Does “Good” Corporate Governance Help in a Crisis? The Impact of Country‐ and Firm‐Level Governance Mechanisms in the European Financial Crisis

Abstract

Manuscript Type Empirical Research Question/Issue We examine the effects of firm‐ and country‐level “good” corporate governance prescriptions on firm performance before and during the recent financial crisis, using a large sample of 1,197 firms across 26 European countries. Research Findings/Insights We propose a contextualized agency perspective suggesting that firm‐ and country‐level good governance prescriptions designed to assure managerial oversight may not hold in a financial crisis. This is because firms can benefit from broadening managerial discretion so as to facilitate the exercise of initiative and decisive leadership. Overall, our firm‐ and country‐level findings support this argument. In a crisis, CEO duality is associated with better performance. We also find that the use of incentive compensation and the existence of a wedge between ownership and control rights negatively impacts on firm performance in a crisis. Hierarchical linear modeling shows that 25 percent of the heterogeneity in firm performance is among countries, indicating the importance of including country‐level institutions in our analyses. In a crisis, we find that the general quality of the legal system and creditor rights protection are positively related to firm performance, but protection for equity investors is not. Theoretical/Academic Implications The findings challenge the universality of good governance prescriptions and contribute to the growing body of work proposing that the efficacy of governance mechanisms may be contingent upon organizational and environmental circumstances. Practitioner/Policy Implications The study offers insights relevant to policy and practitioner communities, showing that governance mechanisms operate differently in crisis and non‐crisis periods. The tendency to respond to a crisis with more stringent rules may be counterproductive since such measures may compromise executives' ability to respond appropriately to systemic shocks. Practitioners are encouraged to optimize rather than maximize their governance choices.

Supervisory boards, financial crisis and bank performance: do board characteristics matter?

“…Hence, laws protecting shareholders' rights improved banks' performance during the financial crisis. Differently, Erkens et al 18 and van Essen et al 81 do not conclude that antidirector rights have a beneficial impact, respectively, on financial firms and non-financial firms' performance during the recent crisis. Finally, creditor rights protection has no impact on banks performance, unlike non-financial firms.…”

“…First, as Beltratti and Stulz, 3 Fernandes and Fich, 41 Fahlenbrach and Stulz, 76 Aebi et al, 77 Fahlenbrach et al, 78 and van Essen et al 81 18 In this case, the crisis period is defined as starting at the beginning of 2007, because the first wave of the crisis started in the early 2007, 82,g and ending at the third quarter of 2008 for two main raisons: (1) at the end of the third quarter of 2008, regulators in various countries imposed short-selling prohibitions on the stocks of many financial institutions to contain sharp falls of their stock prices 18 and (2) in October 2008 the International Accounting Standards Board (IASB) issued amendments to grant companies the option of abandoning fair value recognition for selected financial assets. Such changes allowed companies to reclassify financial assets from market value based on historical cost based valuation.…”

“…76 BoardEx provides detailed information on the board's composition of publicly listed firms. Recent studies also rely on BoardEx as a source of governance and board data (e.g., Erkens et al, 18 Fernandes and Fich, 41 Engelberg et al, 80 and van Essen et al 81 ). We define "Board independence" as the percentage of independent directors.…”

“…Finally, creditor rights protection has no impact on banks performance, unlike non-financial firms. 81 …”

Country level governance variables and ownership concentration as determinants of firm value in Latin America

“…We want to measure whether the explicative pattern of independent variables changed after the subprime crisis. In fact, previous literature seems to show that economic crises are suitable events to assess the performance of corporate governance systems (Baek et al, 2004;Erkens et al, 2012;Lemmon and Lins, 2003;Mitton, 2002;van Essen et al, 2013). For instance, Mitton (2002) argues that corporate governance becomes more critical in explaining cross-firm differences in performance during a financial crisis for two reasons.…”