Bank Boards: What Has Changed Since the Financial Crisis?

Shiva Rajgopal is the Kester and Byrnes Professor of Accounting and Auditing at Columbia Business School; Suraj Srinivasan is Philip J. Stomberg Professor of Business Administration at Harvard Business School; and Yu Ting Forester Wong is Assistant Professor of Accounting at the University of Southern California Marshall School of Business. This post is based on their recent paper.

The Financial Crisis Inquiry Commission (FCIC) (2011) identified dramatic failures of corporate governance and risk management at many systemically important U.S. financial institutions as one of the key causes of the 2008 financial crisis. If the crisis is viewed as the byproduct of failed incentives for managers, owners, creditors, and regulators, corporate governance could potential identify and address misaligned incentives to prevent undesirable firm behavior in the future.

However, the prospects for significant improvement in the governance structure of banks remain limited. Banks are pulled by conflicting demands to be value-maximizing business entities and simultaneously to serve the public’s interest. Demonstrating directors’ negligence in a court of law is difficult. The traditional monitors of management and boards, such as equity block holders and the takeover market, are heavily regulated in the banking context. Creditors have diminished incentives to monitor bank management as they can fall back on deposit insurance and potential government bailouts to protect their interests. Given the primacy of the board and conflicting forces affecting improvement in the banks’ governance, it seems natural to ask whether board oversight in banks has strengthened over the decade following the financial crisis.

In our paper titled Bank Boards: What Has Changed Since the Financial Crisis, we investigate how board oversight of U.S. banks has improved since the 2008 financial crisis. In particular, we compare the progress of the following four key deficiencies between 97 U.S. banks and 1,297 nonbanks before and after the crisis covering the years 2007-2015:

  1. Group think among bank board members. To measure progress on reducing group think, we examine whether banks have appointed (i) new directors to the board, and (ii) board members with diverse backgrounds. We focus on director Turnover, defined as the percent of the directors who have left the board since 2007. After comparing Turnover at the boards of 97 banks with the boards of 1,297 firms in other industries over the same time period, we find no evidence that banks have replaced directors at a higher rate. Except for Bank of America and Citigroup, we do not observe a significant overhaul of bank boards of systemically important banks. For instance, three years after the crisis in 2011, two-thirds of the individuals who served in 2007 remained on the board for the overall sample of banks considered. We also examine whether banks have increased cultural and gender diversity within their boards. Again, we find no evidence that bank boards are more diverse after the crisis relative to nonbanks in the sample over the same time period.
  2. Absence of prior banking experience of board members. Turning to banking experience, we find no evidence that directors appointed to bank boards after the crisis are have more relevant financial industry experience or better track record of successful leadership. In 2007, on average, 15.69% of the banks’ directors had prior banking experience. In 2011, that percentage had decreased slightly to 15.38%. To measure successful leadership, we use (i) the stock-return performance of the other firms where a director has served before joining the bank’s board, and (ii) the three-day announcement return associated with news of the appointment of a new director at the bank. We find no evidence of improvements using these measures.
  3. Inability of board members, especially of the chairperson, to devote time to understanding the bank’s business model. We proxy for a director’s overall time commitment by measuring the number of outside boards on which the director sits. After the crisis, bank directors have to deal with increased risk management issues. Despite that expectation, we find no evidence that the number of outside board seats on which bank directors sit have fallen after the crisis. Walker (2009, 15) also recommends that the chairperson of a major bank should expect to commit a substantial proportion of his or her time, probably around two-thirds, to the business of the bank, with a clear understanding from the outset that, in the event of need, the bank chairmanship role would have priority over any other business time commitment. In the pre-crisis period, we find that over 36% of the banks’ chairpersons sit on at least one outside board concurrently. Again, we find no evidence that this has changed post-crisis. Moreover, 81% of bank CEOs were also the chairman of their boards before and after the crisis, suggesting no change along that dimension.
  4. Inadequate emphasis on risk management. The one area in which bank boards have changed relates to the appointment of a CRO. Virtually every bank in our sample now has a CRO. However, such CROs are less likely than other executives of the bank to be among the top five highly compensated officers. Banks also are more likely to appoint a separate risk committee now as opposed to a joint audit and risk committee earlier. These committees meet as frequently after the crisis as they did before (an average of 8.1 meetings after the crisis and 8.8 before), and have a similar number of financial experts on these committees before and after the crisis.

Critics might question whether the (i) government-mandated changes in board composition are shareholder-value increasing; or (ii) our empirical proxies to operationalize such changes are valid. To mitigate these concerns, we validate our empirical proxies by investigating the stock market reactions to banks surrounding the 2011 JP Morgan “London Whale” scandal and 2018 Wells Fargo scandal. An event study of stock returns of other banks surrounding these two events reveals that banks that implemented a larger number of changes in board composition (as captured by our empirical proxies) report significantly better returns than banks that did not. These two tests suggest that hypothesized changes to the board structure can potentially add shareholder value.

Our paper is perhaps the first to offer a systematic examination of the changes in the structure of boards at U.S. banking institutions over the decade following the financial crisis. A few papers have considered the state of corporate governance in banks leading up to and right after the 2008 crisis and find that it has important consequences for banks. Yet, our evidence indicates that several observable aspects (highlighted by several government-mandated committees as having key deficiencies) of bank boards do not appear to have changed substantially over the period 2008-2015 following a crisis of such enormous proportions.

The complete paper is available for download here.

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