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

Corporate Governance of Banks: A Survey

“…Similarly, Berger et al . () argue that management structures of U.S. commercial banks, including board size, were not decisive for banks’ stability (i.e., propensity to default) during the recent financial crisis.…”

“…Berger et al . () examine the role of management structures in bank defaults during the recent financial crisis of 2007–2010. Distinguishing between 249 bank failures and 4021 nondefault U.S. commercial banks, they do not find that CEO duality influences bank default probabilities.…”

“…However, for their international sample of financial institutions, Erkens et al (2012) do not find that board size is related to bank performance during the crisis. Similarly, Berger et al (2012a) argue that management structures of U.S. commercial banks, including board size, were not decisive for banks' stability (i.e., propensity to default) during the recent financial crisis.…”

“…Larcker et al (2007) In contrast, Aebi et al (2012) do not find that CEO duality affects buy-and-hold returns in their sample of U.S. banks. Berger et al (2012a) examine the role of management structures in bank defaults during the recent financial crisis of 2007-2010. Distinguishing between 249 bank failures and 4021 nondefault U.S. commercial banks, they do not find that CEO duality influences bank default probabilities.…”

Credit booms and busts in emerging markets

“…11 A potential disadvantage of independent members of a supervisory board is that they may lack relevant firm-specific information (Adams and Ferreira, 2007), which is likely to be especially problematic for small growth firms. It is less clear what the relationship between board independence and bank performance and risk-taking should be (see e.g., Adams and Mehran, 2012;Berger et al, 2016;Cornett et al, 2010;Minton et al, 2014;Pathan, 2009).…”