advice on how to identify, justify, and avoid such
governance failures in the future

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Analysis of CG Failures in RBS PLC

List of Abbreviations

OCED - Organization for Economic Cooperation and Development

CG – Corporate Governance

RBS – Royal Bank of Scotland

BOD – Board of Directors

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Analysis of CG Failures in RBS PLC

Introduction

1.1 Overview of RBS

Royal bank of Scotland was among one of the three UK banks that collapsed and was bailed
out by the government in 2008. The bank was established in May 1727 in Edinburgh by royal
charter in modern day panama. As a deputy chief executive for RBS starting in 1998, Fred
Goodwin was well-known for his aggressive cost-cutting tactics. RBS announced in 2000 that it
had successfully acquired NatWest for £20.7 billion, making it the second-largest bank in the
UK. The acquisition of NatWest resulted in $4 billion in increased profitability for RBS and the
successful blending of two distinct bank cultures (Groysberg and Sherman 2008). Between
2000 through 2004, Fred Godwin was appointed CEO of RBS Group, during which time the
bank also made 20 additional acquisitions. However, despite having a weak capital structure,
RBS purchased ABM AMRO for £71 billion in October 2007. As a result, RBS attained
Mathewson and Goodwin's goal of a worldwide bank, becoming the fifth-biggest bank in the
world by market value and the largest corporate and institutional bank in Europe, employing
171,000 people in more than 50 countries (Groysberg and Sherman 2008; Martin and Hetrick
2010). However, this investment was poor because little due research was done before the
purchase. Unfortunately, the credit crisis started that same month, and RBS declared a
reduction of £950 million in US sub-prime loans and £250 million in leverage loans by the end of
2007. (Thomas, 2011).

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Analysis of CG Failures in RBS PLC

2.0 Corporate governance failures

2.1 Section 3. Composition, Succession, and Evaluation;

2.1.1 Board Succession

While Mathewson, the chairman, had a significant influence on the choice, an effective
succession plan should still be in place for the board and senior management, but only a
supporting role should be played (BBC). For instance, in accordance with the rule, the board
chair should not serve as the committee's chair when it is discussing the appointment of the
board's successor. Nevertheless, in the case of RBS, the board of directors and CEO Fed
Godwin were chosen by George Mathewson (chairman).
Research on whether poor performance results in high CEO succession rates found conflicting
results by concentrating on performance expectations rather than absolute achievement
(Wiersema & Zhang, 2011; Zhang, 2008). discussion of the key performance indicators that
influence CEO successions (Finkelstein et al., 2009). Finally, all members should contribute in a
better understanding of CEO succession procedures so that specialists can find the
"appropriate" CEO (Khurana, 2001).
As the chairman was solely responsible for the hiring process and no other board members'
input or opinions were included, the RBS may have failed as a result of the chairman's poor
assessment of his own choice.
2.1.2 Board Composition

Upon launching "project Columbus" to re-design the bank, the CEO was chosen. He is an
engineer by training and has no prior experience in the financial sector (BBC). Akpan (2015)
aimed to investigate the link between board composition and firm performance and discovered
that board size, board experience, and independent directors had a direct and significant impact
on firm performance. Adebiyi (2017) also looked at how the board's makeup affected the
corporate firm's financial reporting quality, and the results revealed a positive and substantial
relationship between board size, experience, and independence with financial reporting quality.
This study came to the conclusion that an important factor in the quality of financial reporting is
board makeup.
Given the aforementioned considerations, it is clear that board composition has a positive and
considerable impact on board performance. Due to the CEO and other directors' lack of
essential experience in the financial sector, one of the reasons RBS failed may be due to an
improper board composition.
Moreover, (Daily Mail, 2011) argues that the 17 directors on the board failed in their duties in
challenging the acquisition of ABN AMRO. They explained that there was a critical requirement

