Xcellon Institute_ School 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
Index: _________________________________________________________
Case summary……………………………………………………..
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Question & Answer ………………………………………………..
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Conclusion………………………………………………………
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Case Summary When American International Group (AIG) collapsed in September 2008 and was subsequently saved by a government bailout, it became one of the most controversial players in the 2008 – 2009 financial crises. 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. Out of a firm of 116,000 employees, one unit with around 500 employees, AIG Financial Products, was chiefly to blame. Current CEO Ed Liddy, who was summoned by former Treasury Secretary Hank Paulson, 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. While its dealings were risky, the unit generated billions of dollars of profits for AIG. Nevertheless, during his long tenure as CEO of AIG, Maurice “Hank” Greenberg had been open about his suspicions of the AIG Financial
Products unit. However, after Greenberg resigned as chief executive of AIG in 2005, the Financial Products unit became even more speculative in its activities
Immediately before its collapse, AIG had exposure to $64 billion in potential subprime mortgage losses. The perfect storm formed with the subprime mortgage crisis and a sudden sharp downturn in the value of residential real estate in 2008. Since much of the speculation in the Financial Products unit was tied to derivatives, even small movements in the value of financial measurements could result in catastrophic losses
In this case, we trace the history of AIG as it evolved into one of the largest and most respected insurance companies in the world, and the more recent events that led to its demise. AIG had a market value of close to $200 billion in 2007, and by 2009 this amount had fallen to a mere $3.5 billion. Only a government rescue of what has amounted to $180 billion in loans, investments, guarantees, and financial injections prevented AIG from facing total bankruptcy in late 2008
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Saving AIG was not meant as a reward, however. 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, 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, including the philosophy of top management and the corporate culture that set the stage for AIG’s demise. Then it reviews the events that occurred in 2008, including ethical issues related to transparency and failed internal controls. Finally, the analysis looks at the role of the government and its decision to bail out AIG, taking 79.9 percent ownership in a company that grossly mishandled its responsibility to its stakeholders
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Question & Answer 1. Discuss the role that AIG’s corporate culture played, if any, 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. Out of a firm of 116,000 employees, one unit with around 500 employees, AIG Financial Products, was chiefly to blame.
Current CEO Ed Liddy, who was summoned by former Treasury Secretary Hank Paulson, 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. Last fall, the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. for deals it structured for outside clients that allegedly violated insurance accounting rules, although AIG admitted no wrongdoing. 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. (MMC), which led to the ouster of Hank's son Jeffrey as CEO there. AIG admitted no wrongdoing, but two of its executives plead guilty and left the company. AIG has a highly unusual arrangement with three private entities, governed and controlled by Greenberg and other AIG executives. Each serves a different purpose and raises unique concerns
A close confidante of Greenberg, who essentially hand-picked Sullivan as his replacement, he also serves as a director in C.V. Starr and SICO. Sullivan has not been accused of any wrongdoing, but regulators are looking for signs that he knew of or oversaw the dubious transactions. Any hint of that and he, too, could be forced out.
An AIG spokesman says Sullivan has no comment on his future or the company's direction while AIG cooperates with investigators. Is Greenberg out of the picture? 5|Page
2. Discuss the ethical conduct of AIG executives, and how a stronger ethics program might help the company to strengthen the ethics of its corporate culture.
Ethical issues related to transparency and failed internal controls
Nevertheless, during his long tenure as CEO of AIG, Maurice “Hank” Greenberg had
been open about his suspicions of the AIG Financial Products unit. However, after Greenberg resigned as chief executive of AIG in 2005, the Financial Products unit became even more speculative in its activities
Investors in embattled American International Group Inc. (AIG) may have breathed a sigh of relief at the Mar. 28 announcement that Chairman Maurice R. "Hank" Greenberg would step aside two weeks after being pressured to give up the chief executive's role. But the complex $99 billion insurance and financial empire he leaves behind remains mired in turmoil. Investigators believe that AIG may have goosed its financial performance with dubious transactions and improper accounting. Last fall, the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. for deals it structured for outside clients that allegedly violated insurance accounting rules, although AIG admitted no wrongdoing. 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. (MMC), which led to the ouster of Hank's son Jeffrey as CEO there. AIG admitted no wrongdoing, but two of its executives plead guilty and left the company. The problem: AIG never assumed any of the risk associated with insurance underwriting. On Mar. 30, the company acknowledged that "the transaction documentation was improper" and should never have been classified as insurance premiums.
