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E-MailThe following post comes to us from John Byrd of the Department of Finance at the University of Colorado at Denver; Donald Fraser, Professor of Finance at Texas A&M, D. Scott Lee, Professor of Finance at Texas A&M; and Semih Tartaroglu of the Department of Finance, Real Estate, and Decision Sciences at Wichita State University.
In the paper, Are Two Heads Really Better Than One? Evidence from the Thrift Crisis, which was recently made publicly available on SSRN, we provide the first explicit tests of whether unitary leadership protects the interests of taxpayers, who become the residual claimants when financial institutions exploit underpriced deposit insurance through more risky investment policies. We make no attempt to consider shareholders’ best interests. Failure means that shareholders lose, but limited liability assures that they lose no more than their equity stake in the firm and such losses may be nothing more than the bad ex post outcome of a rational ex ante investment to a diversified investor.
We employ a natural experiment that preceded the ubiquitous governance alarms of recent decades. We find that thrifts whose CEOs chaired their boards were significantly less likely to fail during the thrift crisis than their counterparts where CEOs were not board chairs. Thus, CEOs of thrifts who chair their boards appear to protect taxpayer interests by resisting shareholder pressure to adopt riskier investment strategies to exploit underpriced deposit insurance. Mandating the separation of these posts may run counter to taxpayer interests.
Despite a lack of clear evidence against unitary leadership, calls for the mandatory separation persistently surface whenever corporate governance issues are debated. As regulators across the globe once again consider how to revamp regulations to forestall future crises, there is a possibility that conventional beliefs about shareholder interests may impose unrecognized costs on society. We view our evidence as yet another example of how dangerous it is to rely on our collective intuition when regulating something as complex as a firm’s governance. These unforeseen hazards are likely greater in the financial sector with its many different and ever changing regulations. Perhaps, Congress should heed the cautionary advice of Adams (2009) that “until the governance of financial firms is better understood, it may be better not to impose restrictions on the governance of financial firms.”
The full paper is available for download here.
