Is Corporate Governance Different for Bank Holding Companies? (Part 2: The Governance of Banks)

By Adams, Renee; Mehran, Hamid | Federal Reserve Bank of New York Economic Policy Review, April 2003 | Go to article overview

Is Corporate Governance Different for Bank Holding Companies? (Part 2: The Governance of Banks)


Adams, Renee, Mehran, Hamid, Federal Reserve Bank of New York Economic Policy Review


1. INTRODUCTION

In the wake of the recent corporate scandals, corporate governance practices have received heightened attention. Shareholders, creditors, regulators, and academics are examining the decision-making process in corporations and other organizations and are proposing changes in governance structures to enhance accountability and efficiency. To the extent that these proposals are based on academic research, they generally draw upon a large body of studies on the governance of firms in unregulated, non financial industries.

Financial institutions, however, are very different from firms in unregulated industries, such as manufacturing firms. Thus, the question arises as to whether these proposals and reforms can also be effective at enhancing the governance of financial institutions, and, in particular, banking firms. The question is a difficult one to answer, though, given the little research on the governance of banking firms. Therefore, in order to evaluate reforms to the governance structures of banking firms, it is important to understand current governance practices as well as how governance differs between banking and unregulated firms. Otherwise, governance proposals cannot be fine-tuned. Significantly, uniformly designed proposals that do not take into account industry differences at the very least may be ineffective in improving the governance of financial institutions, and at worst may have unintended negative consequences.

Accordingly, this article examines corporate governance in banking firms. In particular, we study corporate governance variables identified as relevant by academics and practitioners and describe their differences and similarities vis-a-vis banking firms and manufacturing firms. Because public information on governance characteristics is generally available only for publicly traded bank holding companies (BHCs), we examine the governance of BHCs and not banks. We also discuss the effect of regulation--such as supervisory and regulatory requirements at the state and Office of the Comptroller of the Currency (OCC) levels--prior to 2000 on banking firm behavior. Many typical external governance mechanisms, such as the threat of hostile takeovers in the industry, are absent in the case of banking firms; therefore, we focus primarily on internal governance structures and shareholder block ownership. Our goal is to provide useful information and a road map for thinking about the governance of financial institutions, in terms of reform as well as research.

We discuss the potential benefits and costs associated with some of the corporate governance variables for an average firm. However, we stress that all of these variables are ultimately part of a simultaneous system that determines the corporation's value and the allocation of such value among claimants. Also, different governance mechanisms may be substitutes for one another. For example, certain executive pay packages can vary across firms, even in the same business environment, for good reason. Firms with more effective boards may have more equity-based CEO compensation in their structure, while firms with greater CEO ownership may have more cash compensation (Mehran 1995). Thus, the quality of governance of any organization must he evaluated along a number of dimensions.

Our sample consists of thirty-five bank holding companies over the 1986-96 period. For these BHCs, we construct governance variables or proxies that have received attention by researchers in law, economics, organization, and management who argue that the variables are correlated with governance practices. We also compare variables in our sample with those for manufacturing firms compiled in other studies.

Our comparison of BHCs and manufacturing firms yields several key findings. First, BHC board size (18.2 members versus 12.1 members) and the percentage of outside directors (68.7 percent versus 60.6 percent) are significantly larger on average. …

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