Greenberg strived for a steadily rising stock price, says a source in Spitzer's office. He used mechanisms now being revealed as deceptive and improper.
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AIG has a highly unusual arrangement with three private entities, governed and controlled by Greenberg and other AIG executives. Each serves a different purpose and raises unique concerns. Greenberg and other AIG directors sit on the board, have large personal stakes, 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. C.V. Starr & Co., on the other hand, is a group of agencies that develops business and issues specialized policies for AIG. It's owned and operated by AIG executives. The arrangement also creates endless possibilities for conflicts of interest. Says North Carolina State Treasurer Richard H. Moore, 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. A charitable entity which Greenberg also chairs and which has a 2% share in AIG. It has come under fire for doling out money for political causes and for giving $36.5 million to the American Museum of Natural History shortly after museum President Ellen V. Futter joined AIG 's board. A stronger ethics program might help the company to strengthen the ethics of its corporate culture.
Ethics programs convey corporate values, often using codes and policies to guide decisions and behavior, and can include extensive training and evaluating, depending on the organization. They provide guidance in ethical dilemmas. Benefits of Managing Ethics as a Program
There are numerous benefits in formally managing ethics as a program, rather than as a one-shot effort when it appears to be needed. Ethics programs:
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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. 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.
This view that clearing could have prevented the AIG problem, and the necessity of spending amounts of huge taxpayer dollars in a bailout, is based on an incomplete understanding of how clearing actually works. 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.
Holding AIG’s positions constant, clearing would have not substantially affected the
allocation of losses among its trading parties, and if these losses required a bailout without a clearinghouse, they would have required them with a clearinghouse
If anything, the losses from an AIG default would have been concentrated at fewer banks (the members of the clearinghouse, a subset of AIG’s counterparties)
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Although clearing would have presumably raised the costs that AIG incurred to hold positions (due to margining), it is very plausible that these costs would not have been so large to have induced AIG to reduce substantially its positions, given its estimation of how profitable they were
Even if AIG had reduced its positions, since its counterparties were trading to hedge their exposures to structured products, these counterparties would have incurred larger losses on these positions; losses that would have likely .have required a government bailout of these firms
Only if clearing had led AIG to scale back its trading, 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, and if this in turn had led to a
substantial decline in the amount of subprime lending, would clearing have had a material effect on the financial crisis During the financial crisis, the Treasury Department and the Federal Reserve committed a combined total of $182 billion to stabilize AIG. 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. Treasury's offering this week of $20.7 billion in AIG common stock is an important milestone. That is because not only was the objective of stopping a financial panic accomplished, but the expected proceeds of this offering will mean that the overall $182 billion commitment made to stabilize AIG is fully recovered. Federal banking regulators bear significant responsibility for not recognizing the risk of allowing regulated banks to buy large amounts of credit protection from AIG
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Conclusion In my view, AIG’s decisions were certainly a disaster for its shareholders; the systemic implications of AIG’s original plunge into CDOs, and the subsequent collapse of this strategy are
vastly overstated. AIG’s collapse was a symptom of the underlying systemic problem, not its cause. The cause was the real estate bubble and the huge pyramid of structured finance built on top of it. Although AIG arguably contributed to the size of that pyramid, its shareholders absorbed a good deal of the blow resulting from its collapse. Without AIG, the major banks and investment banks – the Citis, the Goldmans, and the other firms that traded with AIG – would have suffered even worse losses, and required an even larger bailout. A systemic event would have occurred if AIG didn’t exist, and that crisis likely would h ave been more severe.
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