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for the directors to question and challenge the actions of Fred Goodwin. Although, (Martin,
2013) argues that the reason why some directors did not challenge Goodwin was because they
were scared of him. In contrast, (FSA, 2012) argues that due to the CEO’s wonderful grasp of
detail and skill in forensic, it was hard for other board members to raise more concerns that are
not backed up with evidence. Nevertheless, the fact that RBS had 17 directors on it board made
it less manageable and more hard for individual directors to contribute, therefore decreasing
total effectiveness.
It is evident from above that the other BOD independence has been mitigated due to the
autocratic behavior of the CEO, therefore the RBS failed due to CEO’s own behavior.
Moreover, the RBS board is ‘male and pale’. Diversity is lacking since there is only one woman
on the board since 2004 and there are no directors from ethnic minority background. Due to the
fact that board gender diversity positively influences its operation, this will, in turn,
enhance the firm value (Nguyen et al. 2015). Overall, the agency theory suggests that gender
diversity enhances board effectiveness and improves the financial performance of companies.
It is taken into account that RBS did not practice a broad gender diversity, therefore it failed due
to enabling to enhance firm value.
Additionally There were 16 directors (8 executive and 8 non-executive) in 2004 and 14 directors
(9 executive and 5 non-executive) in 2005. In 2006 and 2007, there were 17 directors (7
executive and 10 non-executive). In 2008, there were 10 directors (4 executive and 6
nonexecutive). Board size was rather large with 16 directors in 2004 in comparison to the
average board size of 11 directors with the FTSE 100 companies (Thornton, 2012). The FSA
questioned the board size in its report and the effectiveness of the board of directors when it is
too big (FSA,2011).
A larger board will have more agency costs, and as the board becomes larger, issues such as
coordination and communication costs will increase due to these reason RBS might have failed.
2.1.3 Board Evaluation

The RBS board had 9 board meetings and 20 ad hoc board meetings in 2007 to discuss the
ABN Amro merger. In 2009, the board held 10 formal meetings; 39 ad hoc meetings to discuss
the Asset Protection Scheme; 4 additional meetings to discuss the bank’s Group Interim
Management Statements and Asset Protection Scheme. The most important concern is the
bullying nature of board discussions. The dominant personality of the CEO (Sir Fred Goodwin)
made it difficult for board numbers to be critical or challenge board decisions. A healthy
boardroom should encourage open, critical and constructive debates about strategy and
evaluate the risks.
Therefore RBS might have fallen due to unable to correctly evaluate the ABN Amro merger
since the board haven’t had sufficient board meeting to evaluate the AMRO merger and no
proper evaluation of the board.

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Analysis of CG Failures in RBS PLC

2.0 Audit, Risk and Internal Control

2.2.1 Audit committee

RBS, the audit committee did not effectively monitor the risk management process. One might
argue that this was due to a misinterpretation of the risks involved in the subprime mortgage and
lack of knowledge on how the risk was hidden. A counter argument might be that the
management’s provided the audit committee with limited information regarding the status of the
risk. Therefore, restricting their understanding to the information given to them (House of
Commons Treasury Committee, 2012). Although, members in RBS’s audit committee were
retired partners of the Big Four accountancy firm. On might argue that with their vast experience
in accounting, they should have been the first to detect RBS risk problem before they embarked
on acquisition of ABN AMRO. However, Bloomsbury (2012) explains that because they were
retired partner of the Big Four accountancy firm does not mean they will understand banking.

2.2.2 Internal and external Auditors

In RBS, the internal auditors did not adequately monitor the risk involved when the board chose
to invest in the subprime mortgage market. It might be argued, however, that this was caused by
a reduction in auditor-supervisor meetings. Due to in 2006, there was only one meeting between
the FSA and the external auditors of RBS, and both in 2007 and 2008 , there was no auditor
meetings between FSA and the auditors of RBS (Parliament, 2014). This would not promote an
efficient assessment of risk management because relevant issues that are meant to be discussed in
the meetings are not discussed. Furthermore, the external auditors failed to ensure that the
information given to the shareholders was transparent. This is because the capital ratios were not
included in the accounts and the acquisition of ABN AMRO was shown to be going well (Fraser,
2014). Therefore, one might argue that as a result of Goodwin’s dominant culture, the external
auditor could not perform their duties well because, they were scared of Goodwin.

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Analysis of CG Failures in RBS PLC

3.0 Remuneration.

3.1 Remuneration Committee

In RBS, the role of the remuneration committee was achieved, but the policy that was used had
an adverse effect on the strategy of the bank. The remuneration policy was based on short-term
revenue and profit targets. This encouraged managers to focus on revenue, profit and earnings
per share but ignored capital, liquidity and risk. This caused the bank to have a weak capital and
it became very risky. Furthermore, remunerations are designed to motivate CEOs to pursue high
performance and increase shareholder’s value. However, in RBS the amount paid out as CEO’s
remuneration was very high when compared to other companies. Neokleous (2013) argues that
the payments of excessive remuneration do not encourage CEOs to pursue shareholder’s
objective, but instead it increases agency problem. One might argue that this is evident in RBS
because the CEO’s remuneration was highly influenced by operating profit, EPS growth and
return in equity (RiskBusiness, 2011). Hence the CEO might have chosen those investments that
will guarantee him short-term growth instead of long-term once. An alternative explanation
might be that the high remuneration was paid to RBS executive directors so as to prevent tough
and effective challenge of the CEO (FSA, 2012c).

