The Roles of Corporate Governance in Bank Failures during the Recent Financial Crisis

Abstract

This paper analyzes the roles of corporate governance in bank defaults during the recent financial crisis. We investigate the impact of bank ownership and management structures on the probability of default of US commercial banks. Our results show that defaults are strongly influenced by a bank's ownership structure: high shareholdings of lower-level management, such as vice presidents, increase default risk significantly. In contrast, shareholdings of outside directors and chief officers (managers with a "chief officer" position, such as the CEO, CFO, etc.) do not have a direct impact on the probability of failure. These findings suggest that high stakes in the bank induce lower-level management, which has direct influences on the bank's daily operations, to take high risks, which may eventually result in bank default. Our results further show that the probability of default specifically increases when incentives of chief officers and lower-level management are aligned. Some accounting variables, such as capital, earnings, and non-performing loans, also help predict bank default. However, other potential stability indicators, such as the management structure of the bank, indicators of market competition, subprime mortgage risks, state economic conditions, and regulatory influences, appear to be less decisive factors in predicting bank default. JEL Codes: G21, G28, G32, G34

To be bailed out or to be left to fail? A dynamic competing risks hazard analysis

“…In the same modelling environment, DeYoung and Torna (2013) show the importance of non-interest income activities, such as securities brokerage, investment products and asset securitisation to the failure likelihood of U.S. banks in the 2007-8 crisis, whereas Distinguin et al (2013) use a sample of major listed banks from eight East Asian economies to show that both accounting and market measures are effective indicators of bank failures. Berger et al (2016) also resort to data from the recent crisis to examine the roles of ownership, management, and compensation structures in U.S. bank failures applying a multivariate logit model. Other recent studies that also resort to logistic probability models to predict failures in the U.S. banking industry are those of Jin et al (2011), Cole and White (2012),…”

“…Following the relevant studies (see Cole and White, 2012;Cornett et al, 2013;Li, 2013;Berger et al, 2016), we exclude thrifts -i.e., savings and loans associations-from our empirical analysis because they file a different report (the Thrift Financial Report). 4 Another important reason that justifies the exclusion of these institutions is that they operate under a different charter.…”

Do all new brooms sweep clean? Evidence for outside bank appointments

“…While we label the period from 2007 to 2014 as the post-crisis period, the split may not capture effects stemming from the financial crisis as in other studies that primarily capture US banks (e.g. Fahlenbrach and Stulz, 2011;Berger et al, 2016). The reason for this is that the majority of banks in our sample are small and medium-sized banks with almost no exposure to US subprime products.…”

“…Also, many dimensions of strength of the board of directors (e.g. Pathan, 2009;Pathan and Faff, 2013;Beltratti and Stulz, 2012;Berger, Imbierowicz, and Rauch, 2016;Roman, 2015) are not applicable. The supervisory board consists of shareholders' representatives and elected employees according to the German codetermination law.…”

“…Diamond and Rajan, 2009;Berger et al, 2016). Berger et al (2016), for example, find that in the case of US banks non-CEO managers with high ownership stakes take higher risks, which consequently increases the probability of bank default. However, not all studies come to the same conclusion.…”