Corporate Governance and Depository Institutions Failure: The Case of an Emerging Market Economy

Abstract

In this paper we study the relationship that exists between ownership and governance structure of depository institutions (DI) on one side, and the dominant cause of failure on the other. Extant theory implies that in stock owned DI where management is either well controled (through markets or board control) or interests are aligned with those of shareholders, the dominant cause of failure will be moral hazard between shareholders and debtholders, manifested in balance sheet or off-balance sheet risk taking. On the other hand, in DI of diffuse ownership with poor management control or where management's interests are not alligned with those of owners, the dominant cause of failure will be agency costs, manifested in expense preference behavior that leads to failure. We exploit the opportunity that offers the Colombian crisis of banks and financial cooperatives (FC) and the relatively good quality of data available for this country to perform the study. Our objective is to establish empirically the relative importance of these two conflicts as determinants of insolvency in DI. Results suggest that, in the case of Colombia, moral hazard is a key factor in explaining bank failure while agency costs explain insolvencies among FC. In state-owned banks both moral hazard and agency costs are signifficant in explaining failure.