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Analysis of CG Failures in RBS PLC

4.0 Stewardship code

The stewardship theory holds, essentially, that directors act as stewards and will not be
concerned about fostering their own economic interests, as agency theory holds, but will be
willing to act in the best interests of their company, and they will act in a way that leads to
collectivist/organizational utility rather than self-serving benefits( Kluvers and Tippett
2011).Stewardship theory also holds that an organisation requires a structure that allows
harmonisation to be achieved most efficiently between directors and shareholders. Thus it might
be thought that issues of “motivation, goal congruence, trust and organizational identification
have been captured in the stewardship theory of management.” (Van Puyvelde et al 2013: 65)
If we consider the Principle 3 of pupose and goverance RBS have to manage conflicts of
interest to put the best interests of clients and beneficiaries first. If the CEO of RBS practice this
principle he want be having a huge amount of money as bonus when RBS failed, he will benefit
the shareholders first.
The RBS did not consider about the risks in the market, did not consider about the liquidity issue
applicable after the ABN ammro acquisition, also the RBS did not anticipated about the financial
crisis, but if RBS comply the principle of identifying and responding to market-wide and systemic
risks to promote a well-functioning financial system, RBS did not fail because they know the risk
beforehand.
In addition to that if RBS review their policies, assure their processes and assess the
effectiveness of their activities, RBS wont fail. For example if policies about the nomination and
remuneration assured their effectiveness might not be a problem.

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5.0 Recommendations

As a result of significant weaknesses in RBS's capital position, management decisions and

permitted by an inadequate global regulatory capital framework. It is advised to discuss with all
the banks in the UK and USA come up with a minimum capital balance all throughout the
financial year.

As a answer to over-reliance on risky short-term wholesale funding, which was permitted by an

inadequate approach to the regulation of liquidity. It is advised that all funding processes should
be evaluated.

It has been concerns and uncertainties about RBS's underlying asset quality because of little
fundamental analysis by the FSA. It is recommended to do a fundamental analysis by FSA and
get a approval about asset quality.

Another failure is underlying deficiencies in RBS management, governance and culture which
made it prone to make poor decisions, to overcome this it is advised that the management
should rotate, should comply with all the corporate governance codes and the culture in the
organization structure should never be a dominant approach.

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6.0 Conclusion

It has been investigated the Collapse of RBS by tracking it back to the origin of the financial
crisis, origin of the RBS until the financial crises, failure of corporate governance in RBS and
Consequences of its failure,. From the evidence explored above, it is concluded that RBS
collapsed because of multiple problems.

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7.0 References

Adebiyi, W. K. (2017). Board composition and financial reporting quality of deposit money banks in
Nigeria. International Journal of Innovative Finance and Economics Research, 5(4), 97-104.

Aduda, J., Kiragu, P., & Ndwiga, J. (2013). The relationship between agency banking and financial
performance of commercial banks in Kenya. University of Nairobi.

Akpan, E. O. (2015). Corporate board meetings and company performance: Empirical from Nigerian
quoted companies. Global Journal of Commerce & Management Perspective, 4(1), 75-82

. Amran, N. A. (2011). Corporate governance mechanisms and company performance: Evidence from
Malaysia company. International Review of Business Research Papers, 7(6), 101-114.

Arosa, B., Iturralde, T., & Maseda, A. (2013). The board structure and firm performance in SMEs:
Evidence from Spain. Investigaciones Europeas de Direccion Y Economia de La Empresa, 19(3), 127-135.

Azutoru, I. H. C., Obinne, U. G., & Chinelo, O. O. (2017). Effect of corporate governance mechanisms on
financial performance of insurance companies in Nigeria. Journal of Finance and Accounting, 5(3), 93-
103.

Barnhart, S. W., Marr, M. W., & Rosenstein, S. (1994). Firm performance and board composition: Some
new evidence. Managerial and Decision Economics, 15(4), 329-340.

Bertoni, F., Meoli, M., & Vismara, S. (2014). Board independence, ownership structure, and the valuation
of IPOs in continental Europe, Post-Print hal-02313136, HAL. Bhagat, S., & Black, B. (2002).

The non-correlation between board independence and long-term firm performance. Journal of
Corporation Law, 27(2), 231-274. Drakos, A. A., & Bekiris, F. V. (2010).

Endogeneity and the relationship between board structure and firm performance: A simultaneous

equation analysis for the Athens stock exchange. Managerial and Decision Economics, 31(6), 387-401.

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