Download Corporate Governance in the 2007-08 Financial Crisis: Evidence

Corporate Governance in the 2007-08 Financial Crisis:
Evidence from Financial Institutions Worldwide
Yale University SOM
November 12, 2010
Comments by
Luc Laeven
(IMF, CEPR, CentER)
The views expressed are my own and should not be attributed to the staff, Management and Board of the IMF
1
Contribution of this paper

Literature on corporate governance of banks

Banks are special
shareholders do not internalize social costs associated
with bank failures (excessive risk taking)
 deposit insurance weakens debtholder discipline


Paper convincingly shows that corporate
governance traits (independent board and
ownership concentration) are negatively
associated with stock returns, exploiting
financial crisis as shock
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Specific results

(Institutional) ownership concentration is associated
with greater risk taking and consequently lower stock
returns during crisis
shareholders do not internalize cost of bank failure
 cf. Saunders et al; Laeven and Levine


Independent board is associated with more capital
raising during crisis, resulting in lower stock and
higher bond returns during crisis

Capital issues reduce bankruptcy risks and dilute
shareholder value (Myers 1977)
3
Corporate governance traits

What is an independent board member?


Why is institutional ownership associated with
negative returns, but a large shareholder is not?


In the paper, every non-executive board member
Is this about ownership concentration or IO per se?
If latter, what is different about IO?
Cyclicality of governance
Governance traits that destroy shareholder value
during bad times may create value during good times
 Paper only studies bad times, not complete cycle

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Missing governance traits

Managerial ownership
Owner-managed banks display different risk taking
behavior than widely held banks (Saunders; Laeven
and Levine)
 Should control for managerial ownership


Compensation
Many have argued that compensation schemes gave
bankers even steeper incentives for excessive and
short-sighted risk taking
 Compensation schemes vary considerably across
financial institutions and countries

Bank specific factors

Why did some banks have more MBS exposure
than others? Bad luck? Did governance play a role?
Banks with large real estate exposure experienced larger
deterioration in market values (Huizinga and Laeven)
 Coverage in Bloomberg of writedowns by non-US
banks incomplete; mostly focuses on US losses
 Writedowns subject to managerial discretion; distressed
firms understated losses (Huizinga and Laeven)


Flight to quality effect during crisis

Control for bank capital and liquidity
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Increased discrepancy between
market and book values of U.S. banks
1.12
1.10
0.7
0.6
1.08
1.06
0.5
1.04
0.4
1.02
0.3
1.00
Tobin's Q
(LHS)
Zombie share
(RHS)
0.2
0.98
0.96
20
01
Q
20 4
02
Q
20 4
03
Q
20 4
04
Q
20 4
05
Q
20 4
06
Q
20 4
07
Q
20 4
08
Q
4
0.94
0.1
0.0
Huizinga and Laeven, 2009
Tobin’s Q is the ratio of market value to book value of assets.
Zombie share is the fraction of banks
6 with Tobin’s Q less than 1.
7
Country specific factors



Sample period includes third quarter of 2008
Problematic because following collapse of Lehman in
mid-Sep 2008, governments announced large-scale
intervention packages (including recapitalization
measures) that influenced the value of banks
These country-specific announcements of government
interventions interact with bank specific factors (e.g. real
estate exposure) to influence market values of banks,
and are not controlled for using country fixed effects
8
Bank Interventions in Selected Countries, 2008-09
100%
80%
60%
40%
Failed banks, fraction of total banking assets (%)
United States
United Kingdom
Ukraine
Switzerland
Sweden
Spain
Portugal
Netherlands
Luxembourg
Latvia
Kuwait
Korea, Rep. of
Kazakhstan
Japan
Italy
Ireland
Iceland
Greece
Germany
France
Denmark
China
Belgium
0%
Austria
20%
Government-assisted banks, fraction of total banking assets (%)
Source: Laeven and Valencia (2010)
All (old)
Switzerland
Sweden
Spain
Slovenia
Russia
Portugal
Kazakhstan
Hungary
Greece
France
USA
UK
Ukraine
Netherlands
Mongolia
Luxembourg
Latvia
Ireland
Iceland
Germany
Denmark
Belgium
9
Fiscal Costs associated with Bank Interventions
(% of GDP, over 2007-09)
14%
12%
10%
8%
6%
4%
2%
0%
High Income (old)
Source: Laeven and Valencia (2010)
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Exploit country variation


Analysis is done in a cross-country setting
Yet, little is done to exploit this variation (other
than controlling for some country traits)
There are large cross-country differences in
governance systems and bank characteristics,
including exposure to US
 Sample splits or interaction effects
 Is effect more pronounced in US (AngloSaxon/pro-shareholder countries) ?

0
Mexico
Turkey
Brazil
Greece
Chile
Italy
Australia
Portugal
Finland
Denmark
Austria
Spain
Sweden
Japan
Germany
Ireland
France
Belgium
Canada
UK
Netherlands
50
Switzerland
Foreign Claims on U.S. by Bank
Nationality (end-2006, % of GDP)
300 80
45
40
35
30
25
20
15
10
5
Source: BIS
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Interpretation of results and
policy implications?


Paper concludes that independent boards are ineffective
because they destroy shareholder value during crises (by
getting banks to issue new capital)
Shareholder value creation is not the right metric here


Control of insolvent banks should be transferred to
debtholders
Independent boards are found to increase CDS returns, i.e.,
they reduce probability of bank failure and create debtholder
value during crises, so could be welfare enhancing (especially
in a world of regulatory forbearance)
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