The Role of Corporate Governance in Bank Failures during the Recent Financial Crisis

Abstract

This paper analyzes the roles of corporate governance in bank defaults during the recent financial crisis. We investigate the impacts of bank ownership and management structures on the probability of default of US commercial banks. Our results suggest that defaults are strongly influenced by a bank’s ownership structure: high shareholdings of lower-level management, such as vice presidents, increase default risk significantly. In contrast, shareholdings of outside directors and chief officers (managers with a “chief officer” position, such as the CEO, CFO, etc.) do not have a direct impact on the probability of failure. These findings suggest that high stakes in the bank induce lower-level management to take high risks due to moral hazard incentives, which may eventually result in bank default. Our results further show that the probability of default specifically increases when incentives of chief officers and lower-level management are aligned. Accounting variables, such as capital, earnings, and non-performing loans, also help predict bank default. However, other potential stability indicators, such as the management structure of the bank, appear to be less important.