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Lehman Brothers Crisis in Corporate Governance Case Solution
Lehman Brothers financial condition on September 14th 2008 had declined significantly over the previous year. Although, the total assets increased for the two quarters after September 2007 from $659,216 million to $786,035 million, they fell after February 2008 and amounted to $600,000 million on August 31st, 2008. Much of Lehman’s assets were tied to the subprime market. Hence, with the crash of subprime market, Lehman’s assets fell drastically in value. According to Bank of America’s due diligence team, it was estimated that around 65 billion of assets owned by Lehman brothers were bad assets. Bank of America further identified that $33 billion of assets were soured real estate and commercial mortgage. Additionally, the assets worth $17 billion were residential mortgage-back securities. The crisis increases the default risk of such mortgages and reduced the value of residential and commercial real estate. Hence, the assets amounts stated on Exhibit D is overstated and assets require revaluation. Furthermore, the due-diligence team also questioned Lehman assets like asset-backed securities for loans on cars and mobile homes, a few private-equity holdings and high-yield loans. They believed that the losses from the bad assets will obliterate Lehman’s equity of $28.4 billion.
Following questions are answered in this case study solution
What is the financial condition of lehman brothers as of sept. 14th? How serious is the firm's liquidity problem? What are your conclusions about its ability to function as an ongoing enterprise? What steps would need to be taken in order for them to open for business on September 15th?
In 2007, the lehman brothers board supported management's decision to take on increasing levels of risk. Did the lehman brother's board of directors fulfill their fiduciary obligations and responsibilities?
Consider the three options that faced the board of lehman brothers at their final meeting on sept.14th, 2008. What should the board of directors do?
Case Analysis for Lehman Brothers Crisis in Corporate Governance
Lehman Brothers was unable to meet the cash requirement of the bank for its day to day operations. After converting 1.4 billion worth liquid assets, it was projected that $4.5 billion was required on September 15th 2008 to open for Lehman to open for business. Additionally, JP Morgan was Pulled around 15 million collateral from Lehman and required that 5 million be readily available. Lehman reported a loss of 3.9 billion by August 31st, 2008. The net income and revenue of Lehman had decreased significantly compared to previous years due to the financial crisis in the market and the loss of confidence of public.
Lehman reduced the leverage ratio of the firm by the end of the third quarter to 10.1 and reduced the dividend payout to $0.5 per share. Although the firm took measures to improve the financial condition of the firm, it is evident from the above discuss that Lehman was facing a financial crisis. Given to the liquidity problems, Lehman had little chance of continuing as a going concern without a merger or help from the Federal Reserve. To open for business, Lehman raise enough capital to manage its daily cash flows and operations.
2. In 2007, the lehman brothers board supported management's decision to take on increasing levels of risk. Did the lehman brother's board of directors fulfill their fiduciary obligations and responsibilities?
The purpose of the board of any company is to ensure that the management works for the best interest of the shareholders. In the case of Lehman, the directors seem to be more aligned with the interests of the management than the interests of the shareholders. Lehman management took an excess risk in 2007 after the collapse of the subprime mortgage market with the agreement of the board of directors. Directors were unsuccessful in fulfilling their duty to the shareholders by failing to prevent Lehman’s management from taking additional risk. They should have advised the management to take risks as long as the risk does not exceed the internal controls and prudent risk management.
The conflict of interest between the directors and the shareholders is caused by a variety of reasons. Firstly, the compensation of the directors was fixed rather than tied to the share value. The board compensation was completely lump sum amounts rather than stock awards. Therefore, the directors lacked the incentive to take prudent decisions for the firm. Secondly, the board was not chosen with care. The average age of the directors on the board were 68 with 4 directors over the age of 75. The directors also included three individuals who were retired. Additionally, the majority of the board consisted of director will little or no experience of financial services sector and banking. Thirdly, Richard Fuld acted both as the Chief Executive Officer (CEO) and as the chairman of board of directors. Hence, the board was not independent of the management.
3. Consider the three options that faced the board of Lehman Brothers at their final meeting on Sept.14th, 2008. What should the board of directors do?
After the final meeting on September 14th 2008, the board faced three options. The first option entailed filing for bankruptcy. The second option was to delay the decision about bankruptcy. Lastly, the third option included opening Lehman Brothers for business and vote against filing for bankruptcy.
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