Corporate Governance the case of Banco Espirito Santo ABSTRACT This is a comprehensive case study of the collapse of BES that failed in 2014 and prompted the government to draft and implement a resolution plan for BES in which they created NOVO Banco, a bridge bank to transfer all the healthy operations of the bank and left the toxic assets in BES to be liquidated. BES collapsed after 145 years of existence after it founded by Jose Maria do Espírito Santo e Silva, who started in Lisbon in 1869 as a moneychanger. This study aims to study the causes of the collapse of BES and discuss the corporate governance mechanism that has gone wrong. This study also examines the evidence of clan culture in BES which is probably one of the core strength of the BES and the ES family that helped the bank to survive 145 years, both world wars, dictatorship regimes and nationalisation. The case of BES gives the opportunity to understand that corporate governance rules and recommendations are just as relevant in family businesses as they are in other businesses. Our study found that the desire to diversify the operations of the ES family by investing into many business sectors through its non-financial companies, combined with the economic recession put significant pressure on Ricardo Salgado, who with his status in the family and his power on the board of directors of BES used fraudulent financial reporting and related parties transactions to hide the bank’s toxic assets made mainly of debt instruments of its holding parent. We also found the clan culture in BES gave significant decision powers to Ricardo Salgado. At one point, he was CEO of BES and chairman of the group, which was likely to have intimidated directors on the board of BES. Our main finding on this study is that the collapse of BES could have been avoided if the corporate governance in BES emphasised on accountability and integrity of financial reporting. KEYWORDS Bankruptcy Corporate Governance Banco Espirito Santo Corporate Fraud Family Business failure JEL CLASSIFICATION SYSTEM G. Financial Economics : Financial Crisis G.3 Corporate Finance and Governance: Corporate Finance, Corporate Governance I Corporate Governance the case of Banco Espirito Santo To Father and Mother II Corporate Governance the case of Banco Espirito Santo Darkness cannot drive out darkness; only light can do that. Hate cannot drive out hate; only love can do that. Martin Luther King, Jr. III Corporate Governance the case of Banco Espirito Santo ACKNOWLEDGMENTS This project would not have been possible without the support of many people. First I would like to thank God for his mercy and the guidance of his spirit. He gave me the strength to continuously pursue with this work. Many thanks to my supervisor Professor. Alvaro Augusto da Rosa, who read my numerous revisions and helped make some sense of the confusion... Thanks to the Business Scholl ISCTE for awarding me a Dissertation, providing me with books and materials to complete this project. And Serges at the Library who encourage me and support through this process. And finally, thanks to my parents, thanks to my lovely Fiancé, who offered guidance and support along this journey. To my Sisters and Brother Flora, Valdes, Marie Michele, Ingrid and Wilfred and numerous friends who endured this long process with me, always offering support and love. IV Corporate Governance the case of Banco Espirito Santo LIST OF ABBREVIATIONS BES : Banco Espirito Santo ES: Espirito Santo ESI: Espirito Santo International ESFG: Espirito Santo Financial Global BESA: Banco Espirito Santo Angola CEO: Chief Executive Officer ESC: Espirito Santo Control GES: Grupo Espirito Santo COSO: Committee Of Sponsoring Organisation EEA: Europeean Economic Area AGM: Annual General Meeting NASDAQ: National Association of Securities Dealers Automated Quotations BNU: Banco National Ultramarino BIC: Banco International de Credito BESCL: Banco Espírito Santo e Comercial de Lisboa RTP: Rádio e Televisão de Portugal ACCA : Association of Chartered Certified Accountants V Corporate Governance the case of Banco Espirito Santo ABSTRACT ............................................................................................................................................................ I KEYWORDS .......................................................................................................................................................... I JEL CLASSIFICATION SYSTEM ......................................................................................................................... I ACKNOWLEDGMENTS .................................................................................................................................... IV LIST OF ABBREVIATIONS ................................................................................................................................ V INTRODUCTION .................................................................................................................................................. 3 LITTERATURE REVIEW ..................................................................................................................................... 5 1. AGENCY THEORY OF CORPORATE GOVERNANCE ............................................................................ 5 i. Accountability of directors. ................................................................................................................... 7 2. CORPORATE FRAUD ........................................................................................................................... 11 i. Ethical climate .................................................................................................................................... 11 ii. Tone at the top ..................................................................................................................................... 12 iii. Accountability, control, audit and governance .................................................................................... 13 iv. Personal interests and compensation packages ................................................................................... 13 v. Bubble economy or market pressure ................................................................................................... 13 3. FRAUD TRIANGLE ............................................................................................................................... 15 i. Pressure or motivation......................................................................................................................... 16 ii. Opportunity ......................................................................................................................................... 16 iii. Rationalisation .................................................................................................................................... 16 4. CORPORATE GOVERNANCE AND BANKRUPTCY RISK .............................................................. 17 5. BANKRUPTCY PREVENTION AND PREDICTION .......................................................................... 17 RESEARCH QUESTIONS .............................................................................................................................. 18 RESEARCH METHODOLOGY ..................................................................................................................... 19 CASE STUDY ................................................................................................................................................. 21 1. INTRODUCTION ................................................................................................................................... 21 2. BES ORIGINS ......................................................................................................................................... 21 i. From Money changer to Banker.......................................................................................................... 22 ii. The Growth ......................................................................................................................................... 22 iii. Privatisations ....................................................................................................................................... 24 iv. The return to Portugal ......................................................................................................................... 25 3. BES’S POWER ....................................................................................................................................... 27 i. Bank of all regime ............................................................................................................................... 27 Table 1: Evolution of BES from 1992 to 2013 ................................................................................... 28 ii. Corporate structure of the empire ........................................................................................................ 29 a) Espirito Santo Control .................................................................................................................... 29 Figure 2: ES CONTROL ..................................................................................................................... 30 b) Espirito Santo International ...........................................................................................................