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This paper examines the failure of the investment firm Lehman Brothers five years after the failure of the firm. We examine weaknesses in corporate governance within the firm. Empirical evidence supports and suggests that the failure of Lehman Brothers was predictable. We also examine Dodd-Frank and other subsequent legislation enacted post-financial crisis and find while the legislation limits the exposure in the financial sector, it does very little in reducing the risks of similar events in other industries.
INTRODUCTION
This article addresses weaknesses in the U.S. financial reporting system disclosed in the bankruptcy of the investment firm Lehman Brothers. We examine the impact weaknesses in the corporate governance had on both the financial reporting system and the firm's risk exposure. The specific weaknesses addressed are in corporate governance within the firm. The paper examines and suggests improvements in corporate governance from within the firm, supported by improved regulatory oversight and corporate governance restrictions.
Prior to bankruptcy filing, Lehman Brothers used an accounting treatment for repurchase agreements ("Repo 105") that was acceptable under US generally accepted accounting standards ("GAAP") but in subsequent financial statement disclosures distorted the true financial condition. (For a detailed analysis of Repo 105 transactions, see our paper on Lehman Brothers, "Law and Accounting: Did Lehman Brothers Use of Repo 105 Transactions Violate Accounting and Legal Rules" in the Journal of Legal, Ethical and Regulatory Issues, Volume 16, which concludes that conflicts between law and accounting contributed to the accounting practices which ultimately resulted in the downfall of Lehman Brothers. This paper continues the analysis by addressing the specific inner workings at Lehman Brothers.) This discussion suggests the present state of corporate governance, based on self-regulation with limited oversight, will continue to contribute to financial reporting failures.) The intent of management in using Repo 105 transactions was to improve the presentation of financial condition. The transactions appeared to serve no other purpose than to provide for financial window-dressing. Lehman Brothers executives used Repo 105 transactions over a 7 year period, impacting both quarterly and annual filings. Yet, the financial impact of the transactions was not disclosed to or identified by the board of directors. This paper then addresses the weaknesses in corporate governance and current governance provisions that permitted financial statement manipulation...