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Abstract
This paper examines three key areas of potential problems for two Wall Street Investment Banks just prior to the global financial crisis of 2008. The financial risk of the firms, risk management processes and corporate governance of Lehman Brothers and Goldman Sachs were compared. A priori, it was hypothesized that both firms would have significantly different financial risk profiles, risk management processes and procedures and corporate governance. The results of this study suggest that the firms were not different with regard to their financial profiles or risk management processes prior to the crisis. The significant difference between the two firms was instead their respective corporate governance. The results of this study are discussed within the context of the divergent market outcomes for the two firms.
1. Introduction
The investment banks at the heart of the global financial crisis of 2008 have been the subject of much public and academic scrutiny. How did the crisis happen? What were its root causes? This paper examines the two investment banks that had the best and the worst outcomes in the subsequent crisis - Lehman Brothers and Goldman Sachs. While the failure of Lehman Brothers was arguably the trigger for the global financial crisis [4], Goldman Sachs emerged relatively unscathed. What were the critical differences between these two firms? What factors played a role in the disparate outcomes between the two? This paper focuses on three key areas of their operations for clues regarding the underlying causes for their divergent outcomes in the subsequent crisis.
This paper examines the potential financial riskiness of each firm, their risk management processes and procedures and each firm's overall corporate governance. Traditional financial ratios have long been used to assess the financial risk of companies [5]. Risk management is vital area of concern for all firms. Risk management plays a particularly vital role in banking firms, such as investment banks, where the firm interacts directly and intimately with the broader financial markets [10]. Risk management, however, is but one function within the broader role of effective corporate governance [1], Corporate governance encompasses all of the significant functions of the organization as it interacts with its stakeholders [2].
This paper examines these three critical areas of concern in relation to Lehman Brothers...