Due Diligence

Article excerpt

In a desire to complete transactions and largely due to the pressure of the market place, financial institutions frequently abandon the due rigor of review. As a result, dubious loans are approved, questionable acquisitions are completed, and shaky investments are implemented. And sooner rather than later, the results are disastrous.While most analysis of the 2008 global financial crisis will pinpoint the excessive use of largely misunderstood derivatives instruments that went above regulatory oversight as one of the culprits, at its core the problem was lack of due diligence. Lack of due diligence allowed the proliferation of sub-prime loans. Lack of due diligence caused investments in complex transactions whose underlying were not fully transparent.Due diligence refers to the process by which a person or a business carefully assesses material facts relevant to closing a deal with another person or business. It is the process of investigation and analysis related to evaluating the soundness of the decision. The objective is to ensure that the deal will not be harmful to either party; rather, that it must be beneficial.Financial management teaches us the problem posed by information asymmetry, when one party to a transaction does not have full data on the other party. The asymmetry may be an innocent incongruence, yet it can be worsened by the active withholding of critical information. The decision making process can only be improved by due diligence.Oftentimes however due diligence is disregarded in the face of expediency and haste, as well as political pressure. For example, it is not uncommon that pressure is applied by politicians on government financial institutions to approve loans. If the GFIs are not allowed to filter and screen the applications based on set standards, the results can be damaging. Diagnosis requires committed investment in background analysis, qualitative review, number crunching, character analysis, and most of all, time. …